Market Volatility is Up Amidst Tight Hog Supply, Uncertain Demand

Belly Market Volatility is Proxy for the Broader Volatility in the Pork Market

Belly prices have been on a roller coaster the last few days. Last Tuesday, the belly primal value dropped $48/cwt or 24.5% from the previous day. It hovered around that level on Wednesday only to jump up $35/cwt on Thursday.

While we do not know exactly what happened, someone had to unload a significant number of bellies and took a haircut to do so. Normally light bellies trade at a premium to heavy ones but on Tuesday and Wednesday derind #9-13 bellies traded 30% under the value of #13-17 product.

Also, we normally see more heavy bellies traded in the open market, but during those two days the volume of light bellies traded was more than double the volume of the heavier category.

This could be a one-off event and the recovery at the end of the week may suggest that. However, as the chart below shows, a sharp correction most times signals more downside coming.

The belly price decline this week was the second biggest one day drop in belly value. The biggest was last May when the primal dropped $61.52. It will be interesting to see how bacon processors respond to this pullback.

If the decline is just a seller caught out of position, then once the market cleared we could see prices return to a more “normal” level. However, it could also be that this is a sign that large users, e.g. fast food operators, may be scaling back orders as they have trouble passing on price increases to final customers. If so, processors may take notice and opt to sit on the sidelines, adding to the downside. Again, the chart is helpful in illustrating past volatility for this item.

The pork cutout last week averaged $123.44/cwt, $10.7/cwt or 8% lower than the previous week. The decline in the value of bellies, which were down $29/cwt, contributed about 44% to the decline in the cutout. Lower ham prices were also a major factor for the decline in the cutout last week.

The ham primal value, which traded in the mid to high 90s the previous two weeks, averaged $79.58/cwt last week, a $14/cwt or 15% decline. Export demand appeared to dry up once ham values hit the 90s, something that we saw play out in early May as well. Tight labor supply has also prevented packers from boning more hams and putting them in the trim supply.

Finally, we heard that Mexico has delisted the Tar Heel plant from exporting product to that country. While we do not know the details of this yet, this is the biggest hog processing plant in the US and the inability to ship product to Mexico would mean more product has to be sold in the spot market.

Fresh pork prices have performed well so far, supported by demand for Father’s Day and 4th of July retail features. However, there are signs of downward pressure on fresh pork prices as well. The loin primal was down 4% for the week while the rib primal declined 8%. Rib primal value was as high as $300/cwt into Memorial Day. By Friday, prices had dropped to $211/cwt. Pork butt primal value also dropped $21/cwt on Friday alone, underscoring the pressure on fresh pork as end users step to the sidelines.

Lean Hog Futures have Declined in 7 of the Last 8 Sessions

This decline clearly reflects fears that the drop in bellies and hams signals more downside risk for the cutout and eventually hog prices. Funds have a significant net long position and heightened risk may have caused some of those longs to rethink their positions.

The latest Commitment of Traders report shows trader positions for the week ending June 8, telling us that managed money added 2k contracts to their net long lean hog position that week, for a total net long of 81,263k contracts. This is on the high end of the range for the last six years (see chart below) and substantially higher than last summer.

The meat margin (defined as the spread between cutout value and hog price) had already come under pressure in recent days. Before the drop in belly prices on Tuesday, the spread was around $6/cwt (cutout was $128.68 on Monday while the CME index was $122.71). The spread all but disappeared Friday night and dropped into negative territory.

This has happened before, however. We had a similar situation develop at almost the same
time in 2019.

Why would packers continue to pay up for hogs at a time when the meat margin has turned negative? At this time, they are looking to fill orders for the weekend (Father’s Day) as well as 4th of July orders.

Getting their customers product and delivering on orders on the books is a key priority. Eventually, however, packers may adjust slaughter schedules to bring a margin back in the business. This is clearly on the mind of traders as they try to assess potential impact on hog values this summer.

Downturn in China Hog Prices Adds to Pork Demand Uncertainty

There has been a lot of talk in the market recently on Chinese hog price trend and the outlook for US pork exports to China. The chart below shows the average Chinese live hog price, which was last quoted at 16.24 yuan per kilogram although in parts of China prices have been as low as 15 yuan/kg.

The average Chinese live hog price converts to $1.14/lb. Chinese hog prices are 55% lower than where they were at the start of the year and near 60% lower from their peak.

Still, Chinese hog prices are higher than US hog prices although the spread has become far narrower. US hog prices are quoted on a dressed weight basis and last week were near $1.15/lb. The live equivalent of this, which would be comparable to the Chinese quoted price, would be $0.85/lb. using a 74% yield.

Analysts that follow the Chinese pork market much more closely than we do suggest that the collapse in price reflects the following:

• the impact of a decline in the quantity of pork demanded (high prices tend to have that effect)
• an increase in the supply of pork imported and stored
• extremely heavy carcass weights (+330lb live) as producers gambled on a supply shortage this summer
• panic selling now that prices have collapsed

We would add to this the negative effect of an opaque market where many don’t trust the information provided and thus distorts price signals. In the near term the pullback in Chinese hog/pork prices and the correction in some domestic pork items has added to the negative sentiment in the hog futures complex.

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