August 10, 2014

A small preface: What I try to in this newsletter is show you the primary reasons leading me towards conclusions as to where I think there are opportunities to make money in the futures markets. I really don’t care which way any of the markets are heading---I just want to make the right “read”. I derive zero benefits from being wrong---Beyond that, my next objective is to present my opinion, in plain English, as clearly and concisely as I possibly can…in hopes you will see what I “see” and act on the ideas. As stated on my website, this newsletter is my primary sales tool and if you think my research has value, please do feel free to pass it along to anyone who might have an interest. And as, always, I welcome any feedback you might have. Thanks. Bill

 Cattle: The Collapse Has Begun?

The Cattle and Hog markets are obviously interrelated in that they are essentially the same basic product. While certain aspects of breeding and growth  cycles are different, they both involve feeding and fattening an animal until it is ready for slaughter.

They also compete for consumer dollars. For example, ff beef prices are out-of-sight compared to pork, the result can be less demand for beef, more demand for pork…or vice-versa.

Understandably, with both products being staples in the American diet, it is no surprise Cattle and Hogs often trade together (chart following), as whatever happens in one of them can easily affect the other.

For the past few years, both markets have had bullish stories to spur them stratospherically higher, particularly the cattle I think, and if what comes next is anything like what I’ve seen 1000 times in futures, we’ll now see both markets going totally in the tank while analysts keep chirping about the “historically low numbers” and “strong demand”…ALL THE WAY BACK DOWN.

As I am forever reminding you, price levels in the futures (and equities) markets are determined by mob psychology more than anything else. Certainly, supply and demand imbalances do contribute to prices moving higher or lower, but I remain convinced that the actual levels markets reach have nothing to do with reality…that there is NO way to say, “ Supply is X. Demand is X. Price should be ____”. NO WAY. Where prices finally end up is more a function of fear, greed and a somewhat infinite avalanche of speculative capital that I firmly believe does drive markets to truly incredible extremes…So I’ll say it again: I cannot count the bull markets I have seen that have reached those improbable extremes…and then fallen straight off a cliff.

As market tops can be insanely volatile and seemingly beyond reason in where and when that highest “tick” occurs, shorting a market that has been roaring ever higher is undoubtedly one of  the toughest trades to make in this business…, but the flip side is, in my opinion there is nothing that happens bigger or faster than a commodity market that has finally “flamed out”. Futures tend to go down faster than the go up…and when they falling away from crazy price levels, I think it gets even more dynamic. A LOT CAN HAPPEN IN A MONTH OR TWO.

AN EXCELLENT EXAMPLE OF SUCH A COLLAPSE CAN BE SEEN IN THAT VERY SAME HOG MARKET SHOWN ABOVE, WHICH HAS JUST LOST 15% OF ITS VALUE… IN THE LAST 30 DAYS…ON ZERO BEARISH NEWS WHATSOEVER.

In fact, just a week before that top tick was made on July 1st, the USDA published their June Quarterly Hogs & Pigs report (a big deal in this market) and here is a sampling of analyst’s opinions following the report, all of which expressed the same sentiment: Unequivocally Bullish for Prices…And I did not cherry pick these “expert” comments. I know they must be out there but I could not find a single bearish analyst.  

Take a look at what the overwhelming consensus was about future prices in the Lean Hog market (immediately preceding this 15%, one month collapse):

June 30 (the Monday after the Friday afternoon report)-

“Lean hog futures finished sharply higher on the day with August through May 2015 contracts settling up the daily limit following a sharply bullish response to the hog and pig report. The report reemphasized the lasting effects of PEDV on the hog population and lack of expansion in breeding inventory that most had expected to have shown improvement.”

"This was a bullish report as the key numbers came in well below the trade estimates. If USDA's numbers are close to right, this year's hog slaughter will be around 110.5 million head, the smallest since 2006.”

“Friday saw the USDA Quarterly Hogs and Pigs Report which was viewed bullishly for hog prices.”

“A lot of the numbers reported came out below the pre-report estimates. A number of sources are calling it a bullish report.”

“Pork producers might want to say thank you for the recent USDA reports that have sharply brightened their profit outlook.”

As noted, all of those statements (and innumerable others expressing the same sentiment) were made the day after the report…and yes, the market did keep trading up another 5 trading days, surely sucking in more bulls, but on August 7 it closed higher…and the top tick was made. IT WAS OVER. And here is one more quite typical comment following that last higher close, still expressing the bullish sentiment that was still present everywhere:

Aug 7-

“Hog Highlights

• Holding mild to sharp gains develop as near term fundamentals remain positive

• Buyers continue to remain aggressive in deferred contracts with Oct leading gains”

AND THEN THE DECLINE BEGAN…No new news hit the markets. There were no bearish reports. In fact, even though futures had topped, the cash market kept going up and didn’t make its all time high until 9 days later, and  in general, I can assure you that all those people who were unanimously bullish a week earlier had not changed their opinion…The bull market just quit, same as they eventually ALWAYS do, with everybody thinking any pullback is something you want to buy. But it’s NOT.

