By Matt Dalgleish | Source: MLA, NLRS, ACA, Steiner, USDA
Since March 2016 US Live Cattle futures have declined 19.8% from 305US¢/kg to 244.5US¢/kg on the back of solid beef supply and waning demand. This poses a concern for domestic finished cattle prices in Australia as there is a strong annual correlation that exists between US Live Cattle futures and local heavy steer prices.
Figure 1 highlights the price movements in US¢/kg for both US live cattle and the domestic heavy steer. Not surprisingly, given that 70-75% of Australian beef is exported, there is a reasonably close relationship between the two series. There are times when the relationship can diverge but over the longer term the price movements locally tend to track what is occurring in the US market.
This longer term price correlation is demonstrated in figure 2 which shows the yearly average price for US Live Cattle and National Heavy Steer in US¢/kg. The R-squared calculation is a statistical measure of how closely related the two price series are in terms of variability. R-squared can range between 0 and 1. A measure of 0 indicates that there is no relationship between the two price series. A measure of 1 shows that the two price series perfectly match each other for movement. The R-squared score of 0.9429 demonstrates a very high correlation between the average annual price of US Live Cattle and National Heavy Steers.
Interestingly, the majority of the data tracks very closely to the line of best fit (green dotted line). The red data points, indicative of the 2013-2015 price data, which shows the effect of the drought and high cattle turnoff that suppressed the local prices during that timeframe and highlights how undervalued the cattle market was during that episode when compared to offshore market prices. The current season (blue dot) shows the price relationship has returned to a more normal scenario, although slightly overvalued.
Despite the strong long term correlation there are at times short term divergences in the relationship and this can be shown by looking at the monthly average price data for the two price series, as displayed in figure 3. Included with the line of best fit (dotted line) on this graph is a rectangular dotted box which is indicative of a fair value area for the price relationship. Data points beyond this fair value zone below the dotted rectangle are indicative of when the local heavy steer prices are undervalued when compared to US live cattle futures. Similarly, points that are above the dotted rectangle would indicate that the local heavy steer prices are overvalued when compared to offshore markets. The blue dots that are outside the top range of the fair value zone are the most recent monthly data points They indicates that heavy steer prices are overvalued when compared to current US live cattle futures prices.
Figure 4 demonstrates this another way by looking at the historic percentage spread discount of heavy steer prices to US live cattle. Indeed, the current discount of 12% is the narrowest it has been for over two decades and is very narrow when considering the long term average for this spread discount since 1969 has been 40%.
US live cattle futures are currently sitting at key support levels and appears to be stabilising within the 110-112US¢/lbs range. This futures price equates to a level of 242.50-247US¢/kg. There are a few combinations of price movements that could see the spread discount between US live cattle futures and National Heavy Steer prices widen in the coming month.
The most likely scenario is that US live cattle futures bounce from the current level back towards 115-120US¢/lbs and this would enable the price relationship to return toward a more normal scenario. However, if US live cattle prices remain suppressed or fall further this will create very strong headwinds on finished cattle prices locally.
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