Livestock prices: The top 10 most important drivers

This is the second in a series of articles looking at the top 10 most important drivers behind some of the main commodity futures prices. Episode 2 looks at livestock.

1) Feed prices


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If feed grain prices increase (so that total input costs rise) the cost of raising livestock also goes up, reducing margins for farmers. Rather than feed cows, pigs and chickens at flat to negative operating margins, livestock owners may opt to slaughter more of their herd instead.

This then supplies the market with excess meat and drives prices lower in the short-term. In the long-term, equilibrium in operating margins is restored by either greater supply of feed grains driving input prices lower or decreased livestock production increasing market prices.

Conversely, if feed prices decline, it costs less to feed livestock for each additional pound of gain. This lower cost makes it more profitable to continue feeding animals longer and thus creates a short-run reduction in livestock supply. The expected long-run increase in supply will not appear for a time equal to the length of the feeding period for each animal.

When feed prices decline, livestock feeders buy more young animals to increase their feeding herd size. However, not until these animals are fed to slaughter weight is the increase in supply realized.

2) The weather


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High temperatures affects livestock’s appetite, reducing the weight that they gain and extending the time it takes to get them to slaughter weight. Heat stressed livestock are also less likely to produce fewer offspring, thereby affecting the future size of the herd.

By extension the weather can also affect the supply of livestock and products derived from them. Food items with a shorter shelf life and fast production times are particularly vulnerable. High temperatures means stressed out cattle and poultry and results in less milk being produced and fewer eggs.

Drought also reduces the availability and quality of pastureland, also reducing the amount of feed for grazing livestock.

Any extreme weather conditions can be harmful. Very cold winters can be particularly dangerous for young cattle, reducing future supplies of cattle while also slowing the rate of weight gain among the remaining cattle.

3) Income growth


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The demand for meat is closely linked to a country’s economic development with richer consumers generally consuming a greater amount of meat in their diets. Urbanisation and rising incomes mean that more of the world is converging on European and American levels of meat consumption, which is roughly 100 kg a year. At the moment, most of Africa and South Asia eats less than 20 kg of meat a year.

Although meat demand generally has a positive relationship with income growth, not all meats respond in the same way. For example, if income increases, the demand for more expensive cuts of meat, such as steaks, may increase while the demand for less expensive products, such as ground beef, may decrease.

4) Substitutes

Since chicken and pigs convert 1 kg of feed into 2-4 times as much body mass than a cow, it makes producing poultry and pork less expensive than beef. A rise in the price of beef may encourage consumers to switch away from beef towards cheaper meats like chicken and pork, thereby reducing demand for cattle, but increasing demand for chicken and pigs.

5) The hog cycle

In general, cattle prices follow a broadly predictable pattern known as the ‘hog cycle’ lasting around 10-12 years (a similar pattern is observed in other forms of livestock). Increasing cattle prices spur producers to retain female animals to increase the breeding herd, initially reducing slaughter numbers and as a result, prices increase even further. However, once these female animals begin producing offspring and eventually reach slaughter weight, there may be an oversupply of livestock.

Prices then begin to decline and it eventually becomes unprofitable to raise and feed young cattle. Producers then begin culling the breeding herd and sending them to slaughter, adding additional numbers to supply and causing prices to decrease even further.

6) Disease

A disease outbreak can be devastating for livestock supply. Even in an outbreak where livestock can be treated the medication used may require a withdrawal period before slaughter, delaying the time at which livestock can come to market.

7) Energy prices


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The price of energy affects the cost of running a farm and indirectly the number of cattle that the farm can support. The most obvious impacts is on the price of diesel, used to run machinery and transport while propane is often used to dry grain and heat livestock buildings. Indirectly the price of natural gas is a key determinant of fertiliser prices which may affect the price of feed. In addition livestock also compete with ethanol production for available corn supplies, so an increase in the price of oil may lead to an increase in ethanol demand, further boosting demand for corn away from livestock.

8) The US dollar

Like most internationally traded commodities livestock are priced in US dollars. At its most basic a decrease in the value of the US dollar relative to a commodity buyer’s currency means that the purchaser will need to spend less of their own currency to buy a given amount of the commodity. As the commodity becomes less expensive demand for the commodity rises, resulting in an increase in the price and vice versa. Unlike many other commodities livestock prices (live cattle and lean hog futures) only has a small inverse correlation against the dollar with of around -0.2 with the previous nine factors appearing to be much more important in determining sugar prices.

