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Issue # 570

January 16, 2008

"2008 - Consumers, Corn, and Capacity" - Nevil C. Speer, PhD, MBA, Western Kentucky University (reprinted with permission on 1/13/08 from CattleNetwork.com)

Markets are back in full swing following the holidays with 'swing' being the operative word - 2008 will be full of uncertainty (more on that later). Not surprisingly, mid-December's focus away from beef culminated in some softness in the fed market with cattle trading mostly $93-93.50 and drifted further into negative territory the following week ($91-2). That trend quickly reversed following Christmas as feedyard managers gained back some ground with year-end sales ($92-3). Sellers piled on even further, though, after New Year's in a holiday-shortened week: the first weigh-ups in 2008 were priced at mostly $95; the advance occurred in conjunction with flat wholesale prices thereby extending the streak of negative margins for packers (nothing new there - more on that later also). Packers manage to turn the tide, though, during the first full week of business - fed trade swung all the way back to $92.

The most active and significant market event continues to be the slide in feeder cattle values. CME's Feeder Cattle Index is currently hovering around $98-9. That's a far cry from its mark of $119 in September - $20/cwt in nearly as many weeks and equivalent to $150/head. No great conspiracy or scheme; rather it's almost a perfect dollar-for-dollar trade. Replacements are now being purchased against a $94 June board and $4.50 corn. Compare that the near-term high when yearlings were purchased against a February board at $100 and $3.05 corn: the difference equating to $75/head for each item, respectively (that too…more later).

Now let's zoom out and address those items mentioned above in terms of the big picture. Spring 2008 will prove to be significant for the beef complex. Participants will need to carefully monitor convergence of several key factors influencing the business environment for the coming year - and beyond.

First, consumers: the current climate mandates careful assessment going forward. There's significant pressure on the consumption front. The mortgage / real-estate crisis shows no signs of letting up as home sales continue to slide. Additionally, many economists note housing prices will likely decline through the year. That's putting many consumers in a jam, many of whom are finding themselves upside down in terms of their home equity. And it's not only home loans which are in trouble: the AP reported just prior to Christmas that credit-card defaults rose 18% in October coupled with growing prevalence of account delinquencies. That dilemma is putting a damper on consumer spending. Declining real estate values limits availability for new equity-induced expenditures. Meanwhile, loan customers are finding lenders to be increasingly careful about making new loans.

Accordingly, those troubles coupled with higher fuel prices are taking a bite out of disposable income. That was readily apparent through the Christmas shopping season with retailers carefully managing available inventory and monitoring need for markdowns - much of which was still fell short given reports of sluggish retail sales during December. Economic woes have hit home with increasing concerns about recession going forward. That apprehension has made investors cautious. Consumers are also responding. Gallup recently reported that nearly 75% of Americans intend to reduce debt in '08 and almost half will curtail spending on entertainment. All of those indicators are important with respect to discretionary spending which spills over to the beef market directly through retail beef expenditures or indirectly through restaurant spending. That's especially concerning given the overall flat trend of beef wholesale values through the 2nd half of the year (see graph below).

Second, from a direct production perspective: corn. Traders will be especially interested in the coming months in producer intentions relative to acreage as planting season approaches. Last year's acreage equaled 93.6 million acres. That'll be difficult to match especially in light of $12+ soybeans. Many estimate 2008's corn plantings to be closer to 89-90 million acres. At current yield trends that likely won't be sufficient to match projected '08/'09 usage. Therefore, the corn market has worked higher buy acreage and limit utilization. The tug-of-war between corn and soybeans will be ongoing throughout the spring with week-to-week shifts in planting intentions depending upon the market. Lots of volatility ahead for the grain complex!

The recent surge in corn prices is demand driven (as portrayed in the second illustration below) and possesses some critical ramifications for cattle feeders. A one-dollar increase in corn prices represents approximately $55/head in additional feeding costs, basis yearling steer. And from a calf standpoint $1/bu mandates an additional $70/head. As a result, buyers are forced to bid the replacement market lower to protect deferred closeouts: $7-8/cwt and $12-13/cwt for yearlings and calves, respectively. Meanwhile, some analysts are talking about corn going as high as $6.50 by next December. Given the outlook for tighter stocks and higher prices (strongly reinforced by USDA's Jan 11 WASDE report), cattle feeders will need to protect themselves from the potential for large upside volatility. Buffering against large swings to the upside will equate to increasingly conservative behavior when purchasing replacements. There's more risk going forward and buyers will be less likely to bet on the come. Given that fact and the market's potential for choppiness, it can be overstated how important it is to be well informed when making feeder cattle sales.

