Greetings traders from all around the world.
Thank you for joining me yet again for another Survival Guide episode.
Today, we're going to be covering cattle futures, which has had a profound effect,
as many things have had since the coronavirus pandemic began.
As you can see over here,
we had a tremendous fall off sometime around the beginning
of March, and have yet to break through the support lost, working
as an area of resistance in the future.
So we're going to dive into what cattle futures are, how they
can be traded, as well as some of the strategies that go into
trading cattle futures.
So without further ado, let's get going.
Cattle futures!
Are we talking about spooky time-traveling cattle from the future?
No, luckily we are not. Instead,
we were actually talking about financial instruments that
give the buyer the obligation to purchase a set amount of
cattle on a certain date and for a certain price.
This means that the futures contract buyer and the cattle
producer can lock down a price in advance
so they are not at the mercy of price fluctuations at the
time of sale. Cattle ownership is a pretty significant
investment, therefore, producers need to be able to calculate
their break even points and lock prices in on their commodities
for better price management instead of waiting and getting
whatever price happens to be in the future. Many cattle producers,
a futures contract means to them, that they can now mitigate
risk to ensure they are still operating next year.
The majority of people out today that are trading cattle
futures at the largest of scale would be our ranchers, our
leather manufacturers, as well as small businesses.
In the world of cattle futures trading there are two types
of contracts to choose from, and both of them are traded on
the CME, otherwise known as the Chicago Mercantile Exchange.
We have live cattle and we have feeder cattle.
The underlying difference between the two being the feeder cattle
and the live cattle comes down to the age and weight of the cows.
The feeder category comprises of cows within the calf stage
until they reach a weight of 600 to 800 pounds that is.
This weight gein period can take anywhere from 6 to 10 months
after the cow is weaned from its mother.
So we want to think of the feeder cattle as the cows
that haven't plumpened up enough and still need to be fed more.
So after the cows mature through the feeder cattle stage
The cows are then transferred to lots, which
some of those lots can hold over 50,000 cows.
That's a whole lot of cows.
These cows then fall into the live category
and are kept there in order to continue gaining weight
until they are ready to be slaughtered.
The largest producers of these cattle in the US are: Texas, Arizona
Kansas, Colorado, Nebraska, California, and Iowa.
I don't think it's really any surprise to anyone that Texas
has a lot of cattle, because they have a lot of what? Cowboys.
Naturally the survival guide wouldn't be complete
if I didn't give you some reasons to consider joining "the herd".
See what we did there.
Our first reason is going to be betting on global growth.
The global economy and population are growing, and with it,
the demand for animal proteins, including beef. The United
States, China, and Brazil are the largest consumers of beef
globally, while China, South Korea, and Russia are some of the
largest global importers of beef. The growth of these powerhouse
economies alone is enough to want to bet on continued solid
expansion and profitability, especially when you consider
the expected rising demand from emerging market countries,
as well as Asian markets. Our number two reason to join "the
herd" is going to be a hedging against inflation. Investing
in stocks and bonds is a proven way to hedge against the
loss of purchasing power due to inflation.
The same principle applies to cattle. The steady rise
in the prices of goods and services is ubiquitous worldwide.
You can expect the live stock price to increase, should the
economy experienced higher inflation.
This is because meat and milk from cattle fall under the
food category, which remains the most basic and fundamental
necessity of humans everywhere.
This means we might as well benefit from these expected inflationary
trends. Our third reason to join "the herd" is going to be portfolio
diversification. This means if you've been looking or considering
less traditional investment forms, or are looking to break
into commodities markets, the livestock futures market may
just be the ideal starter for you.
It is a good way to diversify your portfolio due to a low
correlation with the equity and fixed income markets.
As we mentioned previously, live cattle futures are in fact
traded on the Chicago Mercantile Exchange.
The price is quoted in cents per pound. Various market players,
including cattle producers, packers, consumers, and independent
traders all trade using live cattle contracts.
The reason that this type of contract is so interesting and
popular to all of these parties is it gives them an opportunity
to hedge their market positions and reduce the notorious
volatility and uncertainty associated with live cattle prices.
It also allows market participants to assess and bet on cattle
demand and supply in the present and in the future.
