Leo McDonnell: The market collapse had nothing to do with supply and demand
April 19, 2017
I was asked to speak at the Farmers Co-op Ag Expo in Rushford, Minnesota, in February. I believe the content of my speech applies to a broader audience than just those folks gathered in that beautiful Minnesota church, so I want to share that content with this readership. An earlier edition of Tri State Livestock News contained part of my speech; following is the rest:
While the repeal of COOL certainly has had an impact on our cattle market in 2015 as noted to me by an importer friend (see March 16 article), we had a lot of other things going on. Looking back, it was like The Perfect Storm; however, none of it had to do with increasing U.S. beef supplies, which were at a 22-year low, or declining beef demand, as retail beef prices hit an all-time record high in 2015.
I believe some of the things that came into play were changes in CME and future contracts, changes in trade flows, and the simple fact that, with the concentration we have, cattle producers are price takers for the most part. I would also be remiss not to note the declining by-product values; however, the increase to record-high retail prices in 2015 more than offset those declining values.
In 2014, we saw two significant changes in the CME futures board. First was the closing of pit trading or "open cry" as some call it and the move to high speed electronic trading. Secondly, which took place in late December of 2014, were the changes in daily limits for feeder contracts and expand limits on live and feeders. We basically went from a $5 table to a "high stakes" table, inviting in a more sophisticated speculative trader that favored shorts at the point in our market. We took the Board from a risk protection tool for the cattle industry to a high stakes casino, which has ignored the fundamentals of a market and taken $50 billion of equity and another $20 to $30 billion in cash out of the cattle industry. As one analyst noted last fall, "a semi load of calves brings $70,000 less than in 2014," and yet the retail value has increased by $135,000 for that same semi load lot. I believe that, if this had happened in the stock market and with the CME being pretty much self-regulated, some of these folks would have ended up in jail. I also believe our packer friends, who also trade in this arena, have enjoyed the windfall from this activity.
So let's look at a little history. If you go back to December 2014 and January 2015, USDA's WASDA, Cattle Fax, and many other industry analysts predicted 2015 for tighter beef supplies and cattle prices to increase, but not at the rate we saw in 2014.
In the spring of 2015, we started to hear noise about carcass weights being up, and it only got louder through the summer and fall as carcass weight reached record highs. While cheap corn helped this, it's important to note that many packers also encouraged this by not discounting heavy carcasses in fear of a short supply.
So as we went into the first quarter of 2015, we saw beef supplies down about 3 percent. Fed steer prices were up at $165 from $146 in the first Quarter of 2014, and retail prices up at $6.02 from $5.21. So from first Quarter of 2014 to first Quarter of 2015, on a 1,400-pound steer, live cattle price increased about $270, and retail value of that same steer increased around $400, so the retailers and packers had some great margins to work with. In fact, by early fall of 2015, retail prices hit an all-time high of $6.09 per pound, but the fed cattle market was crumbling with fed cattle in the fourth quarter of 2015 averaging $127… or $530 less than the same quarter in 2014.
About this same time, one of the main market analysts reported in November of 2015: "Consumers are still demanding more beef at increased price levels." In fact, 2015 saw a strong restaurant price index, along with relatively positive Consumer Sentiment Index and Consumer Confidence Index and Consumer Spending.
So did these high carcass weights actually increase United States' beef production that much over previous estimate levels? No… and it fact, we ended up slaughtering less cattle in 2015 and U.S. beef production ended up right where USDA had predicted: down from 2014 and the lowest levels in 22 years.
Since conventional wisdom generally attributes one single factor to lower prices – and that is increasing supplies — then it is important we look at trade flow. In 2015, we saw imports reach near record highs at 3.37 billion pounds up over 400 million pounds from 2014, and we saw exports drop over 300 million pounds This change in trade flow put an additional 700 million pounds of beef on the U.S. market; however, much of this was offset by the 500 million pounds decrease in the U.S. beef production. In other words, while changes in imports/ exports added supplies, U.S. beef production was down, leaving a net increase in beef supplies on the U.S. market of less than 1 percent.
One of the problems is — as noted by both the U.S. Senate Trade Deficit Review Commission and the U.S. International Trade Commission — that imports can and are used at times to suppress domestic prices. This can be done through increased supplies or simply the downward pressure that cheaper imports can put on the U.S. market. While the increase in imports in 2015 was mostly in the form of lean beef for grinding, it's important to remember that nearly 60 percent of the beef consumed in the U.S. is ground beef. The collapse in 90 percent lean prices in 2015 was aided by imports and the repeal of COOL, as U.S. 90 percent lean was moved back into an international commodity market. This increase in imports was offset some, on a supply basis, by a 35 percent decline in cow slaughter in the fall of 2015… which just shows you the impact that cheaper imports, loss of COOL, and supply management of imports can have. Remember, retail prices were at record highs and domestic supplies at 22-year lows.
On the trade side, it also did not help that pork and poultry also saw the same shift in trade flow, and when you combine all three meats, we had an additional 4.5 billion percent of meat on U.S. markets. That may very well have been a record. But again remember, retail beef prices reached record highs.
