November 11, 2011
Did China's pork price inflation break -or did somebody break the market itself?
With poultry and layer prices carried in its wake, pork shot up to record levels only to see it level off in the third quarter. Rather than solving underlying market imbalances, a succession of government pork reserve sell-offs are making the situation worse.
An eFeedLink Hot Topic
by Eric J. BROOKS
After setting a new price record at of RMB19.81 (US$3.11/kg) in the first week of September, the Chinese government's release of pork reserves has resulted in declining prices for pork and other meats. According to eFeedLink's monthly Livestock Tracker reports, from an average January price of pork of approximately RMB14.10/kg (US$2.20/kg), live hogs had increased in price by 42% as of mid-September.
Anticipating strong Mid-Autumn festival and National Day demand in the weeks ahead, September saw the government sell pork from national reserves. eFeedLink reported that prices initially fell slowly in late September but the decline's pace accelerated in October. By the second week of November, live hogs appeared to have bottomed out near RMB17/kg, some 14% below their September peak.
The deflation then spread to other livestock markets: With pork becoming cheaper, consumers bought more pork and less poultry. Just like in 2007, the swine price inflation that had driven up poultry prices now went into reverse, inducing notable declines in the prices of broiler and layers. eFeedLink's October Livestock Tracker saw prices for AA broilers, China breed broilers and layers fall by 14%, 5% and 10.7% respectively.
Interestingly, all this appears to closely follow a script from 2007, when an even more intense bout of swine hyperinflation initially broke in the third quarter. Later, 2008's pork reserve sell-off during Chinese New Year was followed by a financial crisis and world recession, finally breaking the back of livestock prices.
Always eager to please the masses, China's government will be tempted to sell off pork reserves for 2012's upcoming Lunar New Year. Curiously, just like in 2008, a financial crisis-induced world recession appears to be just around the corner too. Should we expect China's government to sell-off more pork and will doing so have its intended effect? In truth, that would not be a wise move.
Why can't hog inventories keep up with demand?
The reason why the authorities should refrain from selling pork from national reserves is deeply connected to a riddle at the centre of this following dilemma: China has the feed resources and everything else it requires to support a huge population of nearly half a billion pigs; far more than any other country. Technically speaking, for the last five years, there has been nothing stopping China from raising more pork, yet swine hyperinflation and pork shortages keep recurring. Stranger still, even the deflationary trends and pork inventory sell-offs follow a predictable pattern, right down to the yearly quarter when the price trend breaks.
Market fundamentals certainly provide some clues to the underlying situation: Since 2007's swine hyperinflation, China's hog numbers have been stuck in the 400 million to 450 million. Part of the reason is because with finishing hog weights increasing, the country obtains more pork from the same number of hogs. But with pork demand high and the population increasing, numbers should have risen more consistently.
Hence, something deeper is also at work: Despite years of subsidies available for raising hogs, keeping sows and vaccinating herds, China's pig inventories do not rise by much. This year, even with record hog prices, herds expanded by a painfully small amount. The eFeedLink graphs accompanying this article clearly show that even when live hog prices rise strongly, inventories respond in a weak manner. Clearly, something is not right. Just what is it that's going on?
The answer is an ironic one: The Chinese government's very own market intervention is destroying the very price mechanism required to match swine inventories with pork demand.
Is it piglet costs or feed prices...?
At first sight, this may not be apparent: When one compares graphs showing China's hog prices, piglet prices and hog inventories, piglets jump in price even more than hogs do -and this was true both this year and in 2007. Superficially, this makes piglets too expensive for hog farmers to buy.
Even so, this should only be a problem for backyard farmers -when piglets get too expensive to purchase, integrated or large farms with hog breeding facilities should take advantage to expand their herds more. Spared the expense of purchasing piglets, under normal conditions, integrated farms should simply start supplying a larger proportion of China's hogs even if backyard farms are unable to do so, thereby meeting pork demand. Strangely however, these larger-scale, well capitalised pig farms fail to raise enough new piglets or hogs to supply the country's swine demand, even though they are far better equipped to do so than backyard farms.
Perhaps part of the answer lies in input costs: Both in 2007 and 2011, China's swine price inflation coincided with a sharp rise in feed costs -but with an essential difference: In 2007, feed costs only accelerated late in the year, after the government had released pork from official reserves. In early 2008, amid supplies of pork from official reserves, hog prices fell even as feed costs increased.
With the government pork sell-offs beating down hog prices and feed costs rising, this destroyed any business incentive to raise pigs. Reflecting the life cycle of hogs, two quarters later in mid 2008, with feed costs rising and hog prices falling, inventories which had been expanding quickly, simply froze in their tracks. They only turned downwards during the recession, when pork demand fell faster than the cost of feed.
â€¦No, it's price manipulation!
And that is where the story changes: For all of 2007's pork price inflation, inventories were growing very strongly at that time, stopping only when feed costs conspired with the government's pork sell-off.
By comparison, early 2011 saw the government curry political favour: In late 2010 and early 2011, it released a considerable quantity of pork from official reserves just before Chinese New Year. This depressed the price of pork -and also live hogs -- but kept the masses happy during Lunar New Year. The graph clearly shows that instead of rising the way they traditionally do in the run up to Chinese New Year, late 2010 saw flat prices for live hogs.
