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Cheap Beef Isn't Always a Positive


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The drought of 2012 now covers more than half of the continental United States. Temperatures have set records throughout 2012 leading to the warmest 12-month period since the National Oceanic and Atmospheric Administration (NOAA) began keeping records in 1895. When we combine these temperatures with the 10th driest June on record and consider that the rain we have seen has not made it to the Great Plains, it's no wonder that grain prices have increased by 50% in the last month. Grain farmers are at least partially compensated for their lower output by higher prices on delivery as well as various insurance programs that kick in when output falls to pre-determined levels. The cattle industry faces an entirely different dilemma.

The price for beef and dairy in the U.S. changes very little at the grocery store. The competition between grocers as well as the availability of substitute goods to the shoppers make the livestock industry hold prices steady at the end point while withstanding the expense of higher feed costs on the front end. Their business plan is based on the two-year production cycle of cattle for beef, which places them in the position of absorbing losses this year while hoping to refill their coffers at higher prices two years down the road. How long can they afford to hold on to inventory while maintaining back stock for the coming year?

The cattle for beef industry is a two-step process. Individual farmers breed and raise cattle until they reach about 700lbs. These animals are then sent to feedlots to be fattened up for slaughter. Feeder cattle will nearly double in size for slaughter, ending up around 1,300lbs. The farmers and feedlots are in competition with each other. When feed costs are low, the feedlot operators can afford to fatten up the skinniest of animals. However, when costs are as high as they are now, feedlots are looking for heavier animals that have spent more time at the farms grazing. Iowa State published a paper two years ago on feed costs and determined that it takes 3,360 pounds of corn to increase fed cattle's weight by 500lbs. This is the equivalent of 60 bushels of corn or, $420 per animal at today's prices.

The upward pressure of grain prices forces farmers to determine how many cattle they can hold back and afford to feed versus how many they have to sell to generate more revenue to cover the higher input costs. These decisions show up in the World Agriculture Board's forecast for greater cattle production through this fall. We will see cattle prices fall as a result of this through Halloween. The catch is that there will be fewer animals available next year and this will lead to competition among feedlots for placements because lower grain prices will increase feedlot operator margins as they finish the animals to send to the packinghouses.

These market forces will also show up in the dairy market. The relationship between feed costs and milk production are almost 1 to 1. It takes about 100lbs of feed made up of 75% corn and 25% soybean meal to produce 100lbs of milk. This equals input feed costs of $1.28 per gallon. Dairy farmers will be forced to cull their less productive cows to feed the animals that are producing well. This will add more beef cattle to the supply chain further depressing prices through this fall.

One of the best ways to determine if something is, "going on" in a market is by noticing when market relationships are out of kilter. Cattle and grains typically have a positive correlation. They tend to move in tandem. Moderately increase the price of corn and the cattle will follow suit. The opposite is also true as the cost of feed declines, so does the cost of production. However, when this relationship breaks down it's because one market can't keep pace or, pass on the costs of the other. That is exactly what we're seeing between cattle and corn. The price of feed has exceeded the livestock market's ability to pass on the costs. This brings more animals to slaughter now and will leave us with a smaller breeding herd heading into next year.

 



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Andy Waldock began his career in commodity trading right out of high school, starting as a runner on the Chicago Mercantile Exchange shortly after his 18th birthday. Having been brought up in the family business of Lind-Waldock & Company, commodity trading was, "in his blood," from an early age, so to speak. The importance of starting as a runner and making minimum wage, was not lost on him. The three year process of climbing the clerking ladder from runner to phone clerk to arb clerk and, finally clerking for a broker, served as an apprenticeship to the ins and outs of floor trading. The relationships made during this time were crucial to developing an understanding of how the commodity markets functioned

Andy began trading in the S&P 500 pit of the CME shortly after his 21st birthday. Much of what Andy learned early on was a direct result of getting to know his fellow traders. After five years of trading futures and options in Chicago, It was time to move back to Sandusky, Ohio and enroll the first of his three boys in school in the family environment he grew up with.

Moving off the floor coincided with the electronic trading boom. The future had been seen as Andy witnessed the early development of electronic order routing with Lind-Waldock as well as the inception of the Globex markets and fully electronic trading while still in Chicago. Using this experience, Andy began to work with Tradestation and taught himself how to program and test trading strategies and algorithms. Andy began putting these systems for work in his own trading account in the late 90's and published the top ten performing DCB Bond system in Futures Truth in January of 2000.

Andy's market research, analysis and programming has continued to evolve and has been featured in Futures, Futures Truth, Business Week, Forbes, Trader Planet, Money Show, Consensus, etc. His Tradestation programs and research range from purely technical systems like the DCB Bond, to psychological methodologies capitalizing on market flushes as well as greed and panic. The day trading system he created using the VIX Index to measure investor sentiment as well as a breakout level to calculate their action is still part of his regular trading. Over the last few years, Andy has focused his research on Commitment of Traders data. This has allowed him to combine market fundamentals via commercial traders' interpretation of their own markets with his own neural network to signal actionable trade recommendations in the futures markets. This work is summarized in COT Signals and is also part of his daily trading due, in part to its 65% winning percentage.

2007 marked the end of Andy Waldock's relationship with Lind-Waldock. Lind-Waldock had been purchased by Refco in 2000 and continued to run in a normal fashion until Refco went public in 2006. Shortly after their bankruptcy, Man Financial swooped in to buy the Lind-Waldock name and the good faith it had generated in the commodity markets for more than 40 years. The powers in charge after multiple ownerships decided that neither the Waldock's, the Lind's nor, the Sandusky, Ohio office were necessary parts of Lind-Waldock. At the continuing request of former clients, Commodity & Derivative Advisors was started in July of 2007.

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