Looking Ahead to Winter

Hey Joe! As a farmer/rancher, I'm already making plans for Winter. Can you help me with the relationship between grains and cattle?

We need to begin with the fact that a trend is driven by change. Prices are highest when "things are so good they couldn't be any better!" Prices are lowest when "things are so bad they can't get any worse!" In between, new fundamentals emerge and supply/demand balances shift — and Hope, Greed, and Fear ride changing expectations.

But change is not continuous. Sometimes, its task of balancing supply and demand accomplished, a market rests. Hope, Geed, and Fear take a holiday. Minor shifts in supply/demand remain within the general boundaries of balance. Prices fluctuate back and forth, but within a range. If that range becomes well defined, it can be identified, perhaps even traded. One of our best students has made a fortune trading cattle options when prices are sideways.

This concept is transferable to spreads, the primary difference being that the market must balance supply with demand either over time or between commodities.

When grains are high in price, we should take a look at cattle since they are directly affected by grain prices. Most U.S. cow-calf operations are in regions with harsh winter weather. In order to increase the rate of survival, those cows are bred to bear calves in the spring. This seasonal bulge in the breeding pattern is eventually reflected in the slaughter pattern, with total production (weights plus numbers) tending to decline from December into March and April, and numbers often highest in May and June. The price effects of this pattern of supply are exaggerated by the pattern for demand; declining production during the first quarter coincides with higher consumption because of cold weather and school lunch programs, whereas slaughter is heaviest just before retail beef demand is weakest during the hot weather of July.

Generally, prices for cattle tend to begin a seasonal rise from a December slump in beef demand, other meats being featured for the holidays. Conversely, prices tend to decline into June and July from March and April. The spread created by going long December cattle and short June Cattle tends to inversely reflect these seasonal market tendencies, favoring June during the first quarter into the peak of market strength, only to reverse thereafter in favor of December as the cash market declines. Going long December cattle and short June cattle is usually profitable if the spread is entered in the last week of March. This spread can also be done using options.

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