A 10-year study of hedged and unhedged fed cattle prices in Kansas showed that Kansas prices and the live cattle futures prices were related in the way they should be. There is no obvious upward or downward bias in the hedged price versus unhedged, said Kansas State University Agricultural Economist Brian Coffey, on the department’s web site.
When placing feeder cattle into a feedlot, a feeder should have some expectation of the sale price of the resulting finished live cattle, Coffey said.
Coffey made the comment in a study of 23-week hedges of cattle in the CME Group’s live cattle futures contract, comparing them with an unhedged position.
His study only looked at the prices received for hedged and unhedged cattle and did not take into consideration the cost of the feeder cattle, cost of feed, brokerage fees or futures margins. Brokers will tell customers that they should know the expected breakeven cost of the cattle they place on feed.
Strictly defined, hedging is a way to lay off the risk of price moves in the cash market in exchange for the risk of changes in the basis level by the time the cattle are sold to the packing plant for slaughter. This is helpful because the feeder has a better idea of what the cattle will bring when sold, allowing better decisions about whether to even place cattle on feed.
Expected vs Actual Price Comparisons
When placing feeder cattle, a feeder should have some expectation of the sale price of the finished cattle, Coffey said. There are many ways of doing this, including government or Extension Service forecasts, contracts, or hedging.
For his study, Coffey used only (1) the cash price at the time of feedlot placement, (2) the relevant futures price at the time of feedlot placement and (3) the futures price at the time of placement plus the expected basis.
The first method used seems naïve, but many will be more likely to place cattle on feed when fed cattle prices are high, he said.
Looking at the relevant futures price is better, but not enough but performs better than some other methods, he said.
Finally, the last method is what a hedger uses to calculate expected price, Coffey said. However, a way of predicting the basis 23 weeks into the future is necessary.
A market analyst said the basis will be somewhat different for each feedlot and lot of cattle based on a variety of factors, but a multi-year average for each week is helpful.
There was a stark difference in prediction errors between hedging and not hedging in Coffey’s study. The expected price turned out to be higher at times and at times lower, but the magnitude of the errors was far smaller than those of the first two strategies.
“This is the major benefit of hedging—producers have expected price predictions that are much more accurate and have the ability to plan ahead regarding profit/loss,” Coffey said.
CATTLE, BEEF RECAP
Light fed cattle trading was reported Tuesday at $97.50 per cwt on a live basis, up $2.50 to down $2.50 from last week. Dressed-basis trading last week was at $158 per cwt, up $1 to down $2.
The USDA choice cutout Tuesday was up $0.41 per cwt at $202.96, while select was off $1.81 at $188.32. The choice/select spread widened to $14.64 from $12.42 with 101 loads of fabricated product sold into the spot market.
The CME Feeder Cattle index for the seven days ended Monday was $139.77 per cwt, down $0.22. This compares with Tuesday’s Aug contract settlement of $140.70, up $1.35.