US - While expanding supplies have been one of the key factors contributing to the cattle price decline in the last 9 months, it is also important to consider the impact of competing meats and the effect that this has on overall beef demand, write Steve Meyer and Len Steiner.
The discussion about substitutability and the impact it has on future prices can get quite technical, with a wide range of cross-price elasticities thrown around.
Broadly speaking most economists agree that the substitution effects between beef and pork/poultry are relatively small, with price elasticities of less than 0.3 (i.e. 1 per cent change in beef price leads to 0.3 per cent change in price of pork/chicken) (see Lusk 2015).
As we have noted in this report often, the lack of good data remains a key challenge in trying to estimate the cross elasticity of demand for meat products.
There have been efforts to get around some of these limitation, notably the Food Demand Survey run by the Ag Econ department at OSU. Based on an online survey it seeks to measure the willingness to pay.
Steve Meyer also has covered this point often in this report by tracking real per capita expenditures as a proxy for beef, pork and chicken demand.
The question on the mind of many market participants, however, is whether the expected weak pricing environment for pork and chicken in the fall and winter will continue to exert downward pressure on fed cattle values.
Our opinion is that over the long term ever lower prices for competing meats do indeed impact the price that consumers are willing to pay for beef. But it is not immediate.
Restaurants need time to develop new menus that provide value by highlighting profitable proteins while grocery stores and other retail outlets need to balance their operational demands for higher dollar sales (i.e. sell more expensive products) vs. the larger margins offered by cheaper proteins.
It is also important to consider the dramatic shift that has taken place in the cattle market in the last 9 months relative to the price of other proteins.
The two charts show the ratio of fed cattle prices to the price of lean hogs and broilers.
Fed cattle prices during the period November 2014 - June 2015 traded at an average ratio (or multiple) of 2.28 vs. the price of lean hogs. The average ratio for the period 2002-2012 was 1.43.
In our view, the long run ratio is representative of the relative demand for beef and pork. The jump in the ratio in 2014 and 2015 was largely due to the extremely tight supply conditions in the cattle market but also the rapid expansion of hog supplies in early 2015.
As the fed cattle supply crunch eased last year and early this year, the price ratio has adjusted. We calculate the ratio for the month of July at 1.60. This ratio reflects cattle prices of around $117/cwt and IA/MN base hog price of 73 cents.
December fed cattle futures currently are priced at $113.35/cwt while December hog futures are at $58.5. Making no basis adjustments at all, current futures are pricing the ratio at 1.93. If we were to adjust the lean hog futures so it is equivalent to IA/MN then the ratio gets closer to 2. And as you see in the chart, a cattle/hog ratio over 2 tends to be short lived.
Now the ratio can come down if hog values rally but given ongoing expansion in the hog industry and low feed costs (hence low breakevens) that does not appear to be a high probability event.
As for the ratio of cattle to broilers, that also is now back to the long run range but broiler prices are expected to drift lower following the downtrend in corn prices. We are not trying to make a bear case for cattle, rather would like to point out that cattle, hog and chicken prices are more in sync than they were a year ago but lower prices for competing proteins will remain a headwind for cattle/beef demand going forward.
TheCattleSite News Desk