What the decline can look like…

When markets are falling from major highs, the damage can be relentless…a  day after day after day sort of thing, as there just are no more buyers anxious to get in (everybody is already “in”), just a bunch of people losing, worrying and wondering, “Why in the hell is the market going down? All the fundamentals are bullish”. But the bottom line is they are losing, and starting to lose big, and masses of traders/hedgers having nothing they can do but SELL. And here is what it can look like on a chart when this “relentless” sell off is taking place…

What follow is a “candlestick” chart that uses colored bars to more or less denote strong days and weak days. Specifically, if a bar is green, it means the market closed that day higher than it opened. If a bar is red, it means the market closed lower than it opened…Without getting too technical, I’ll just give you the obvious: If it’s green it most likely an up day. If it’s red, it’s most likely a downer.

While there are certainly some days that are larger than others, what I really want to point out is the cumulative damage that has taken place in one month’s time.

Here’s the contract since it started trading 15 months ago…

And here’s a close up view of the past 4 months…

Or here’s another perspective…Simply counting higher closes and lower closes…

Since that July 7^th high…

My point? When it’s over. It’s often REALLY OVER…and though it doesn’t have to be the case, I see NO reason why it should now be any different in Cattle.

THIS IS A GAME. When something starts happening, it just happens. Markets become loaded with too many people (by which I mean everybody) who have totally bought into the story that is everywhere in the media. They can be speculators, producers or end users who all conclude “the market is gonna stay strong for a long time”. Specs can be loaded to the gills on the  long side. Users who know they have to buy in the future, having become absolutely convinced waiting will only cost them money, go ahead and do so now…and CATTLE PRODUCERS, who should have sold animals that were “ready” in the last 2-3 weeks, but were holding off on those sales because the chatter was SO bullish and they were SO sure they could get bigger bucks for every steer by waiting a few extra weeks, suddenly realize the market has DROPPED SHARPLY (as it did this past week)…and just as suddenly we get three or four weeks of cattle being dumped on one week’s market…BANGING down cash prices (contrary to quite opposite expectations)…Then EVERYBODY who owns them starts getting nervous, more anxious to sell and a chain reaction gets started…And it’s the same old futures story: When a market has topped, IT DOES NOT MATTER HOW BULLISH THE “FUNDAMENTALS” SUPPOSEDLY ARE. PRICES HAVE NO PLACE TO GO BUT DOWN…AND OFTEN IN A BIG HURRY.

Both Feeder Cattle and Live Cattle finished substantially lower this week…and without going into detail, I WILL say there are a number of similarities between Cattle today, and Lean Hogs a month ago…inclusive of a July 25^th USDA Cattle on Feed report that was unanimously called “Bullish” (lowest numbers in years) and a cash market that WAS (until last week) absolutely giddy on the upside…And I DO CONTINUE TO BELIEVE THE CATTLE MARKET IS FACING, DEAD AHEAD, AT LEAST A 25% DECLINE IN PRICES AND I CONTINUE TO BELIEVE IT WILL BE DOING SO IN FAIRLY STRAIGHT DOWN FASHION.

I RECOMMEND BUYING PUTS IN BOTH FEEDER CATTLE AND LIVE CATTLE…

Here are updated charts and possible options to use…

While nothing is certain in this business, and though I may be dead wrong, I think there is enough evidence to argue the move HAS started…and it is definitely time to initiate new positions, or add to existing ones…Furthermore, if you look at last week’s action and think, “ I missed it”,  I would emphasize it is NOT too late to get on this…All we have had, really, is one decent down week…and I think there will be MANY more to come…In fact, my guess is this bearish “phase” is going to last all the way out into next spring…at a minimum.

Maybe I’m wrong, which generally means losing money, but I think this is a killer…NOTHING stays up forever in this stuff…EVER…and I honestly don’t think you will ever get a shorting opportunity much better than this…

And Finally, if you are a cattle producer, I would urge you to NOT just sit there and “see how they do”. You know how it goes in your business. It can be real good…or REAL BAD…and you can’t ever afford to forget this. In general, I think you should be hedging your production (buying puts) all the way out to next summer. Those puts may look expensive, but if you figure a 25-30% drop from current prices (or worse…It CAN happen), those options are NOT expensive…Remember $18 Soybeans, $8 Corn, $10 Wheat, or $2.25 Cotton in recent years? And look at them now…and the percentage changes in their values...and remind yourself, Cattle are no different.

And a quick last note…Per that very first chart, comparing Cattle and Hogs for the past 40 years, and my point that they “trade together” to some extent? Wouldn’t you suppose the 15% (to date) drop in Hog prices must represent SOME degree of competition for sky high beef prices? And have SOME impact on beef demand? Seems logical to me…We’ll see.

Thanks…Give me a call if you are interested…I think this is it…FINALLY.

Bill

866-578-1001

770-424-7241

The author of this piece currently trades for his own account and has financial interests in the following derivative products mentioned within: Feeder Cattle, Live Cattle