This month, we’ll focus on two related markets at opposite ends of their respective trends, cattle and corn. The domestic cattle industry has been expanding its herds for the last couple of years. Ranchers have taken advantage of low grain prices to hold cattle back, and drive up prices. After recently reaching a 60-year low, the U.S. cattle herd is expected to be the largest it has been in 10 years heading into 2018.
Obviously, these animals will need to be marketed. This is where the story divides the market’s players’ actions. Speculators tend to move from one hot market to the next with expectations of capturing quick profits. We noted this behavior last month as the speculators jumped into the energy markets to play the hurricane action. The 16% cattle rally since the September low has caught the eyes of speculators looking for the next hot market. Speculators in the live cattle market are long 4.5 contracts for every contract they’re short. This is only the fourth time in the last 20 years that the market has been so imbalanced that the speculative COT ratio has climbed above 4 to 1. The record for this ratio is just over 6 to 1, which was set in August of 2004.
Building further on last month’s piece, we noted that the COT ratio might not tell us when the next trend begins but it is very good at measuring speculative bubbles.
This leads us to the commercial side of the equation. Commercial traders use the futures markets to hedge their positions. Their actions explicitly state that they do not expect to be able to market these cattle at delivery anywhere near the $130 per hundred weight level at which we’ve been trading. This is most obvious in the feeder cattle market where the commercial traders just set a new net short record.
Meanwhile, the commercial traders in the live cattle market are very near the record short position they set last June. We’ll be watching their actions closely as they may set a new record short position now, at lower prices than they did last summer. When they set new record positions at worsening prices, we pay attention.
Cheap corn prices have fueled the cattle herd expansion. The corn market has been on a downward slide since the August 2012 peak, except for a couple of brief spikes. However, the market is beginning to behave in a manner that suggests it’s finally building a base that could lead to higher prices. The December 2010 corn futures contract bottomed near $3.43 per bushel. The current December contract has bottomed at $3.425. The noteworthy part is that the speculative position is short more than 70k contracts with less than 50¢ in anticipated short side profit potential, at best. They seem earnest in their attempt to drive prices towards $3 per bushel.
Remember to look at the actual expired contracts to find the real prices, rather than a continuous back-adjusted chart. The formations and prices are significantly different. The significant numbers are the 2014 and 2016 lows at $3.18 and $3.15 as well as the 2008 and 2009 lows at $2.90 and $3.02, respectively. Our guess is that the speculators will not be able to push the market much lower for very long.
Finally, the corn and cattle market have a unique relationship. Between trends, their price action is typically positively correlated, as the final price of cattle varies with the price of the corn input. At the extremes, this relationship turns negative as either the cattle or corn market move becomes unsustainable. Cheap feed prices have helped restrict consumer supply as ranchers rebuild their herds. These animals are beginning to come to market as ranchers decide whether to keep them through the winter or cash out. We expect this to lead to herd liquidation with this year’s corn harvest being stored for spring feed. We’ll have to keep an eye on the stocks-to-use ratio in the Dec. 12 U.S. Department of Agriculture supply and demand report to see which side has the upper hand heading into the New Year.