March 10, 2009

A window of time allowing cattle feeders to lock in a profit on fed cattle is open, and some see recurring profit opportunities through the summer.

 

For the last week or so, the spread between cash feeder cattle prices and a Chicago Mercantile Exchange live cattle futures sale has been wide enough for many Plains states cattle feeders to lock in that profit. Some futures traders have been able to do the same thing by buying nearby feeder cattle futures contracts and selling deferred live cattle contracts.

 

In futures parlance, such futures trades are called crush trades or artificial crush trades, referring to a similar practice in the Chicago Board of Trade's soy, soymeal and soyoil pits.

 

These opportunities sometimes come along about three times a year, said independent cattle feeder and trader Narciso Perez.

 

The window of time for a profitable hedged feeding position may close, however, because of the rising price of feeder cattle, market analysts and traders said.

 

The CME's feeder steer average cash settlement price for Thursday (March 5) was US$91.77 per hundredweight, up US$0.06 from Wednesday but US$1.06 higher than the last low on Feb. 24.

 

For an individual cattle feeder, it comes down to the cost of feeder cattle locally.

 

John Nalivka, president of Sterling Marketing Inc., said some Plains feeders can lock in that profit, but just barely. He calculated a feeder placing cattle on feed now would need a sale price of $80 per hundredweight to break even on his investment.

 

With an August futures price of 84.00 cents a pound that would lock in a profit, Nalivka said.

 

That's a far cry from the estimated US$230 a head each animal is losing at last week's fed cattle price, Nalivka said.

 

But for some feeders, it doesn't matter if the feeder cattle can be hedged at a profit. These traders will switch easily between owning the physical cattle and working the futures markets exclusively.

 

Perez is one who doesn't care. He concentrates on capturing a margin on feeder cattle, either synthetically or with the leather-upholstered variety. He and others have their own proprietary formulas that allow them to trade CBOT corn futures and CME feeder and live cattle as a unit.

 

Perez' mindset about the feeder cattle crush spread is such that whenever putting cattle on feed doesn't "pencil out" to a hedged profit, he'll put on what he calls a "reverse crush" position in the futures markets and "let someone else own money-losing feeder cattle."

 

Mike Zuzolo, analyst with Risk Management Commodities, said traders were trying to decide just how tight feeder cattle supplies will be later on in the spring. The deciding factor likely will be rain, he said.

 

The industry could see a "flush" of feeder cattle supplies if dry conditions persist in parts of Texas, Oklahoma and Kansas, Zuzolo said. Continued dryness could prompt cattlemen to push feeders to the feedlots rather than keep them on wheat pasture.

 

Zuzolo said, however, that if sufficient moisture does move into the Plains soon, more feeder cattle likely will stay out of the feedlots and stay on pasture, which could tighten supplies and raise prices to pinch margins.

 

"That's why people have been playing around with that spread because weather will dictate the feeder supply within the next 30 days," said Zuzolo.

 

Every spring the "crush" spreads become increasingly active, said Zuzolo. There are cattlemen in the Plains in April, he said, who weigh whether to take their light weight backgrounded calves and either put them on pasture a couple of months longer or drive them into feedlots early, and the basis often makes the difference in their decisions.

 

"A lot of that is traced to corn prices, but the determining factor is the condition of wheat pasture," said Zuzolo.

 

Eric Ocrant, vice president of Oak Investment Group, said the "crush" spread was created for speculators and hedgers. Speculators, he said, are banking on the feedlot-level profit margin offered by the spread using spring feeder cattle and corn contracts versus late-fall or early-winter live cattle months.

 

A feedlot operator would use the spread as a hedge against price movement tied to their operating costs and in the event the futures market moves against their position, said Ocrant. The cost of running their feedlot includes the cost of feeders, buying feed and paying for help to run their operations.

 

Most feedlots simply trade live cattle futures, said Ocrant. But some feedlots should protect themselves now by implementing the spread to lock in a certain profit margin.

 

"As a feedlot operator, I'll buy the feeders and the corn and put the cattle into the feedlots," said Ocrant. "And then when I get close to when live cattle are to be delivered, I will slowly roll out of the hedge."

 

The problem that traders had in the past in trying to put on the crush hedge was that the CME and CBOT were in two separate buildings, said Ocrant. There has been more live cattle and feeder cattle trader interest in doing the spread because both exchanges are now under the same roof, he said.

 

"I would like to be able to have the crush spreads physically traded as such on the floor of the CME," said Ocrant. "Because then, we would be able to go to the feedlot operators and they can use the crush spread as a hedge and banks will in turn be more at ease in lending money to the feedlot operators to do business."