June 8, 2009

A soggy spring and widespread fund-buying continues to push Chicago Board of Trade corn futures to new highs, but some analysts say the market will eventually have to reckon with some bearish news on the demand side.

 

The livestock sector, which has been struggling for months due to the recession, has lately been getting even worse. The fallout will mean continuing weak feed demand for corn, likely through the end of 2009 if not longer, analysts said.

 

About 45 percent of the corn crop goes toward feed and residual use, according to the US Department of Agriculture. Problems with the industry are the "canary in the mineshaft" that shows how the recession could impact corn, said John Kleist, broker/analyst for Allendale.

 

The sector's woes are widespread, from cattle to dairy cows to pork, and are directly tied to the recession, analysts said. Most recently Chicago Mercantile Exchange hog futures have been under intense pressure. Prices have dropped significantly, and agricultural lenders say they may have to force hog producers to either trim their herds or liquidate completely.

 

Hog prices took a beating after the AH1NI flu scare erupted in April, as anxiety and bad publicity caused the market to plummet even though the "swine flu" cannot be caught from eating pork. Prices have recovered slightly, but the timing of the flu scare robbed the market of its crucial springtime seasonal surge, analysts said.

 

"It's almost like India needing the monsoon," Kleist said. "Hog producers needed the monsoon of a strong seasonal uptrend."

 

Many smaller hog producers are expected to go out of business during this slump and even industry giant Smithfield Foods Inc. has a "murkier" outlook, according to a research note from Credit Suisse on Friday. The report notes that over the past three weeks, spot hog prices have fallen 18 percent while grain prices have risen 5 percent.

 

The story is similar for the dairy industry, which could lose 15 percent to 20 percent of its dairies in what is a crisis for the industry, said Joel Karlin, analyst for Western Milling in Goshen, Calif. Dairies are "bleeding red ink," said Karlin, who analyzes both the dairy and feed sectors.

 

"They're completely, completely in survival mode now," Karlin said of milk producers. "They don't need milk, they just want to maintain (their cows) until conditions improve."

 

This means that even if herds aren't thinned out, those cows are feeding on more forage and less corn, because cows feeding on grain produce more milk, Karlin said.

 

Livestock prices and demand have also suffered, as more consumers stay home and eat less meat and cheaper cuts, analysts said. The possibility of herd liquidation looms there as well, analysts said.

 

While eventually the herd liquidation would be expected to tighten supplies and help prices rebound, that process will take months, analysts said.

 

"If we happen to have any cattle liquidation, it takes a while to do it," Kleist said. "If that was set in motion, that would be a problem all the way through the end of the year, if not beyond."

 

Dan Basse, president of AgResource Co., acknowledged the problems with the industry but said there's not much correlation between animal numbers and feed use.

 

"I think the issue here is not so much the herds but the negative margins," Basse said. "There is a relationship between negative feed margins and corn use."

 

Although weakening demand has prompted some chatter among traders recently, it has mostly been drowned out by the bullish declarations stemming from the slow-starting crop and fund activity.

 

"It's something that I as an analyst probably won't be giving a lot of attention until we get a crop size determined, and decide how high prices will have to go to ration or slow demand to leave us adequate stocks. " Basse said of the feed issue.

 

Basse is among many analysts who see 2009-10 corn carryout headed below 1 billion bushels. Others say that weakening demand will keep a reduced crop from pushing carryout too low.

 

Kleist said the psychology for market bulls right now is: "The USDA says we're going to have more feed use? Sure, I'll go along with that."

 

But weaker feed demand will be a limiting factor for any potential market rallies later this year, analysts said.

 

If the corn crop takes a big hit this year - it is considered more susceptible to extreme summer heat or an early first frost because of its late progress - the livestock sector could be in even greater peril, analysts said. Producers can't handle any more increases to feed costs, they said.

 

"That would be the final death blow," Karlin said. "At that point, you're going to do some real long-term structural damage to the meat, dairy and poultry sector."

 

Analysts said the recovery in feed demand will be closely tied to any recovery in the economy.