Given the rationally intense focus that pork producers are having to commit to monitoring agricultural commodity prices, which are elevated in both absolute levels and in volatility, it’s increasingly valuable to find accessible tools that can help summarize market sentiment. The purpose of this article is to highlight two such resources.
The first is the probabilistic price forecasts provided on a weekly basis by Jim Hilker, agricultural economist, Michigan State University. At his website (https://www.msu.edu/user/hilker/), he describes how information from the futures and options markets can jointly be used to derive market-based price forecasts. More narrowly, the information allows analysts to assign probabilities that reflect the likelihood (based on current futures and options market transactions) of different prices occurring in the future.
An example may best demonstrate this concept. As of Feb. 10, the April 2011 lean-hog futures contract was trading at $93.70 per hundredweight. However, the combined information from both the futures and options markets for April suggests there is a 10 percent chance that April lean-hog futures will expire at a level exceeding $104.53 per hundredweight and a 10 percent chance of them dropping to less than $83.42 per hundredweight. Stated another way, there is an 80 percent chance of April lean-hog futures expiring at a price between $83.42 per hundredweight and $104.53 per hundredweight. This probability-based price range provides notably more information than the point forecast ($93.70 per hundredweight) provided solely by the futures market, which producers commonly monitor.
While many producers may initially consider this an "imprecise" price forecast as it covers a span of more than $21 per hundredweight, I encourage you to recognize that this wide range reflects today’s marketplace uncertainty and is considered by many to be the best summation of market sentiment regarding where lean-hog prices may be headed (for April, in this example).
Readers who see value in this example should note that Hilker's website provides comparable information for multiple contract months — currently April, June and October forecasts are provided for lean hogs. He also addresses multiple other commodities, including corn and soybean meal. For instance, as of Feb. 10, the futures and options markets suggest an 80 percent chance of July corn futures closing between $5.31 per bushel and $9.18 per bushel (with a futures price of $7.14 per bushel). For soybean meal, there’s an 80 percent chance of July futures closing between $315.44 per ton and $464.38 per ton (with a futures price of $386.80 per ton)
Combined, a pork producer can use probabilistic price forecasts for lean hogs, corn and soybean meal to gain insights regarding the likelihood of different outcomes. More narrowly, producers with a firm understanding of their cost situation and associated breakeven hog prices can use this information to assess the market's views on how likely it is to obtain the breakeven or a target profit margin. This insight may be particularly useful in guiding risk-management decision making in today's increasingly volatile markets.
Watch Interest Rates
Given the understandable focus on commodity price levels and volatility, it’s easy to lose sight of other important characteristics of today's marketplace. One less visible trait is rising farm debt, particularly among livestock producers, and the associated implications for operation management. Brian Briggeman, Kansas City Federal Reserve economist, recently noted that real farm debt has risen about 5 percent annually since 2004. He notes that historically low interest rates are among the factors enabling this growth in farm debt.
Livestock producers are cautioned to monitor the potential ramifications on their operation if interest rates begin to rise. Perhaps it is more accurate to say when, rather than if interest rates rise. Accordingly, the implied probability of interest rate hikes in upcoming months should be of interest (pun intended). Hence the introduction of another useful resource tool for management in today's pork industry. While you monitor the lean-hog futures contract information provided by the CME Group (go to, http://tinyurl.com/4kq8hfa), you may not be aware of information provided regarding interest rates. Information on interest rate contracts is summarized in a rather user-friendly tool named CME Group FedWatch.
For example, the implied probability of interest rate hikes in upcoming months at the Federal Open Market Committee meetings is provided in the accompanying table. (See sidebar.)
Implications of Probable Interest Rate Hikes
Similar to my disclaimers on "not knowing where the livestock market is headed," I refuse to proclaim any crystal-ball abilities and provide specific operational advice. That, of course, is because each operation is unique and has distinct needs, opportunities and restrictions. That said, the stress exerted by losses throughout 2008 and 2009 for most pork producers was not likely erased by improved profits in 2010. Accordingly, it would be prudent to take careful note of the market's own signals that interest rate rises are likely to occur in 2011. Even if interest rates do not hit historic levels held in the distant memory of many producers, the impact of historically small increases is magnified by the recent damages to the financial structure of today's pork operations.
Furthermore, the increased capital requirements associated with elevated commodity prices and volatility make this relevant for all producers. This point should be given full consideration in formulating decisions, such as possible implementation of risk-management strategies. Similarly, this point should be noted by producers operating under short-term loans who may now be eligible and willing to lock-in what may be considered advantageous, long-term borrowing rates.