The basis, or difference between the futures and cash price of fed cattle is something a futures contract cannot protect, yet it is crucial in relating futures to cash prices.
UNDERSTANDING BASIS
The basis is calculated by subtracting the futures price from the cash price. A positive basis indicates the cash price exceeds the futures price, while a negative basis shows the futures price is higher than the cash price.
When cattle values are hedged against the futures market, there always is a basis at the time the hedge is put in place. But hedging can only protect the original value of the commodity being hedged at the original basis. The basis can change before the hedge is removed depending on the vagaries of the futures or cash markets or both.
FACTORS INFLUENCING BASIS
Several factors contribute to the basis in commodity trading. They include supply and demand dynamics, market participants’ expectations, transportation costs, storage costs, local market conditions and government influences.
- Supply and Demand: If the supply of live cattle exceeds demand, the cash price may decrease, leading to a negative basis if the futures price remains relatively stable. Or the futures market may respond more quickly than the cash market, resulting in a positive basis before the cash market can react.
- Market Expectations: The basis also can be influenced by market participants’ expectations regarding future price movements. Traders and hedgers analyze various factors like weather conditions, government policies and economic indicators to anticipate price changes. Their expectations affect the basis as they buy or sell futures contracts accordingly.
- Transportation and Storage Costs: Commodities often need to be transported from the location of production to the delivery point specified in the futures contract. Transportation and storage costs can affect the basis, and higher transportation or storage costs in the cash market can lead to a positive basis.
- Local Market Conditions: Basis can also vary based on local market conditions. Factors like regional supply and demand imbalances, differences in grading or quality standards, or specific local factors affecting cattle prices can contribute to basis changes.
FUNCTION OF BASIS
The basis serves several important functions in commodity trading.
- Price Discovery: The basis provides market participants with insights into the current supply and demand dynamics in the cash market. It helps traders and hedgers gauge the relative value of the futures contract compared with the underlying commodity. A widening or narrowing basis can indicate changes in market sentiment or fundamental factors affecting prices.
- Arbitrage Opportunities: The basis facilitates arbitrage activities, where traders exploit price discrepancies between the cash and futures markets. Traders who feel the basis is too wide or too narrow can try to profit from the perceived imbalance.
- Risk Management: Farmers, processors and livestock producers can use futures contracts to make informed decisions about hedging their price risk by taking opposite positions in the futures and cash markets.
CATTLE, BEEF RECAP
The USDA reported formula and contract base prices for live FOB steers and heifers this week ranged from $260.25 per cwt to $264.00, compared with last week’s range of $251.82 to $260.00 per cwt. FOB dressed steers and heifers went for $404.17 per cwt to $410.76, compared with $400.43 to $409.84.
The USDA choice cutout Tuesday was up $3.61 per cwt at $395.75 while select was up $3.35 at $393.58. The choice/select spread widened to $2.17, from $1.91 with 69 loads of fabricated product and 12 loads of trimmings and grinds sold into the spot market.
The USDA-listed the weighted average wholesale price for fresh 90% lean beef as $469.49 per cwt, and 50% beef was $190.77.
The USDA said basis bids for corn from feeders in the Southern Plains were unchanged at $1.12 to $1.20 a bushel over the Jul corn contract, which settled at $4.75 1/4 a bushel, down $0.01 3/4.
The CME Feeder Cattle Index for the seven days ended Friday was $367.63 per cwt, down $2.46. This compares with Tuesday’s May contract settlement of $369.57, up $0.77.