9) Seasonal trends


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Seasonal periods can clearly and predictably result in changes in tastes and preferences. For example, there is increased demand for certain cuts of meat during the summer (more pork and beef) because many people enjoy BBQs. Similarly, at Christmas the demand for turkey increases while the demand for pork and beef decreases

The supply of livestock is highly seasonal too. For example, most cattle herds are bred in late summer and after a 9 month gestation period, produce a spring calf crop. Most producers breed their herd to calve in the spring to avoid the harsh weather of winter and to assure abundant forage for the new calves during their first few months.

10) Consumer preferences

For health, moral, environmental or for other reasons demand for meat, or certain types of meat may reduce over time. In contrast to the impact of changes in price on demand for substitutes, changes in consumer preferences results in much longer term changes in demand.

Related article: Sugar prices: The top 10 most important drivers

Watch out for episode 3 which will focus on the top 10 most important drivers of copper prices.

 

 

 

Sugar prices: The top 10 most important drivers

This is the start of a series of articles looking at the top 10 most important drivers behind some of the main commodity futures prices. Episode 1 looks at sugar.


howzey / Foter / CC BY-NC-ND

1) The Brazilian Real

Brazil is the largest producer of sugarcane, producing around 740 Mt in 2013, almost 40% of global output. A decline in the value of the Brazilian currency, the real increases the incentive for Brazilian farmers to increase output for export while at the same time reducing their production costs.

Millers in Brazil can crush sugarcane to make ethanol for the domestic fuel market, priced in reals, or sugar for export, priced in dollars. A decline in the value of the real versus the dollar encourages Brazilian producers to divert more to the export market.

2) Long supply cycle


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Key to understanding sugar prices is its long agricultural supply cycle. The agricultural supply cycle describes the process of activities relating to the growth and harvest of the crop. These include loosening the soil, seeding, watering and harvesting etc. The typical cycle from planting to harvest for sugar takes 12-18 months. This means that farmers price expectations (i.e. whether they expect high or low prices to continue) are vitally important in determining future supply and prices for sugar.

3) Ethanol demand


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Brazilian sugar cane growers can crush the cane they harvest to produce sugar or for ethanol. As ethanol also competes with gasoline as a transport fuel, a drop in the price of gasoline (as a result of lower oil prices) will tend to lead to lower ethanol prices and hence less demand for sugar to produce ethanol. The origins of Brazil’s use of ethanol as a fuel date back to the late 1920’s but it was the first oil crisis of the 1970’s that highlighted the dangers of oil dependence.

4) Government intervention

Subsidies and import tariffs have distorted sugar markets resulting in sugar producing countries making more sugar cane than would be the case in a normal competitive market. Many of these distortions have a historical legacy. In Europe for example difficulties sourcing sugar from the colonies in the early 1800’s prompted planting of sugar beet. Today the EU is the second largest exporter of sugar in the world. In the US import tariffs designed to protect domestic farmers have raised prices for US consumers, prompting them to look for alternatives such as high-fructose corn syrup.

5) Affluence

The consumption of added sugar (sugar not contained in natural products like fruit or milk) or high-fructose corn syrup has increased dramatically over the last few decades, yet consumption varies considerably from country to country. At the top, we find the USA, Brazil, Argentina, Australia and Mexico, all at more than double the world average; ranging from 40 teaspoons for the USA to 35 for Mexico. At the other end, we find China with 7 teaspoons. Growth in demand for sugar is strongest in emerging economies, particularly South America and Asia.

6) Health concerns


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Sugar is thought to be a leading cause of obesity, diabetes and tooth decay. With governments and consumers more aware of the risks of sugar over-consumption the growth in sugar demand could slow in the years ahead.

Related article: Excess sugar consumption leaves a bitter aftertaste

7) Substitutes

Sugar accounts for about 70% of world demand for sweeteners with chemical sweeteners, such as saccharin and aspartame, as well as an expanding number of synthetic chemical products accounting for the rest. High-fructose corn syrup is a more natural alternative to sugar that has been widely adopted in the United States.

