By Augusto Semmelroth | Source: USDA, MLA
After plummeting to a 40-month low in September and sending a shockwave of despair around global beef markets, US live cattle prices have rebounded 16% in the last three weeks. From the onset, the selloff in US futures and physical markets pointed to an overreaction from the trade. As markets finally return to normality, what are the most important fundamentals we should look at going forward?
The US Department of Agriculture (USDA) has just released its Livestock, Dairy and Poultry Outlook report, providing us with insight into what the supply and cattle price scenario will look like into 2016. Although beef supply is not the only factor determining the price of cattle, it is generally the key price driver for US prices.
Figure 1 helps to put this statement into perspective by showing US beef production and the average choice steer price for 2011 to 2014, and the USDA’s forecasts for 2015 and 2016. After a gradual decline in production between 2011 and 2013, US beef output collapsed in 2014 and 2015 as producers held onto females in order to rebuild their herds.
The impact on prices has been obvious (see orange line). Not only did cattle prices reach a record level in 2014, but our key export product (i.e 90CL beef) surged into uncharted territory during the period. This year, cattle and beef markets have cooled slightly despite the further contraction in supply. This has occurred as demand for beef slows amid strong competition from cheaper pork and chicken products.
That said, the supply and price outlook from the USDA looks far less gloomy than September’s price collapse suggested.
While beef production is expected to climb 5% year-on-year in 2016 to 11,350 million tonnes cwt, it will still fall 3-5% short of the levels seen in 2011-13 when the US population was much smaller and the economy was still dragging itself out the global financial crisis.
As a result, the USDA believes cattle prices will only fall marginally in 2016, while still remaining 15-20% above the 2011-13 levels. Interestingly, its forecast also points to prices reaching a floor in Q4 2015 before staging a price recovery in early 2016 (figure 2). This view is also shared by CME futures market participants, with contracts maturing in 2016 trading at around 130-135US¢/lb. This equates to 420-455¢/kg lwt in our terms (figure 3).
There are a few take home messages from USDA’s report that can help us understand what is in store for cattle markets going forward. Firstly, short-term market dynamics should not overshadow our view of medium and long-term market fundamentals. In other words, the poor performance of US cattle prices and the Eastern Young Cattle Indicator (EYCI) of late do not tell us where prices are heading. Rather, long-term supply/demand fundamentals do.
Secondly, despite the 5% increase in US beef production in 2016, the overall output will still be historically low and the impact on prices is expected to be relatively mild. As such, the US will remain a major buyer of Australian beef and export prices are projected to remain firm, particularly with an A$ around the US70¢ or below.
Thirdly, the 6% fall in US beef production in 2014 resulted in a 22% surge in cattle prices. Meat and Livestock Australia (MLA) is estimating our beef throughput to fall 11.5% in 2016 and a further 9.6% in 2017. The impact on cattle prices under that scenario will be clear.
Lastly, the EYCI will bridge the discount gap to US live cattle futures in 2016 and 2017. The levels seen during 2010 and 2011 serve as a benchmark (-25 to -50¢/kg lwt). Assuming US live cattle prices remain around the levels suggested by the USDA of 420-455¢/kg lwt, this means an upside potential for the EYCI of 400¢/kg lwt (740-750¢/kg cwt). We've made several bold statements before. While this one looks extreme, the circumstances are unprecedented and point to good times ahead for cattle producers.
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