As we moved into and through 2016, U.S. beef production was back up significantly, and we saw the collapse of feeder prices and feds. Feds in the fall hit a five-year low at $98 with the futures continuing to pull the market down as cattle feeders were being required more and more to hedge a fair amount of their purchases and futures were falling below basic and fundamental values. Even the CME noted on July 12, 2016, "October fed cattle future prices were down the daily limit yesterday even as fundamentals in the beef market are some of the best they have been in some time."
At the same time, real disposable income grew through all four quarters of 2016, and while the Restaurant Performance Index softened some, it still saw its 28th quarter above 100, and consumer spending hit an all-time record high. In fact, U.S. beef production in 2016 was down nearly 2 percent from 2013, and yet fed cattle prices had dropped nearly $6/cwt or $84 per head on a 1,400 pound steer from 2013, while retail values for the same steer had increased (I'm talking just the increase from 2013) by around $350.
While I appreciate that retail prices, as reported by USDA, do not account for featuring, you can bet that, if they did, it still wouldn't come close to even 25 percent of cattle producers' loss of this nearly $450 market share shift to packers and retailers. In fact, from 2012, the spread for fed cattle to retail increased by $700-$800, and again that's just the increase to retailers and packers. And remember, unlike you, they turn this same per retail animal investment over every couple weeks.
The bright spot — and what I believe will bring cattle prices back some — is the simple fact that beef demand is tremendous. I also believe that half the drop in retail beef prices in 2016 had as much to do with retailer and wholesalers knowing how cheap packers were buying cattle for and the gross profit margins they were operating with than it did anything else.
So what are some opportunities to address this?
Start by making trade work for cattle producers. Get aggressive negotiating bilateral trade agreements with major CONSUMING countries and not just producing countries, like Canada has with Japan and Singapore and Australia has with China, Japan, Singapore, and the U.S.
The U.S. has given access to nearly all, if not every, major beef producing country in world, but outside of Korea, it has done little in regards to FTAs with major consuming countries. Korea, however, shows the power of such bilateral as we've surpassed Australia as their #1 importer of beef.
This idea by some cattle groups that we have to "give access to gain access" has been a Golden Cow to this industry. The U.S. is the number one country in the world for importing Chinese goods and #2 for Japanese goods, and we carry a huge trade deficit with both countries. We have the leverage to get these folks to the table and reduce some of the trade barriers they have used against us. They are very dependent on a healthy relationship with the U.S.
Trade laws & safeguards…
We need to strengthen our trade laws and safeguards when it comes to perishable and cyclical ag products like beef, making them timelier and more sensitive. Unfortunately, we have some in our industry who are trying to do away with such market protection tools and trade laws.
We need to tighten up our SPS (sanitary and phyto-sanitary) rules. The U.S. should not be the dumping ground for ag products that other countries refuse for health or disease reasons.
We need to reinstate a more meaningful COOL law. It's foolish to think you can compete in a market with the highest quality and valued product and not differentiate your product. No other industry or business operates today under those false assumptions that COOL opponents have thrown out. Just stop and think for a second… the opponents to COOL are the ones who benefit by not having it, and they are the same folks who have pushed such social capitalistic agendas as standardization of product cuts, and they are the ones that have said, "Beef is beef no matter where it comes from." They have pushed for unfettered free trade, and they have partnered with major beef importing countries to do away with our trade laws. They have also pushed for other socialistic agendas such as mandatory ID. This industry cannot continue to follow these failed policies.
We need more timely and detailed trade data for imports and exports. We wait three months to get such data while the U.S. steel industry not only gets it every week but also it comes with more detail.
When it comes to our markets, cattle producers are price takers. I don't see the political character or 'want to' to address the concentration problem we have at packer and retail levels. There's no doubt that, if we truly had competition, the gross fed cattle to retail margins we've seen the last few years would not exist. But at this time, I think you're trying to ride a dead horse. I'm not sure what can be done to modernize GIPSA. The scare tactics being used are coming from the same folks who benefit from these outdated regulations. We need to address some of the problems we have without micromanaging them.
We do need to put more focus on increasing market transparency at all levels. We're in what is called "the Information Age," but cattle producers are being kept in the dark. Mandatory pricing today heavily favors the packers.
We have to address CMF and Future Trading. You need to remember that the CME Board is self-regulated and made up of traders. It's not hard to understand that the more volatile the board, the more money they make. There are three things that could be done:
1. Go back to the old limits prior to 2014. We have seen at times the Board move $7-$8 in a 36-hour period with no change in demand or market fundamentals. Why in the world would anyone go long after what we've seen happen the last couple years? I'll say it again: the futures board is no longer a risk protection tool for cattle producers and has become instead a high stakes casino that has robbed us of billions and billions of dollars. I believe it is criminal what we have witnessed.
2. Delay trading 3-5 seconds. Again, demand shifts don't happen that rapidly, and we need to discourage these algorithmic traders from disrupting our markets.
3. Increase the number of delivery points to be sure they are in areas where there are multiple packers. We need to find a way to encourage the longs. Right now and for the past two and a half years, it has favored the short position.
Certainly, there are other things we could discuss. I do think it is wrong to try and micro-manage a market, but our forefathers recognized that it takes a little government to insure that opportunity is there and that competition is allowed to thrive. Pure, unfettered Capitalism destroys competition, and I think it's important to note that Capitalism comes in many forms and that not all of them are founded on the same values this great country was.