One last observation relative to the corn market: ever-higher prices will likely keep expansion plans in check. That occurs on several fronts. First, and most obvious, as described above, it means lower calf prices at the farm / ranch level. Increased revenue from the calf crop is fundamental to building cow inventory. Conversely, declining revenue discourages producers from building cow inventory. Second, higher grain markets equates to growing demand for acres. Cow/calf and stocker operators are increasingly finding themselves choosing between cows and tillage - either through internal return analyses or competition for cash rent - it appears the grain side is winning as estimates indicate more acres of wheat, soybeans and corn combined will be planted in 2008 compared to 2007. Lastly, input costs across all fronts have risen. Be it fuel, fertilizer, or equipment - there's no relief in sight from an operating standpoint. Producers find themselves getting squeezed.

Third, packer margins: beef processors have continuously found themselves on the wrong side when it comes to operating margins. Packers are stuck in a rut stemming from relative overcapacity. That scenario has is proving to be a significant driver for the fed market, especially during the second half of 2007. Weekly negotiations have reflected hyper-competitive bargaining among processors; their efforts to ensure procurement of inventory has influenced the market in an important way.

The final graph below is adapted from one produced earlier in the year. The trend line represents multiple regression solutions for the fed market based on '05 and '06 indicators (for more description see MMP: July, 2007) versus the actual spot market in 2007. Markers below the trend line are indicative of weeks in which the spot price was below the calculated expectation; data points above the line indicate weeks in which the market outperformed expectations established by 'the 05 and '06 statistical model. The graph depicts weekly packer-feeder negotiations in 2007: 19 out of 26 weeks (July through December) resulted in positive deviations from '05/'06 expectation.

During the previous two years ('05/'06) gross packer margin (according to my estimates) hovered around $140 or so during the 1st-half of the year and subsequently declined to $110 during the 2nd-half: a difference of $30/head between the 1st- and 2nd-half, respectively. Now consider 2007: 1st-half margins were approximately $140 (similar to the previous 2 years) but plummeted to $75 during the 2nd-half - a difference of $65 - or $35/head more than the previous two years. Why the difference?

That packer is pinned down. Ideally, the solution would be to slow throughput to minimize expenditures on the front-end - the variable cost of purchasing cattle. But that's a tenuous strategy because it negates the ability to leverage increased volume and endeavors to offset or dilute fixed costs. In other words, production slowdown simply means a greater proportion of fixed costs are deferred to the production which is incurred.

From a business rivalry perspective rationalization must occur. At some point capacity must be taken out of the system to obtain semblance of supply/capacity equilibrium. That's compounded by the above discussion: the long-term outlook certainly doesn't provide much inducement for increasing domestic supply. Commonly accepted paradigms about cattle cycles likely need to be reevaluated. October's cattle-on-feed report indicated that any hope for cowherd expansion in the near future is misplaced. Decision-making at the farm/ranch level is becoming increasingly complex. Despite an extended run of high prices there's little interest in growing the cowherd and that'll be muted further by lower prices stemming from higher grain markets. Thus, the processor is left in a no-win quandary given limited supply - pay too much for cattle to gain efficiencies or relinquish efficiency in hopes of obtaining more favorable margins: neither is favorable right now. Enduring overcapacity, concerns about beef demand and absence of cowherd expansion possesses some important implications for the packing sector.

The convergence of all these factors possesses some important implications which will reverberate throughout the industry and agribusiness in general. 2008 will likely be a year to remember!

Forage Focus: Recovering from the freeze and drought of 2007 - Bryce Roberts, Kentucky Extension Educator

Spencer County farmers are not likely to soon forget the past year. A double punch of a late spring freeze and a summer drought has left pasture and hay fields gasping. Now that some rain is again falling, producers may be wondering how well their fields will recover and if they can make changes to better prepare for future weather problems.

"There are no easy answers for recovery," said Ray Smith, extension forage specialist with the University of Kentucky College of Agriculture. "There's no miracle cures. Good, sound forage management is really what is needed."

Some plant species will recover more easily than others. Alfalfa stands that were cut after the spring freeze, and the dead top growth removed, recovered better than those that weren't cut, he said. Some winterkill did occur because of the freeze and, in a few cases where the alfalfa fields had been cut or heavily grazed in the fall, substantial winterkill was noted.

