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Ranchers poised to enjoy great margins; dairies will benefit

Vernon Crowder Published on 19 March 2012

The cattle market, including dairy culls, is expected to see continued strength in 2012, with the potential for double-digit gains again this year – which is good news for dairy operators. The dairy industry will continue to see strong prices for its culled cows through 2012, with more upside potential than in 2011.

This rise in prices has been driven by severe weather in Texas, meat supplies lagging global income growth, a depreciation of the U.S. dollar, which encouraged beef exports and discouraged imports, and expanded export opportunities. This secondary income stream offers some reprieve to dairymen, as margins for milk have again tightened.

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In the first quarter of 2012, there exists limited downside price risks due to a slightly larger global supply amidst a backdrop of slowing winter demand in the Northern Hemisphere. However, for the rest of the year, cattle prices could post more record highs as markets transition from the short-term supply bulge (primarily U.S. and Brazil) to materially lower supplies.

For the longer term, global meat protein supplies will continue to lag income and population growth in important emerging markets, raising volume risks to processors and price risks to everyone from feeder cattle buyers to consumers.

To these ends, prices for dairy culls will continue to be strong, being highly correlated to the larger cattle market, but the exact spread will continue to be determined by values of various cuts of beef. Dairy cows are typically processed into hamburger and lower-end steaks and roasts.

The price spread between the higher-value and lower-value products is ultimately determined by consumer demand for these products. A preference for fast food versus restaurants selling premium steaks, or consumers trading down to cheaper cuts during economic stress, are both examples of variables that can influence this spread.

The price for Holstein bull calves will continue to be determined by what buyers expect on future cattle returns. Holstein steers have much more high-value cuts than dairy cows, but with some differentiation compared to traditional beef steer breeds.

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While large supplies in the early part of 2012 will weigh on prices, the sharp shortfall by sometime next spring should lead to another year of record-setting cattle and beef prices in the U.S. Fed steer prices in 2011 averaged $115 per hundredweight (cwt) compared to $96 per cwt in 2010, a 19 percent increase.

On top of this sharp rise, and despite a surge in production early in the year, fed steer prices will continue to increase further and are projected to average $116 per cwt in 2012. In turn, tight cattle supplies will push power up the value chain. Ranchers are set to enjoy some of their best margins in years and dairies will, in turn, benefit from the higher prices.

Conversely, feedlots and packers should be concerned about both higher prices and limited availability of inputs, exacerbating low capacity utilization problems and causing margin compression.

These developments should be of concern to all in beef procurement and will also have a follow-on effect to proteins such as pork and poultry. Some of this is already reflected in futures prices, but outright availability could become an issue.

Also, assuming domestic consumption will not fall as sharply as production but will continue its longer-term decline trend, the availability issue will be especially pronounced for importers of U.S. beef.

Furthermore, declines in the U.S. dollar could make imports into the U.S. more expensive, adding further potential challenges to domestic supplies. Beef packers will be challenged to manage capacity utilization in such a way to cover fixed costs with reduced output, but the industry has been doing a good job of managing for margin rather than market share in recent years.

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Additionally, beef available for export from the U.S. will be down at double-digit levels, which could be of concern to importers but create opportunity for exporters from Brazil and Australia, which are in a herd rebuilding phase and in turn should increase production in 2012.

Additional factors to play on U.S. cattle prices:

• Fed cattle and choice cutouts achieved their high prices for the year in Q4 2011 of $128 per cwt and $1.96 per lb, respectively. However, negative beef packing margins since the end of Q3 have pushed processors to cut back on slaughter. The six-week rolling average for slaughter fell from 653,000 head at the beginning of Q4 to 608,000 head for the week ending December 31, which is 1.5 percent below year-ago levels. Packing margins have yet to respond positively. Reduced slaughter levels will have to be maintained to get packing margins back in the black.

• The choice-select spread widened dramatically in Q4 2011 as the world’s largest retailer, Walmart, began stocking its meat case with choice beef. The spread, which averaged only $7 per cwt in Q3, spiked to almost $20 per cwt in Q4, a level not seen since 2006. The spread is likely to remain at historically wide levels with the ongoing demand generated by Walmart.

• U.S. beef exports remained strong in Q4 2011. Year-to-date export volume is up 25 percent over 2010 levels, led by exports to Canada and Mexico. A still relatively weak U.S. dollar relative to other major exporters also helped drive strong exports to Japan and South Korea. Export demand is expected to continue on the back of a weak U.S. dollar and progress in trade barrier reduction. The Korea-U.S. Free Trade Agreement calls for beef import tariffs to fall from 40 percent to zero over the next 15 years. A positive outcome in the U.S. beef industry’s campaign to raise Japan’s age limit on imported beef from 20 months to 30 months could further support exports in 2012.

• USDA’s December Cattle on Feed report showed that continued Texas drought induced placements of light cattle. Overall inventory of cattle on feedlots was up 3.6 percent over year-ago levels and placements onto feedlots were 4 percent over 2010 levels. However, the higher placements were driven almost entirely by light cattle that would typically spend more time on pasture prior to being placed in a feedlot. Placements of light cattle – those weighing less than 600 pounds – were up 20.8 percent over year-ago levels while total placements of all other heavier-weight categories was down 3.7 percent. These light cattle are less likely to grade choice than heavy cattle, supporting the choice-select spread well into 2012.

• Softer cattle prices are expected in Q1 2012 as typically lower winter demand coincides with last summer’s high placements becoming market ready, causing fed cattle supply to outstrip demand. However, scarcity in the fed cattle markets will begin to make itself felt in Q2 2012, likely resulting in record-high prices as we move through the remainder of the year. PD

Vernon Crowder and the Rabobank Food and Agribusiness Research and Advisory (FAR) team provide reports on sector-specific information and global market trends exclusively to Rabobank and Rabo AgriFinance clients. If interested in learning more about how this group’s research can provide insight for your daily business decisions, visit www.RaboAg.com .

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Vernon Crowder
Vice President and Agricultural Economist
Rabobank

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