Cattle prices have been on a downward trend since the 2014 highs. August feeder cattle, as we'll discuss specifically, are trading at $143 per hundred weight(cwt), last year they were at $194 and at $182 the year before that. Over the last ten years there have only been two significant periods under our current prices. We'll examine the placement and marketing numbers as well as the choice vs select spread as it relates to the domestic demand we believe will drive prices seasonally higher through the end of the summer.
Cattle prices have fallen over the last two years as grain prices have declined, lowering the cost at the feedlots, which has resulted in heavier weights from fewer animals. The combination of falling finished cattle prices along with still declining grain has made holding cattle back to rebuild the domestic herd from multi-generational lows a profitable endeavor because the spread between summer grilling choice cuts versus winter roasting cuts will require more animals not, heavier animals. This is an important distinction. From the Ag Center at LSU, "... found that choice and select quality grades are substitutes during winter at the wholesale level but that select beef is not a substitute for choice beef during the spring and summer – 'the grilling season.'” Furthermore, "Fewer cattle grading choice in the spring combined with increased demand for steaks produced from the rib and loin primals going into the summer lead to a wider choice/select spread." The key here is that heavier weights don't fix the specific cut requirements of the intended consumers.
We expect domestic demand to remain strong through the summer. We expect this summer's travel season to be one of the best on record. We can argue about why Americans are afraid to travel overseas or, we can focus on the fact that we may see a 3% climb in miles driven and reach a new all-time high. Even surpassing the heady days of 2007. Domestic travel means more grilling, which means more choice cuts. This is one 2016 theme on which we've been consistently correct.
According to the June 24th USDA reports we can see that animal placements at the feedlots are growing. Our point is that this is a domestic demand story as you'll see in the marketing chart below.
Thus, even though placements have risen, they're far short of the packers' demand. This is also why we expect the choice to select spread to remain wider than normal for a longer period of time. The cattle market's rigid laws of supply and demand can create temporary price dislocations and opportunities like the present situation. The cattle market is in tight supply heading into a seasonal period of strength.
This makes the recent decline in the cattle market due to last week's Brexit vote a case of, "risk off." This helped flush an already oversold market that is supported by increasing domestic demand and strong seasonality. Finally, the commercial traders are now showing up on the buy side as feedlots are hedging their expected demand through the futures markets as reported in the weekly Commitments of Traders reports as you'll see below.
Commercial traders have been net buyers in four out of the last five weeks and their momentum has been clearly positive for nearly a month. We use their action to cue our own. Their actions are based on the fundamental value of their market versus where the market is currently trading. Their actions inside these margins help them to lock in the spread between their business model's required inputs or outputs against known production or consumption costs in the future.
The trade setup requires daily market action to move sufficiently against the broader commercial position by enough to create an overbought or, oversold reading in our momentum trigger. In this case, commercial momentum is positive and the recent sell-off had created an oversold condition indicating a potential turnaround. Monday's continued rebound off the Brexit low triggered a long entry to our subscribers for Tuesday's trading. While typically, we view our discretionary Commitments of Traders signals to have a holding period around a week, we believe that the macro-economic outlook will continue to foster domestic demand, which will further trigger the need for more choice cuts and more animals. Given the significantly oversold levels from which this potential rally is beginning, it seems quite reasonable that this rally could continue through a late summer seasonal peak.