Here we have the live cattle contract specifications, as can
be acquired from the CME group's website.
The contract ticker symbol will be LC,
but as far as the electronic ticker symbol, that will be LE
if you're looking. The contract size will be 40,000 pounds
of live cattle, being the underlying commodity over here.
The price fluctuation will be $10 per contract, which is
going to be somewhere around
.00025 of a pound. The trading months will be February, April,
June, August, October, December, and the trading hours will be
Monday through Friday 8:30 a.m.
to 1:05 p.m. Chicago time.
The termination of trading will be 12 noon Chicago time on
the last business day of the contract month.
We don't have a whole lot of random breaks occurring with
this futures contracts, as we are familiar with others futures
contracts that we have discussed in the past.
As with any type of trading or investing, we should always
be aware of some of the risks that might potentially present
themselves in the area that we're interested in trading.
In this situation, we're talking about live cattle future trading.
So let's cover some of the top three things that we should
be aware of here.
Number one is going to be the volatile prices. Unlike with
gold or crude oil like we've talked about in the past, the
primary traders of live cattle are not speculators like you
and I, but industry players looking to hedge their risk exposures.
This means that sudden events like changes in feeder cattle
supply, consumer demand, weather, among other factors, could
lead to extreme price volatility.
Our number two risk we should be aware of is the healthier
living and environmental concerns.
The beef production process is heavily energy-intensive. In
addition, the Amazon Rainforest and other forests are being
cut down to make room for livestock.
This only fuels negative perceptions about beef consumption
as not only a poor dietary option, but also one that affects
the environment in a poor manner. Number three on our "be on
the lookout" list is going to be bovine spongiform encephalopathy.
This is going to be BSC, which most of us will recognize
when I say: mad cow disease.
So known as mad cow disease, BSE is caple... capable
...
Known as mad cow disease,
BSE is capable of crippling demand for beef products on a huge scale.
Naturally, an outbreak affects the trading volume adversely,
and cattle prices ultimately will plummet any time there
is a hide mad cow disease scare.
On the subject of feeder cattle futures, feeder cattle are
crucial to the global ecosystem of beef production, and they
are a vital commodity in the world.
The industry is also responsible for millions of jobs.
This includes suppliers, distributors, and retailers. Consumption
of beef worldwide is teetering at around 60 million metric
tons annually, and the economic impact in the United States
alone means the meat and poultry industry is worth over 1 trillion dollars.
That is a powerhouse to say the least. One of the most appealing
features of feeder cattle futures is that they allow traders
to play an active role in the all-encompassing market, which
includes price demand for feed grain, and the cattle themselves.
In addition, traders are able to address the price risk among
those involved in the trade of feeder cattle for both the
current and future outlook.
Here, we have a feeder cattle contract specification sheet.
The contract ticker symbol will be FC, but the electronic
ticker symbol will be GF
if you're looking to type it into your platform.
Our contract size is going to be 50,000 pounds, or 23 metric tons.
That is a lot of cattle.
The underlying commodity is going to be feeder cattle, of
course, and our price fluctuation will be 1250 per contract,
otherwise .00025 a pound. Our trading months will be
January, March, April, May, August, September, October, and November.
The trading hours will be the same as our other contract
that we already discussed; Monday to Friday 8:30 to 1:05 p.m.
Chicago time, with the termination of trading occurring on
the last Thursday of the contract month, with exceptions for
November and other months.
Just as we discuss the potential risks associated with live
cattle futures trading,
there are risks associated with feeder cattle futures trading.
Boy, say that one five times fast. The first risk we should
discuss is the open interest gap between live cattle and
feeder cattle contracts. As the trade volume between the two
types of contracts widen, increase vulnerability starts to
set in. This is especially true with the weight of spreading and crush trades,
derived in the live cattle market, which overwhelms the feeder
cattle contracts. This eventually makes price nothing more
than a reflection of the direction of the deferred live cattle
contracts. Then we have number two, which is going to be
fluctuations in feed prices. These include prices in hay,
corn, and soybean. Any of these can directly affect the feeder
cattle market. If the feed prices are too high, cattle are often sold at
lower weights, which results in price drops for the cattle market.
Then we have number three: Extreme weather. High temperatures
can decrease the appetite of the cattle, which in turn reduces the amount of weight
they gained while at the feedlot. This again results in lower cattle prices.
