John Nalivka: A few thoughts – on a futures contract for the Beef Cutout
The CME recently approved a Pork Cutout Contract to begin trading on November 9. This new contract, together with the currently traded Lean Carcass Contract, will further enhance the ability to manage risk in the market. So, here I am writing an article in a beef publication talking about managing risk in the pork market. There is a method to my madness. It provides a great introduction to why it would make sense for the CME to offer another new contract similar to the Pork Cutout Contract – the Beef Cutout Contract.
In short, the Beef Cutout is a composite value of each day’s primal beef values taking into account both the price and what those primal cuts yield to the carcass and generated mathematically. Each of the primal values that comprise the Cutout are calculated according to the price of the sub-primal cuts comprising the primal and their representative yields to the primal. The Beef Cutout value is reported through Mandatory Price Reporting twice daily by the packers and consequently, provides a solid pricing mechanism for market participation and transparency.
For the past several years – yes, years – there has been an inordinate amount of time spent discussing and cussing the pricing mechanism for fed cattle. And, while the current discussion centers on the need to increase the number of cattle traded in a negotiated market in order to create “fairness,” the market continues to demonstrate the importance of adding value to each of the sub-primal cuts and building demand. We are all familiar with currently proposed legislation to require a percentage of cattle priced through negotiated trade. Yes – legislating market activity!
In essence, the market is truly focusing on the importance of enhancing the beef cutout value with innovative pricing while the discussion centers negotiated pricing of live cattle. As the industry transitions into the future, the comfort level of preserving the past remains strong. To address this dilemma, the Beef Cutout Value should be the focus of the pricing mechanism. A Beef Cutout contract on the CME would take the lead in that approach.
Long term financial success for the beef industry will require fostering market approaches that are consistent with the future direction of the industry. It involves everyone across the supply chain going the same direction. While some of the old market systems may need to be abandoned, that does not necessarily mean giving up independence. In 1967, IBP defined the future direction of the beef industry with the advent of boxed beef. I believe the next major innovation in pricing will be a focus toward a Beef Cutout pricing model beginning with a CME Beef Cutout Index and Contract.
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