"The freeze reinforced the university's recommendation to not cut or graze alfalfa between the middle of September and early November," Smith said. "You want to let it replace its root reserves."

Smith said they have also noticed some drought damage in orchardgrass stands resulting in thinning of the stands. These stands will need to be interseeded with some clover or additional orchardgrass early next spring, he said.

Some sound forage management techniques for today and everyday include using lime and fertilizer as called for by soil-testing fields. It is very important to maintain phosphorus and potassium for legumes as well as some grasses such as orchardgrass to give them winter hardiness and disease tolerance, he said. Light fall nitrogen applications can also be very helpful to allow grasses such as bluegrass and fescue to thicken up and improve their spring productivity.

In a good management program, it is also important to use what is available such as grazing harvested corn fields, Smith said. It is important though to remove cattle from the fields when a frost is anticipated if Johnsongrass is present. Johnsongrass will emit prussic acid after a frost, which can be deadly to livestock. Cattle can return to the field a couple weeks after the frost. After a hard freeze, the grass is safe to graze after a few days.

Another important point to remember is weeds have done quite well this summer, and weed control is important. November is a good time to control many winter annual weeds.

"If you are going to plant clover, then use a fall application to knock back weeds, frost-seed clover in February and remember to avoid herbicides that persist in the soil over winter," he said. "Once you've planted the clover you can't put down an herbicide or you will kill the clover."

Getting early growth this spring will be important to many forage producers this year, especially those who have very limited hay supply for their livestock. An early application of low rates of nitrogen this spring will encourage growth in these fields.

"Putting a low rate, 30 to 60 pounds per acre, of nitrogen on as soon as the grass begins to green up will give you a couple of weeks earlier potential for grazing," he said. "If you are going to be cutting a hay crop from the field, then a higher rate of nitrogen would be used."

In renovating and reseeding pastures, remember to have the fields grazed down or mowed for better seed to soil contact and less competition for new seedlings. Smith also encourages farmers to go ahead and line up what seed they will need now, because seed production problems and a likely high demand will mean tight supplies on some species like orchardgrass. Getting the seed lined up now will ensure that farmers have the seed they need to sow midwinter or spring.

As farmers work to recover from this year's weather damages, they need to remember that other weather problems likely are looming in the future.

Smith advises farmers to be prepared for the next drought with a grazing management plan appropriate to their individual farm operation.

"It's been a tough year," he said, "but hopefully we've learned a few things to help us in the future."

EDITOR's NOTE: Dr. Ray Smith is the featured speaker at the February 8, Ohio Forage and Grasslands Council annual meeting. Find more detail and registration information in the January 9, 2008 issue of the Ohio BEEF Cattle letter.

2007 Forage Variety Trial Results Available - Mark Sulc, OSU Extension Forage Specialist

Field performance data collected from forage variety trials in Ohio during 2007 is available online at http://www.ag.ohio-state.edu/~perf/. The report was published in Ohio's Country Journal in December, and is also available from county extension offices in Ohio.

The report includes performance of commercial varieties of alfalfa, red clover, orchardgrass, tall fescue, perennial ryegrass, and annual ryegrass in tests at South Charleston, North Baltimore, Wooster, and Jackson, Ohio.

Forage yields varied widely from north to south in 2007. The effect of a late spring freeze and dry summer were more severe in the southern half of Ohio. First harvest yields in the performance trials ranged from 14 to 62% below normal, and total season yields ranged from 18 to 80% below normal.

The lowest yields were at Jackson in southeast Ohio, where alfalfa yielded only 1.1 tons of dry matter per acre and tall fescue yielded 2.4 dry tons/acre. In contrast, alfalfa yields at Wooster in northeastern Ohio were near normal with first harvest yields of 2.8 dry tons/acre and total season yields averaging 7.4 dry tons/acre.

Orchardgrass yields at South Charleston in west central Ohio in 2007 were 24% below the 2006 yields. Perennial ryegrass at South Charleston suffered winter injury, and yields were further reduced by the drought, averaging 68% below 2006 yield levels.

The USDA National Agricultural Statistics Service reported alfalfa yields in 2007 were 23% below 2006 yields in Ohio. Other hay in 2007 yielded 25% below 2006 levels in Ohio. The lower yields and a 6.6% drop in acreage resulted in a 30% drop in total Ohio hay production.