8) Weather

While warm dry weather is important for the growth of sugar cane, drought in Brazil can be especially damaging for sugarcane farmers. Meanwhile, wet weather presents an obstacle to harvesting the sugarcane, delaying getting the sugar to market and risking damage to the crop. Wet weather also reduces the sugar content of the cane, especially if it occurs late in the crushing season, i.e. when mills are processing the cane.

9) Stock levels

As with all commodities, low levels of stocks indicate strong demand, weak supply or a combination of the two. In addition, low stocks provide very little in the way of a buffer in case of disruption to future harvests.

Unlike oil or copper, where the well or mine can be shut down when prices slide below production costs, sugar-cane mills can’t just leave the cane in the fields, nor do they have the capacity to store the sugar they make until prices rise. With such a long supply cycle, if problems occur on the way to or at storage (e.g. due to fire or transport delays) then this can significantly affect the price.

10) The US dollar

Like most internationally traded commodities sugar is priced in US dollar. At its most basic a decrease in the value of the US dollar relative to a commodity buyer’s currency means that the purchaser will need to spend less of their own currency to buy a given amount of the commodity. As the commodity becomes less expensive demand for the commodity rises, resulting in an increase in the price and vice versa. Unlike many other commodities sugar only has a small inverse correlation against the dollar of around -0.15 with the previous nine factors appearing to be much more important in determining sugar prices.

Related article: No sugar high in sight

The next article in the series looks at the top 10 most important drivers of livestock prices.

Iran nuclear deal: 4 key implications for commodity markets

1) Lower oil prices

Brent crude prices fell around 2% following the announcement of the deal. However, it may not be until early 2016 until we actually see any additional Iranian crude being exported.

The medium term impact will depend on the when sanctions will be lifted and then how quickly Iran can raise oil production. Sanctions are likely to remain in place until the end of the year when the IAEA published a report on Iran’s compliance with the terms of the deal.

At this point it may be possible for Iran to begin selling the crude it has stockpiled offshore, somewhere between 30 and 50 million barrels. Although this could come to the market very quickly, it wouldn’t be in Iran’s interest to just dump this.

According to Goldman Sachs it could then take another six months or so to revive aging oil wells, potentially adding 0.5 million b/d (vs current output of 2.8 million b/d).

The longer term impact will depend on Iran’s ability to attract foreign investment and then for that to bring additional production to market. Estimates from Wood Mackenzie point to output potentially rising as high as 4.4 million b/d by 2025.

2) More pain for higher cost producers

With all OPEC members free to produce what they wish, extra output from Iran will help assist Saudi Arabia’s strategy of pressuring those higher cost producers.

More downward pressure on the futures curve, not just near term prices but 12-18 months out as investor’s price in the return of Iranian barrels will make it harder for US shale oil producers to hedge their crude production.

Many of the weaker shale producers have relied on hedging to preserve their profit margins and to maintain credit lines with the banks. If hedging becomes less financially beneficial then it will act as a brake on future drilling activity, particularly for those financially weaker operators.

3) Complications for OPEC?

Pressure from those OPEC producer’s outside of the Middle East for output to be cut to help support prices is likely to intensify as Iran increases oil production.

The return of Iranian crude is an issue for Saudi Arabia too, it being chemically similar to Saudi crude as well as from Kuwait and Iraq. More Iranian crude will mean more competition in those markets that these OPEC producers sell into.

Yet, any change in Saudi strategy just gives a free pass to those higher cost producers (see point 2).

Expect more details on how Saudi Arabia could respond at the next OPEC meeting, scheduled for 4th December.

4) It’s not just about oil

Iran has the second largest gas reserves in the world, yet its market share of the global gas trade is less than 1%. The potential for growth here is thought to be more longer term though.

Meanwhile, although Iran ranks as the world’s seventh largest oil producer, it vies with the US as the biggest grower of pistachios. Although China, India and Turkey remain large buyers, current restrictions on banking and shipping are limiting Iran’s ability to export the cocktail nibble into Europe.

Pistachio prices have risen 40% over the past five years due to shortages. The removal of sanctions could see supply increase, putting downward pressure on prices.

More broadly though, the Iranian nuclear deal adds to the bearish sentiment for commodities. Recently investors have focused on fears over Greece and China as potential brakes on economic growth and hence commodity demand.

Although there are big uncertainties about timing, the direction of travel is a lot clearer with Iranian supply to add to downward pressure on oil and other commodities.