- The hog market in general has taken a beating of late, with strong selling coming from both noncommercial (fund) and commercial (fundamental) traders.
- This has the cash live cattle vs. lean hog index spread in position to test its high from March 2015.
- If the lean hog market is going to turn around, the buying needs to begin on the commercial side of the market.
In the 2005 film The Dark Knight, there is a great scene where a semi-truck goes rumbling by a police squad in the underground streets of Gotham City (aka Chicago). The truck seems to be the property of a carnival on the move, with pictures of tents and rides accompanying the tagline “Laughter is the Best Medicine”. However, the Joker (one of the best cinematic villains of all time) has edited the slogan with a blood-red “S”, making it “SLaugher is the Best Medicine”. Up until that moment, how many of us made the connection to how simple it was to turn “Laughter” into “Slaughter”?
I was reminded of this scene while watching the ongoing carnage in the lean hog market. Less than a year ago, August 2022 to be exact, the CME Cash Hog Index (HEY00) hit a high of $122.25, taking out the July 2022 mark of $121.42 and moving within sight of the June 2021 peak of $122.68. Since last August, though, the index has fallen to its latest reading of $71.52. The odd thing is we can’t even say this move is unprecedented as the same index fell to a low of $70.04 during November 2021, immediately following its June 2021 high. Both instances remind us of how quickly laughter can turn to – well, you know.
Given the ongoing uptrend in the boxed beef market, a move that has led to a record high live cattle cash index (LEY00) of $175.00, I’ve been asked a number of times about the price relationship between cash cattle and cash hogs. A look at the monthly close-only chart for this spread shows the most recent calculation coming in at $103.36 (cattle over hogs), closing in on the record high monthly close of $105.25 from March 2015. When I respond with this information, the follow-up question is almost always, “Why?”
Those of you familiar with my analysis and commentary might recall Newsom’s Rule #5: It’s the what, not the why. Unlike the other 99.9% of the industry, I don’t like to make up reasons “why” markets move day-to-day, week-to-week, month-to-month, and so on. My thought is we will find out at some point, so it’s more important to figure out “what” is driving the market, and it’s here where things become a bit clearer.
Recall every commodity market is made up of two sides, noncommercial and commercial. We can read the activity of noncommercial traders by watching the trend of futures (price direction over time) while tracking the mindset of commercial interests (those involved in the underlying cash market) through basis and futures spreads. Evaluating the view (bullish, bearish, or neutral) of these two sides gives us 9 possible market types, with Type 9 being the most bullish (both sides bullish) and Type 1 the most bearish (both sides bearish). It’s not hard to figure out which Type the lean hog market is at this time.
A look at the weekly chart for the June lean hog futures contract shows a clear intermediate-term 3-wave downtrend that began with the high of $109.775 the week of December 26, 2022. This week has seen the contract hit a low of $84.65 before bouncing a bit to near $86.00. The move in futures has coincided with noncommercial selling as the chart for the CFTC Commitments of Traders report (legacy, futures only) shows this group moving from a net-long futures position of 44,713 contracts the week of December 26, 2022 to a net short futures position of 24,092 contracts the week of April 10, 2023. The bullish nugget we can take from the latest Commitments of Traders report is the noncommercial short futures position has grown to 89,189 contracts, the largest it has been since the week of February 17, 2020. This sets the stage for potential short-covering buying.
On the commercial side, as mentioned before the cash index has collapsed to a test of the November 2021 low, but it hasn’t taken it out. Yet. On the other hand, this has created an incredibly weak basis (cash in relation to futures) with May futures (HEK23) still sitting near $78.00. Recall a weak basis is not bullish. As for futures spreads, we have seen a good deal of commercial selling push the June-August to Tuesday’s close of (-$4.125). The previous 5-year low weekly close for this week is (-$2.025) meaning the spread is more than $2 weaker than its previous weakest mark. That too is not bullish.
As for government numbers, which so many folks in the industry seem to get frothy about, the latest Quarterly Hogs and Pigs report for March 1 showed 72.9 million head (mh), up slightly from the March 1, 2022 figure of 72.6 mh but down slightly from the December 1, 2022 number of 73.1 mh. As for Cold Storage, with the next monthly update set for release next Tuesday (for March 31), total pork as of February 28 was reported at 521.2 million pounds as compared to the previous month’s 418.9 million pounds and the previous year’s 478.3 million pounds. Based on what was seen in the cash market and futures during March, the next update should show another build in stocks.
The bottom line is all this makes lean hogs a Type 1 market, but one that is sharply oversold at this time. Sure, there is an old saying of “markets can stay overbought or oversold longer than we can stay solvent”, but there is also a chance we could see buyers view the market as a bargain. If so, it will be important for buying to start on the commercial side for as Newsom’s Rule #6 tells us: Fundamentals win in the end.
And that is no laughing matter.
On the date of publication, Darin Newsom did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
