This summer, market advisor Nevil Speer wrote a series of articles for Beef magazine about the futures market, explaining various aspects of futures hedging and trading.
This is the last in the series, and Beef has graciously allowed its republication here, edited for style and length.
HEDGING LEVEL
During the past several weeks, this space has been reviewing some of the basics around futures markets – with a primary focus on the cattle markets. One of the primary questions that often comes up surrounds the level of hedging that occurs within the cattle sector.
This article helps address that question. Many people just assume that it’s a function of open interest. They do the math across the total number of contracts and the associated number of pounds and then subsequently translate that into some function of the number of cattle on feed.
For example, one commentator recently remarked, “Everyone’s pretty much hedged up. If you go and look at some of the reports that come out of the CFTC, you can pretty much estimate that around 75% of the cattle are hedged. I would say it’s probably more than that.”
I’m not sure why anyone would want to extrapolate beyond the CFTC. But nevertheless, as has been demonstrated in previous articles over the past several weeks, there are different types of participants in the market – as such, the method just described, and the commentator’s guesstimate, overshoots what happens in reality.
THE REALITY
The more appropriate approach is to dive into the detailed reports provided by CFTC. These provide a precise breakdown of short and long positions for four distinct categories:
- Producer / Merchant / Processor / User: entities that use the futures markets to hedge the physical commodity to which they’re tied.
- Swap dealers: an entity that deals primarily in swap (derivative contract) transactions.
- Money managers.
- Others.
For the purpose of this discussion, our interest is primarily in the “producer” classification. And for live cattle, a short position represents cattle feeders using futures contracts to hedge a selling position.
A long position represents packers attempting to hedge their respective buying positions.
FEEDERS INCREASINGLY USING FUTURES
It’s clear that cattle feeders (producer shorts) are increasingly hedging over time – nearly doubling the 52-week moving average since 2006 from 100,000 contracts to roughly 200,000.
That said, 200,000 contracts represent 8 billion pounds of cattle (at 40,000 pounds per contract). This translates to approximately 5.9 million head of cattle at any one time – or just about half of the total cattle-on-feed population – a far cry from “75% of the cattle [being] hedged.”
Meanwhile, the packing industry has remained fairly consistent in its use of the futures market over time.
Amidst this discussion, there are lots of lessons to learn when looking at the patterns surrounding 2014 and 2015 hedging levels – but they probably are best saved for another time.
CATTLE, BEEF RECAP
Cash cattle trade was reported last week at $100 to $104 per cwt, up $1 from the previous week. Dressed-basis trade last week was at $160 to $165, up $1 to $3.
The USDA choice cutout Wednesday was down $0.76 per cwt at $214.63, while select was up $0.17 at $189.83. The choice/select spread narrowed to $24.80 from $25.73 with 117 loads of fabricated product sold into the spot market.
The CME Feeder Cattle index for the seven days ended Tuesday was $140.03 per cwt, up $0.27 from the previous day. This compares with Wednesday’s Sep contract settlement of $141.57, up $0.32, and the Oct settlement of $142.45, up $0.80.