As with all futures trading, having a strategy or a plan of
attack is crucial to success.
We have three different strategies in regards to cattle trading
that should definitely be talked about before going forward.
The first idea is invest in a diversified basket of commodities
that includes the cattle contracts.
Due to the large price volatility of futures, you'll want
to think carefully before taking large speculative positions
in the commodity. One good way to mitigate this risk is to
invest in a basket of commodities
that includes cattle, poultry, other agriculture commodities,
metals, and energy. This approach can help us accomplish a
couple goals. It protects our portfolio against inflation,
and it also protects against the volatility of price movements
of each individual commodities.
Then we have number two, which is to look for imbalances
in the prices between live and feeder cattle. The prices of
live cattle and feeder cattle are highly correlated, which
often leads to traders trying to profit from the spread between
the two. For instance, some traders capitalize on the price
spread between live cattle and feeder cattle, as well as the
price of corn and hay needed to feed them.
What traders often do, is buy live cattle and sell futures
in feeder cattle and corn. This is definitely a sound
strategy that can also lead the trader to benefit from price
discrepancies between the two types of cattle. Feeder cattle
represent future supply,
so any disruption will most likely influence the price in the demand
for live cattle. In the event of live cattle over supply,
the price for new cattle coming onto the market will also
be affected. Then number three: We have trade in meat production
and processing stocks.
If you'd rather skip the nitty-gritty that's involved in
just directly trading the asset of cattle, live or feeder cattle futures contracts,
you have the option of marginally being invested, just down
the line by trading in meat production and processing stocks, like companies
such as Tyson Foods or Cranswick.
There's a bunch of companies out there that are indirectly
related to the value of the feeder and live futures cattle
contracts, and trading in them will give you a way to be involved
with the market, without being directly involved with some
of the higher volatility aspects of live and feeder cattle trading.
Here, we have a chart to help us illustrate some
of the seasonal fundamentals associated with live and feeder
cattle futures trading. Based on historical data, cattle
prices tend to increase just before and during the summer
months, but not necessarily because it is prime grilling season.
After all, the feeder cattle used to supply that beef were
already being priced back in February and March, and conversely,
summer is when feed supplies are lower and more expensive.
As we can see, as we work away from Spring to Summer, the cattle
price actually has a rise where it overlaps the dropping
feed supplies themselves.
We see the overlap here, where then as we work in Autumn,
we have a sharp decline in the price of cattle, where the
feed supplies then jump up higher, giving the decline in cattle
the somewhat correlation there.
The global outlook is good news, for those of us that are
interested in feeder and live futures cattle trading. The
United States Department of Agriculture, which we all know
as USDA, estimates that beef exports will increase by more
than 2.7% this year.
This is mainly because of the potential expansion of markets
in Asia. For instance, on May 17th of 2019
the overall CME market surged following the news that Japan
was reopening full beef trade with the United States, causing
a sharp incline in prices. On the global scene,
the production of cattle is forecasted to grow somewhere
around 1% this year to 63.6 million metric tons.
This growth is driven by Argentina, Brazil, and the U.S.
at the top. These top producers, and exporters for that matter,
are looking to increase their output to meet growing demand in Asian markets.
They're also looking to capitalize on the weather-related
herd reduction in Oceania, as the anticipated competition
in Asian markets is lowered.
With this anticipated rise in cattle supply,
it is likely that the cost of feeding cattle will also rise
this year, especially as the feeds industry will work to
keep up with a higher demand for live and feeder cattle.
In conclusion, live cattle futures and feeder cattle futures
make it possible for beef to not only be something that we
have on our dinner plate, but something that we can use as
a way to diversify our portfolio, and/or increase our overall futures trading gains.
Currently, the market has seen a tremendous fall.
We watched it fall to extremely low levels as a result of
the coronavirus, now exhibiting a very range-bound volatile
behavior, awaiting the next big move. If you get into the game now,
there's a good chance that you might be able to stay ahead
of the curve when that next big pop happens.
But until next time, thank you for joining me for another
Survival Guide episode everybody.
Please make sure to click the like and subscribe button down
below, and I'll see you on the next one. Over and out everybody.