Weekly Roberts Agricultural Commodity Market Report - Mike Roberts, Commodity Marketing Agent, Virginia Tech

LIVE CATTLE futures on the Chicago Mercantile Exchange (CME) closed mostly lower on Monday. FEB'07LC futures finished off $0.450/cwt at $90.900/cwt but and $3.700/cwt lower than last Monday. The APR'08LC contract closed at $95.200cwt, off $0.300/cwt while the JUNE'08LC contract finished up $0.40/cwt at $94.500/cwt. Surging grains and bear spreading provided the pressure. Bear spreading is selling the nearby contract while buying a deferred one. The February was pushed to a 13-month low while the April'09 contract posted a contract high. Lower cash cattle and expensive corn got the selling going. On Monday USDA's 5-area cash cattle price was off $3.00/cwt from the previous week. USDA put the choice boxed beef cutout at $148.30/cwt, down $0.48/cwt. One floor source said there was some thinking in futures today that said "higher corn prices today, fewer cattle in 2009." There was also talk by some analysts that even though feed prices are high, some producers would be expanding herd numbers ahead of an expected price uptick because fewer cattle will be in feedlots. We'll see. Also pressuring prices were funds rolling into the April and June. Funds rolled about 12,000 lots on Monday with 8,000 of those coming in a flurry at the end of the day. If you have the corn, cash sellers should sell cattle only when ready. Try and offset corn inputs with hedges.

FEEDER CATTLE at the CME were down on Monday. JAN'08FC futures closed under $100.00/cwt at $98.425/cwt, off $1.075/cwt and $2.00/cwt lower than a week ago. The MAR'08FC contract finished at $101.45/cwt, off $1.050/cwt and $2.650/cwt behind last Monday's close. Feeder losses were paced inversely with the CBOT corn rally even gaining somewhat at the close as corn slipped late. Looks like feeders traded strictly opposite corn today. Feeder supplies are plentiful right now because wheat is more valuable to harvest than to graze amid slack feedlots demand. Cash feeders kept pace with last week's weakness trading $3-$5/cwt lower in Oklahoma City auctions. The latest CME Feeder Cattle Index for January 10 was placed at $98.82/cwt, down $0.03/cwt and the lowest since February 28, 2007. Feeder sellers should hold cattle with hay if possible.

CORN on the Chicago Board of Trade (CBOT) gapped up tremendously on Monday. The MAR'08 contract finished up 17.0¢/bu at $5.120/bu, 45.8¢/bu (9.8%) higher than a week ago. The DEC'08 contract closed up 17.2¢/bu at $5.304/bu, 44.8¢/bu (9.2%) over last Monday's close. All contracts settled above $5.00/bu. Friday's limit up closing, a weaker dollar (higher crude oil and gold), and fund buying provided the momentum. Profit-taking limited the up-side. Fundamentally speaking corn was supported by a very bullish USDA World Agriculture Supply Demand Estimate (WASDE) report as it emphasized shrinking U.S. corn supplies. Exports were supportive in light of cheaper U.S. corn. USDA put corn-inspected-for-export at 50.5 mi bu vs. expectations for between 34-38 mi bu. South Korea bought 116,000 tonnes (4.57 mi bu) of U.S. corn, Israel bought 40,000 tonnes (1.57 mi bu), and Taiwan is expected to tender for up to 35,000 tonnes (1.38 mi bu) of U.S. corn on Wednesday of this week. Some are projecting 2008 U.S. corn plantings will shrink by up to 6% to 88.0 mi acres, down 5.6 mi acres from 2007. Productive rains on Argentina's corn crop last week were considered too late to help their corn crop recover. Funds bought over 4,000 lots while the CFTC Commitment of Traders report showed bullish funds increasing positions in CBOT corn by 11,000 contracts to 244,620 lots. Cash corn bids fell somewhat in the U.S. Midwest as farmers filled elevators with the valuable crop. Cash bids for corn in the U.S. Mid-Atlantic States were firmer amid slow farmer selling. If you have any of the '07 crop left, it would be a very good idea to sell it. It could be a good consideration to price another 10% of the '08 crop now bringing it to 40% priced.

Visit the OSU Beef Team calendar of meetings and upcoming events

BEEF Cattle is a weekly publication of Ohio State University Extension in Fairfield County and the OSU Beef Team. Contributors include members of the Beef Team and other beef cattle specialists and economists from across the U.S.

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