Real Estate - NOVEMBER 3, 2014

Investors beef up their portfolios

by Steve Bergsman

Cattle futures have been nothing but prime cut for the past few years, but even veteran traders have been stunned by the record prices that topped $170 on Oct. 24. That is about 50 percent above where pricing for cattle futures had grazed just two years ago.

All this fine red meat has attracted a slew of hungry investors to this relatively small corner of the investment world. The question for investors now is how to put their brand on this fast-moving market?

There are a number of ways to play the cattle market, including investment funds and ETFs. Some people will head for stocks, usually in what folks in the industry call “packers” but are really the big ag-food companies such as Cargill, JBS and Tyson Foods. Some investors even try to get into the ranch business. However, most invest in cattle futures directly because the market is so small that an overly aggressive ETF or investment fund can stampede the market.

So, here are some very basic notions to understand before diving into this market.

Technically, cattle futures are called Live Cattle because the reference is to the actual cattle raised from calves until they are heavy enough for beef production. Along the way, the ownership of the cattle will be transferred about four times: from the farm where the calves are born (cow-calf stage) to a backgrounder operation (wide grazing lands, cattle to about 450 to 650 pounds), then to feed lots (cattle to 1,250 to 1,450 pounds), then to the packers that operate the slaughterhouses and package the meats for sale to retailers.

Cattle futures can occur anywhere on that continuum. For example, if you are a backgrounder who bought 100 head of cattle, those animals won’t be ready to sell to a feed lot for about four months, which means you find yourself with price exposure for that period of time — the price of cattle can fall. So, the backgrounder forward sells the inventory four months before the cattle are ready to be delivered. The buyer could be a feed lot operator, but it is just as likely to be speculators, who are more than willing to offset the risk of the backgrounder. (The backgrounder hopes the price of cattle rises; speculators want downward movement.)

Generally, the two main things that affect the price of cattle futures are the cost of feed to fatten up those cattle and the demand for beef. The trend line for beef consumption has been steadily declining as more Americans eat more fish and poultry or switch to vegetarianism. However, Virginia McGathey, president of McGathey Commodities, a Chicago commodities trading company, says demand for beef has been picking up in Asia, which has slowed the slide in beef sales.

However, McGathey says, demand is not what has caused the record prices for cattle futures. The genesis of the climb goes back to recession years.

“When the stock market crashed in 2008, it was the beginning of a bull market for grains,” she says. “Grain prices went so high it hurt the cattle farmers because it was too expensive to feed their cattle. The farmers sent their cattle to slaughter.”

Since then grain prices have fallen dramatically, and farmers have been able to fatten their cattle cheaply, so weights are up. Meanwhile, replenishing the herds has been slow, first because of fewer heifers from the sell-off during the recession years and now because farmers are pushing more cattle into beef production. The U.S. Department of Agriculture reports that beef supply is at a 63-year low, with an inventory of 87.7 million heads of cattle.

“Tighter herds have pushed up prices,” McGathey says.

Traders have used the term “stratospheric” for beef prices and “violent volatility” to describe the swings in the market, which for old hands in the commodities business is perplexing, since for almost 40 years the cattle futures market was stable, trading in a very narrow range. Then about two years ago the market started creeping up; this year prices skyrocketed. The wholesale cost of beef is up 26 percent in 2014.

This rally has been one that “everyone hates,” McGathey says: “Not believing prices could go any higher, they sell and get run over by the market. So they end up buying back again, which results in still higher prices.”

One protection, McGathey says, is to buy some put options to protect the down side. Otherwise, she adds, “We are getting to the extreme end of the market. Even traders are looking at the charts and saying, ‘how can anyone buy?’ — but prices keep going higher.”

Steve Bergsman is a freelance writer based in Mesa, Ariz.

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