Live cattle futures have been trading in a sideways pattern since making lows in early December. The front month cattle contract recovered in February only to set back and test the lows, recovered again in April only to set back again and recovered in May. Once again, after peaking in May, the market retreated and actually penetrated the early December lows, but quickly turned back up, showing a real lack of downside follow through below 80 cents. Recently, the market has been working upward and on Monday of this week (June 29) the board closed sharply higher with the August contract penetrating the May highs in the process. The deferred October live cattle contract penetrated the May, April and February highs on the rally June 29th. The recent action indicates that live cattle futures are waking up from their six month slumber. A six month consolidation represents a huge base of support in which a major bull market may be developing. The weekly and monthly live cattle charts indicate a major low may have been established in the live cattle market.

The seasonal tendencies for the winter cattle suggest that it would be normal for a low to be established in mid-June. This appears to be the case in the event of the October, December and February live cattle contracts. In some years the market will move higher into early August and then retreat and make a secondary low in mid to late August.

Fundamentally, the live cattle market can most simply be described as a market facing tight supplies and possibly improving demand. Looking more closely, fed cattle supplies, which are referred to as on-feed inventory, currently are at 10-year lows. Also, perhaps more importantly, I’m expecting placements of cattle into the feedlots this summer to decline relative to last year, creating even tighter supplies of fed cattle into the fall time frame. Placements into the feedlot during May were down 14% from last May and represented the smallest placements since May of 1996. Sources indicate that placements during June were likely lower, as well. This data will be released by the USDA in their cattle-on-feed report on Friday July 24th. Cattle placed into the feed yard in June will typically be ready for market in the October/November timeframe. The significance of cattle supplies tightening further during the fall timeframe is magnified by the fact that beef demand tends to improve markedly at the end of summer.

The supply of feeder cattle (the calf crop) is at a 50-year low. Cow/calf producers have been liquidating beef cows for several years. The reasons for this are numerous, but one reason has been consistent drought in various areas of the country over the last several years. When a large region or area suffers drought the cow/calf producer is forced to find adequate pasture or supplement the feed with hay. Many producers, over the last several years, when faced with this dilemma, have chosen to simply cull the cows or reduce the size of their herd. First there was drought in the northern plains, then in the southern plains and finally in the south east. Each time drought impacts a region large numbers of beef cows have been culled from the herds. Over time this has resulted in a shrinking calf crop. This “pool of calves” is what is used to place cattle into the feedlots for finishing. Thus, it’s fairly easy to reach the conclusion that placements are going to be down relative to historical levels.

The supply of beef can also be impacted by average cattle weights at the time of slaughter. The seasonality of cattle weights is fairly reliable. For example, because cattle are kept outside in huge feedlots in the Great Plains, typically cattle weights decline in the winter and increase in the summer. Cattle tend to perform better in the spring, summer and fall than they do in the winter. However, sometimes harsh summertime conditions can create poor performance at the feedlot. It takes a rare combination of heat, high humidity and lack of wind to create such conditions. These exact conditions, however, were experienced across the wide portion of the Great Plains in the week ending June 27. The result will likely be a decline in average dressed cattle weights, further reducing the total tonnage of beef put into the pipeline.

Beef demand, whether holding the same, decreasing, or increasing, will be a critically important factor in determining how high cattle prices can/will go this summer and fall in the face of tight supplies. The U.S. and global recession has hurt beef demand; there’s no doubt about that. Beef is especially vulnerable to economic hardship due to higher per pound prices and due to the fact that a large percentage of beef in the U.S. is consumed in the high end restaurant and hotel business (HRI). Late last summer, when the severity of the current recession became evident, beef prices and live cattle prices collapsed. It’s my opinion, based upon many factors, that beef demand (both domestically and globally) will improve in the months ahead. I’ll save the arm chair economic analysis for phone conversation. However, what I do know is that economists, in general, have found it tougher to predict the end of a recession than it is to predict the beginning of one.

SO WHAT DO I EXPECT?

Based upon expectations for cattle placements to continue light and based upon the theory that beef demand will improve into the fourth quarter, I’m expecting a major rally in live cattle futures to begin this summer and continue for several months. This could be the start of a major bull market in the live cattle market. My speculator clients are positioned in the October live cattle from the long side. Current support in this contract should be evident at 8950 and again at 8850. My first upside target using a measurement off the daily chart is 9230. My longer term upside target for this contract comes in at 10230. The current speculative margin to hold a live cattle contract is $1,080 per contract. Call me or send an email if you’re interested in pursuing this trade strategy to Dennis Smith at dennis.smith@archerfinancials.com or 1. 877.377.7905.

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