Higher but Risky Calf Prices

Farm Business Management Update, August 1997

By Wayne D. Purcell of the Department of Agricultural and Applied Economics, Virginia Tech

Virginia cattlemen are looking at much better calf prices this summer than were seen in the summer of 1996. Last year was a disaster, with calf prices dipping to $.50 per pound and below as corn surged to $5.00 per bushel and above in the cash market. This is an age-old law of beef economics at work. Cattle feedlots have to buy two things: cattle to place on feed and corn to feed them. It takes about 50 bushels of corn to finish a typical feeder steer, and if corn goes up by $2.50 per bushel, that is $125 that the feedlot cannot pay for the calf or yearling steer. If you are talking about a 500-pound weaned calf, that translates to $25 per hundredweight. Those record corn prices were the reason we saw calf prices go to $.50 per pound and below last summer. This year you are looking at the prospects for $2.50 a bushel or lower for corn, and calf prices are around $.90 per pound, with some lighter calves $1.00 a pound and higher.

Corn was the problem last year, and it could become a problem again this year. Dry weather is threatening corn yields in Illinois and Indiana. The first weekend in August brought some fairly widespread relief in Illinois but very little coverage of significant rainfall in Indiana. The October feeder cattle futures that had traded as high as $83.15 on July 21 are trading below $81 on August 4. If this dry weather pattern in Indiana continues, we could see corn being $.50 per bushel higher this fall than we expected, and that would definitely put a crimp in these higher calf prices. Step back for a moment and look at what might be a reasonable price risk management strategy to follow given what is happening in the corn market.

You can forward price those fall cattle by selling that October feeder cattle futures contract. Alternatively, as many of you are finding, you can buy a put option, which sets a price floor and leaves the possibility of upside prices open to you. I think, at this point in time, anything up in the $82-83 area for the October ought to be seen as a forward pricing opportunity. I would sell the futures at those price levels because I see little or no upside potential for feeder cattle from the $82-83 level. If you don't have capital for a margin account and don't want to worry with handling and managing margin calls in the event prices do go up against short futures positions, then look at buying the put options.

On August 4, with the October futures trading at $80.82, an $80 put was carrying a premium cost of $1.45 per hundredweight. This would establish a price floor for you at $80 minus the $1.45, or $78.55, and then you would have to adjust that $78.55 for basis. If you are talking about a 500-pound weaned calf, you might have to add $6-8 per hundredweight to that price, which would put you back up in the mid-to-high $80s in terms of a floor price. If you are talking about 900-pound steers, you might have to take $2-3 off that, which would bring you down toward $75. Talk to your extension agent or fax a question to me at (540) 231-7622 if you are not quite sure how to handle this. Alternatively, you can reach me on the Internet at purcell@vt.edu. What I am suggesting is that it might be prudent to get some price protection on these fall cattle. I think it is unlikely that there will be any substantial damage to this corn crop, and I find it more likely that cash prices at harvest will be well under $2.50 in the Midwest this fall. But there is some small but significant possibility that the weather will mess things up and that would suggest at least taking a look at a pricing strategy on your feeder cattle.

If you are going to use the futures, you might want to look at selling this October futures contract on any rally back toward $83 if that type of rally occurs. If there isn't a rally, those of you have looked at charts in this market might want to hook the two lows that developed in June and sell this market on a close below that uptrend line. If you want to buy put options, remember that an $80 put or any strike price you might want to use will carry a cheaper premium when the market rallies.

It probably doesn't make that much difference which way you go in terms of price risk management strategy. What I am suggesting is that I don't see much upside potential from the $82-83 on the October feeder cattle. Cash corn would have to be pressed down toward $2.00 to put much more into this feeder cattle market or you would have to see the outlook for the fed cattle market be well up into the mid-to-high $70s when October gets here for October feeder cattle futures to trade to still higher levels. I think the possibility of fairly cheap corn is there, but I don't see the likelihood of fed cattle prices in the mid-to-high $70s moving into the fall and winter months this year. Beef demand continues to struggle, and there is too much competition from expanded supplies of pork and poultry in front of you to argue that you are going to be in the high $70s in the fed cattle market. Thus, when you put it all together, it sounds as if it might make sense to look at getting price protection on these stocker and feeder cattle. Most of you cattlemen in the state have some money made on your calves this year if you can protect against any significant break in price, and the only big fly in the ointment is the still uncertain outlook in the corn market.

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