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The Market's Fine Print
Wednesday, July 1, 2015 8:46PM CDT

By John Harrington
DTN Livestock Analyst

Ever since the first narcissistic cave man lovingly gazed into his reflection by the water's edge, our kind has been crazy about mirrors. Nothing feeds the bottomless ego like a well-placed looking glass: My God, we're gorgeous.

If you're having serious doubts about what a gift you are to the world, just lay it on the line with that totally sincere piece of eye-candy who flirts each morning from across the bathroom sink. Believe me you'll be reassured in no time. You might even join the confidently humble crowd and file for the Iowa primary.

Yet we live in a strange culture that associates mirrors with more than practical functions of grooming and self-worship. Given countless examples from both literature and folklore, mirrors can symbolize predictive powers of magic or contrary systems of rule and order.

You know, like when the evil queen intones "mirror, mirror on the wall" or when Alice climbs through the looking glass over the mantel pierce into an alternative world of talking chess pieces.

For some reason, I've always thought of livestock futures as the market's mirror. Indeed, sometimes the board serves as a reasonable reflection of supply and demand realities. That's not to deny that bulls and bears often see what they want to see, primping at the image that best suits their marketing strategy. Yet given how markets correct to avoid long periods of volatility, extreme cracks in the mirror will eventually shatter.

On the other hand, deferred contracts can often embrace the more magical definition of a looking glass, shimmering with less certain assumptions and a wide array of interactive contingencies. When St. Paul told the Corinthians "for now we see through a glass, darkly," he could be honestly discussing how the board truly conjures 2016 feeder cattle prices.

In fact, it's the current state of the feeder cattle mirror that has prompted my comments today. There seems to be an unusual disconnect between the feeder board and the cash feeder index. Specifically, even though spot August surged 377 points higher on Thursday, it remains nearly $10 below the most recent calculation of the cash index. Assuming we're not trapped in the fun house hall of mirrors, how can the former possibly be a reflection of the latter?

Using both of the mirror definitions suggested above, I can think of three possible scenarios (separately or in combination) justifying CME clarity:

1) Feeder futures assume that the combination of light second-quarter placement activity and excellent holding capacity of summer grass will result in the largest calf and yearling run this fall seen in years, large enough for feedlot managers and backgrounders to command significant, cost-controlling leverage.

2) The threat of higher feeder costs this fall seems to have recently increased thanks to reduced planted acres, expanding livestock herds, and technically strengthening grain charts. If the cost of gain is seriously ready to jump higher, the prices of feeder cattle must be adjusted proportionally lower.

3) The massive equity drain suffered by cattle feeders through the first half of 2015 is simply unsustainable. Feedlot managers will simply be required (i.e., either by bankers or their own sense of self-preservation) to buy replacement cattle sharply lower this fall or not buy them at all.

The first and third of these possibilities are probably the strongest. Frankly, the second scenario strikes me as very much in the bubble. I'm not much of an agronomist, but I vaguely remember something about "rain making grain." We could still easily have a bumper crop, one that would again drive corn prices sharply lower and actually increase the demand for calves and yearling.

While the size of the fall run should be larger, the potential advantage to feedlot buyers will depend somewhat upon the actual size of the new bred heifer class and the demand for calves vis-a-vis winter wheat pasture.

Theoretically, the bleeding balance sheets of feedlots alone should be enough to lend credence to the board's predictive mirror. But will cattle feeders find enough discipline (possibly in the face of cheaper feeder and still-tight ranch offerings) to spend less, letting even more pens go empty if necessary?

At the debut of the third quarter, the board's magic mirror seems to be reflecting a big "YES."

John Harrington can be reached at feelofthemarket@yahoo.com

Follow John Harrington on Twitter @feelofthemarket

(AG)


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