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Losses have arrived but the fundamentals will bring the panic stricken back to reality

The impact of Chinese tariffs on US pork, the pork exports picture, feed costs forecast and more...

Friday 13 April 2018 (5 months 10 days ago)
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The ground is shifting a bit under our feet but the fundamentals are still firmly in place. We are expecting the low of the late winter/early spring seasonal dip to be put in within a couple of weeks and the rise into summer months should then begin. Expected profits for the remainder of the year have evaporated but so far it is only an expectation and it is overly influenced by speculative reaction to a lot of worst case scenarios, none of which are likely to materialize. However, there has been some increased risk around producer profitability for the year since last month so let’s take a look at what is happening.

First, never take your eyes off the fundamentals because they will always drag the panic stricken and the over reactors back to reality in time. I am speaking here of the hand wringing over the Chinese tariffs on US pork and the uncertainty about NAFTA. The Chinese restructuring of their pork industry is following the model produced during the 1990s in the US when low technology and outdoor production gave way to modern systems of confinement and dramatic capital infusions. In the same way that the 1990s in the US were kind of a wild west of individual expansion with far less coordination than exists today, China has seen the major producing companies go public and source billions of dollars in capital and with it laydown hundreds of thousands of head of new sow capacity. Many have done this using (temporarily is the plan) less than adequate and mismatched finishing structures to complete the production system quickly. The idea is to back fill the inadequate stuff with new structures over time.

The theory is the same as in many of the big tech expansions, fill the space quickly to discourage competitors as it is likely that there will be only a handful of dominate players when the dust settles. Unfortunately, the only way competitors know that it is time to stop expansion is when the market becomes saturated and prices begin to plummet. Then, there are many months of pigs in the production system that keep coming long after the decision to decrease matings is actually made. It is never made at the same time by everyone either so the slowing down phase is usually accompanied by catastrophic price plunges which take out the inadequately funded and lower quality “ideas” that were made real by investment. This is a necessary but painful phase as it brings coordination into play to encourage new capital investment once the industry is stung with big losses. It appears that China is reaching the beginning of this phase as prices have fallen significantly and now the mergers and acquisitions phase will sop up failed units very cheaply and the race will be on to get better, not just bigger.

With all of that as a backdrop, how seriously should producers worry about Chinese tariffs? They were not likely to buy that much anyway given the situation above and in any case, they are highly skilled at acquiring what they need by scanning the world sources of production and picking at the best prices until their needs are satisfied. So, I have been saying I am not taking the bait on this one. This is all done to raise political clamoring, not inflict much financial damage. Besides, it is more likely to cause some growling by Chinese consumers who are developing an increasing taste for US Beef and will now see it jump in price. Just can’t get too worried about it myself.

Besides, the February numbers are finally in for the actual export picture and good news abounds. The fundamental reality of wide spread increases globally in national gross domestic product (GDP), a measure of national income is keeping demand strong. The USMEF (US Meat Export Federation) reported that February pork exports increased 4% in tonnage from a year ago and 12% in value. They noted that the newly renegotiated Korean trade agreement (the first existing US trade agreement ever substantially revised before expiration) has resulted in US pork flowing into Korea duty free. In January, the principle bank of Korea marginally raised its GDP forecast to 3%, and Koreans are showing strong increases in per capita pork consumption. The trade agreements with central and south America are resulting in increases in purchases by countries like Colombia, Honduras, El Salvador and Peru for instance. Mexico and Japan, the two biggest importers of US pork (Mexico in tonnage, Japan in value) both advanced in value taken and Japan took more tonnage while Mexico, did not slide backward on tonnage compared to a year ago.

We have to talk about costs too. Corn prices are up some on the drought in Argentina. Less production from there will pull some corn into the export market. USDA thinks it will be a five cent per bushel increase or less. Corn is trading around $3.40 to $3.50/bushel in Iowa even with the increase and is below the long term breakeven price for producers. You cannot expect to indefinitely take an input at below cost of production so I am not griping about the price of corn. Beans are up too but the likely shift of acreage toward beans this spring to avoid more corn losses should take care of any big increases there. In addition, the weather forecasters are giving their sneak peek at the summer prognostications and it looks like normal rain and above normal temperatures for the Midwest. Not so good for a picnic but it’s a recipe for bin busting corn production.

Lastly, we are at the bottom of the normal late winter/early spring seasonal dip in pork prices. Bellies are very weak right now but within a couple of weeks, the move to summer highs will begin and if the weather guy is right, that heat ought to slow down the four percent increase slated to wash over the industry this year.

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