Take a look at the 2010-11 inventory graph: Before November 2010, hog inventories were rising rapidly, in expectation of higher prices just before Chinese New Year. Within a month of the government selling pork from official reserves and keeping hog prices low, live hog inventories started to fall. Net result? The government won political popularity but in doing so, it made it inevitable that there would be a shortage of hogs -and pork- by mid 2011.
Politically, the policy was brilliant but from the viewpoint of economics, keeping live hog prices flat in late 2010 and early 2011 was a very bad move. With China's economy growing strongly, the country badly needed more pigs just to keep up with rising consumption. Farmers needed financial encouragement to raise pigs, not the threat of forced losses every time pork's selling prices increases.
Pork sell-off batters piglet replenishment, stores up future inflation
Instead, with hog feed costs going through the roof and hog selling prices staying flat, farmers looked at the situation in a rational manner and refused to expand their swine herds. Cornered between high feed costs and a government unwilling to let them make a free market's rate of return, many of them simply stopped raising enough pigs in the run up to Chinese New Year.
Net result? Over the short-term, many hogs were slaughtered and too few of them were replenished with new piglets. Over the medium term, the artificially low selling prices made it less economical to raise piglets: This artificially-induced piglet shortfall actually created more trouble than the initial pork price deflation itself.
By destroying interest in expanding herds, piglet supplies started falling short of demand growth. eFeedLink's Livestock Market trackers clearly show that by spring time, the pork sell off's impact was gone but long-term damage had been done to the piglet market: By destroying the motivation to raise more hogs, late 2010 and early 2011 saw breeders concluding that it was uneconomical to breed a lot of piglets. In sum, government pork releases had the impact of making piglets more expensive several months down the road.
This factor on its own pushed up the price of pork as much as flat hog numbers themselves. A quick look at the accompanying graph shows that from May to July, when high hog prices should have been stimulating demand for more hogs, piglet replenishment actually fell! This was merely a side-effect of the pork reserve sell off's artificial deflation of the swine market.
Consequently, amid spring time's surprisingly high hog demand and skyrocketing pig prices, farmers wishing to take advantage of the situation found themselves short of piglets, which had become highly expensive. Both in late 2010 and in mid 2011, farmers faced rising feed costs. Then, mid 2011's high piglet prices replaced late 2010's artificially depressed hog selling prices in undermining swine farms' gross margins.
Net result? Unlike 2007 when the swine population responded to high prices, this time, even as China's pork prices set new mid-year price records, China's hog inventories stagnated, merely trending sideways.
â€¦and then they did it again!
Of course, if markets are left alone, supply and demand will sooner or later catch up to each other. By the late third quarter, replenishment had bottomed out and was ready to rise again -and then government made the same big mistake.
In early September, with pork prices setting new records just before the Mid-Autumn Festival and National Day holidays, the government again sold pork from national reserves. Instead of rising as it should before high-demand festivities, pork's price fell by more than 10% within weeks. This occurred when the cost of hog feed and piglet replenishment was setting its own price records.
What happened? Just like in late 2008 and in early 2011, swine farmers where hammered by a three-way collision between high feed costs, high piglet and falling hog prices -even though demand for their product has never been higher!
Instead of using high returns to encourage the expansion of herds, the resulting price deflation made profits at backyard hog farms fall by 36%. Large-scale farms with breeding units saw their returns decline by nearly 13%. Why should hog farmers raise a lot of pigs when the government leaves them with insufficient revenue and high costs every time the price of pork goes up?
Sure enough, instead of responding to record high prices and falling piglet costs, the accompanying graph shows that piglet replenishment fell in September and October. This could not have happened at a worse time. Pigs take months to raise, replenishment has been flat for six months, and Chinese New Year is about to push pork demand through the roof.
By depressing piglet numbers and destroying the incentive to raise hogs, the government's late 2010, early 2011 and autumn 2011 pork reserve sell-off pushed off the swine market's inflationary day of reckoning to late 2011 and early 2012.
Is it becoming an addiction? A corn market repetition?
Of course, the government could opt for political expediency and sell another boatload of frozen pork from official reserves in late 2011 and early 2012. Unless a world recession profoundly cuts China's pork demand growth, this would make for a potentially even greater piglet shortage -and another intense round of hog price inflation- in mid 2012. Which could be followed by yet another sell-off from state pork reserves six months or a year later, over and over again.
In a sense, China's consumers and governments now depend on a market intervention strategy that is hurting its long-term ability to feed itself.
The fact is that while it keeps the masses satisfied, continued pork sell-offs in the face of rising feed prices is driving China's hog farmers to the wall. If amid politically expedient pork reserve sell-offs, demand keeps growing and supplies stagnate, the day will come when reserves are depleted. Because of China's huge population and high pork consumption, in such a situation, overseas imports will be insufficient to fill the supply gap.
Although such an extreme outcome might be some ways off but there is a historical precedent: For the better part of ten years, China used similar state reserve sell-offs to control the price of corn. After putting off inevitable corn market adjustments for ten years, the country now faces large corn shortages, corn that costs 30% above the world price and too few state reserves with which to artificially balance the market.
The good news is that corn is mostly eaten by livestock. The bad news is that pork is eaten by people. When the reserve sell-off's day of reckoning comes, super-high prices and pork shortages during Chinese New Year will be far more politically difficult to explain than the high cost of a feed grain.
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