Fed cattle basis with odd pricing pattern
Early in the year, a common marketing practice among cattle producers is to take a look at livestock basis levels, explained Matthew Diersen, SDSU Extension Risk/Business Management Specialist.
“You never know when subtle changes can derail price expectations. The focus here is on fed cattle basis, which has a strong seasonal pattern. The most common way to look at fed cattle basis is to compare a monthly cash price for a given market to the nearby futures price. Basis equals the cash price minus the futures price,” Diersen said.
Using the cash price for fed steers from Sioux Falls Regional Livestock and the futures prices from the CME, basis was calculated for 2013 and for the recent 5-year average (see table). The average covers enough years to smooth out aberrations, but Diersen said is short enough to adjust to changing seasonal patterns.
“Because the fed cattle cash price has a strong seasonal pattern based on both production levels and demand for beef, there is also a seasonal pattern in the basis. The seasonal peak often occurs in April, but it can be anywhere from February through May. The typical seasonal pattern was evident in South Dakota in 2013 (see table). Thus, basis for the early half of the year is worth watching every year,” he said.
In most months, the basis is negative which Diersen said implies a cash price below the futures price.
“This is because of some transactions costs when delivering cattle – regardless of the market,” he said.
For par delivery locations the transactions Diersen said costs should be minimized, but may still be $1 to $2 per hundredweight.
“Using a basis estimate can translate directly into a planning price. Adding a basis for a given month to its nearby futures price gives an expected cash price. The same can be done with a forward basis,” he said.
The price rally in early 2014 has pushed up the nearby February contract price and the following contract prices decline through August. Thus, for planning purposes, Diersen said livestock producers should approach the averages with more caution than usual.
“February’s basis might still hold, as it reflects typical basis for a delivery month. March’s basis is more suspect, as it should reflect more of the premium the February futures contract trades at relative to the April futures contract. May’s basis could be suspect as well, given the very steep slide from the April futures contract to the June futures contract,” he said.
For comparison, he said it pays to also consider the forward contract market. The USDA’s Agricultural Marketing Service reports the weekly minimum, maximum and average basis levels on forward contracted fed cattle: http://www.ams.usda.gov/mnreports/lm_ct153.txt.
“For example, the basis levels the week of Feb. 3, 2014 for February and March have been higher than the five-year average,” he said. “The May basis has been positive for a couple of weeks. The delivery location of the contracted cattle is not given, but the basis levels suggest that the forward market has adjusted to the unusual futures pattern observed this winter.”