Tuesday, May 27, 2008

Update on Corn and Livestock

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The coming agflation in meat prices is a theme we've been watching for a long time; I've had my eye on Smithfield Foods (SFD) in particular since blog inception [Aug 26: Is Pork the Next Chinese Boom Play?] Since then, as input costs to feed livestock have increased we've seen a bevy of bad news out of the livestock producers (chicken, hogs, cattle) - one example of many posts on the subject [Feb 28: Smithfield Foods Continues to Struggle with Input Costs] I wrote then

I do think however (and today's news reinforces this thesis), this is what you will see a year from now: We are going to see cows slaughtered now because they are getting too expensive to feed. So what will that lead to down the road? You guessed it; a (relative) shortage of beef. And what does that mean for our pocketbooks? Inflation. Even more than we see now. Right now producers are passing along the grain costs - but at some point it's just going to get to a point where they raise less livestock... and for a country (world) increasingly loving protein that causes more issues.

By late this winter/early spring we started seeing the first capacity destruction at the major food producers [Mar 12: Pilgrims Pride Cutting Chicken Output] I wrote

Ironically, I just wrote about this subject in the previous post; but first mentioned it earlier in the winter - I thought it would hit cows and hogs first but it appears chickens will be the first to go. I've been writing about this group (Smithfield Foods, Tyson Foods, Pilgrims Pride and the like) since last fall, not that I am that interested in the companies themselves, but as macro economic flag bearers, especially on inflation. These politicians have helped create an epic disaster. It is playing out step by step as I forecast, but at a much quicker pace than expected. When meat producers start cutting back in the face of a spike in world meat demand, basic economics tells you where prices are going in the future. I just wrote I expect this to happen in the next 12-18 months - I was very wrong. It is already happening.

Timing the effects are tricky but I've been joking, you are going to need the equivalent of a mortgage payment for that Labor Day BBQ - I started a position in iPath DJ Livestock ETN (COW) in mid April as we started seeing some relative strength. A strategist I highly respect, Don Coxe agrees with my thesis [May 2: Don Coxe on Food Crisis] To make matters worse rainy weather in the Midwest [Mar 25: This Day in Agriculture] has created a lot of issues with this spring's planting season (most corn is no longer consumed by humans, but put into feedstock)....

So put that all together (and no, don't get me started on the ethanol boondoggle), shake it all about, and you have a thesis. One that Bloomberg reports today (citing information blog readers have known for many months) is starting to take shape, rather nicely (from our investment standpoint) and rather morbidly for American consumers. If you listen to the government, you have nothing to worry about as there is no meaningful inflation; now or in the future (they've been beating it into our heads since the first Fed cuts that they can cut as much as they want because as the US economy slows, inflation will magically disappear). If you listen to the companies i.e. Tyson Food's CEO saying "prices are going up materially", you see the truth.

As with much inflation - many of the price increases are now sitting at the producer level. So one of 2 things happen next. Producers eat these costs and their profit margins erode. Or they attempt to pass it on to a rapidly weakening US consumer. Or some of both. The key takeaway is what you see in the food aisle today or in just about any "consumer product" that requires petrol to transport (which would be.... EVERYTHING) is not showing the full effect of the inflation pass through. That should be coming in the next few quarters - coinciding nicely with the "2nd half recovery" story. (ahem)
  • Enjoy your next steak, because prices from Shanghai to San Francisco are only going up.
  • The highest corn prices since at least the Civil War, based on Chicago Board of Trade data, mean U.S. feedlots are losing money on every animal they sell, discouraging production as rising global incomes increase meat consumption and a declining dollar spurs exports. Cattle may rise 13 percent by the end of the year on the Chicago Mercantile Exchange and Brazil's Bolsa de Mercadorias e Futuros, futures contracts show.
  • Not since 1996, when corn reached what was then a record $5 a bushel, have cattle been this cheap relative to their primary source of feed.
  • ``It's pretty certain that we'll see a decline in domestic supply in the U.S.,'' Joesley Batista, chief executive officer of JBS SA, the world's biggest beef producer, told reporters in Sao Paulo on May 15. ``As a result, we'll have price hikes and improved margins.''
  • ``We expect meat prices, especially beef prices, to rise this year,'' said Peter Weeks, chief economist at Meat & Livestock Australia, a trade group in Sydney. ``We've already seen big increases in beef prices in China, Russia, India and throughout Southeast Asia.''
  • Steakhouse Partners Inc., operators of 21 steakhouses in California and the Midwest, filed for bankruptcy May 16, citing rising costs for corn-fed beef.
  • Feedlots lost money on animals sold for slaughter the past 11 months, including $139.56 a head in April, compared with a profit of $46.79 a year earlier, said Erica Rosa, an economist at the Livestock Marketing Information Center in Lakewood, Colorado.
  • Corn more than doubled in the past two years as demand for meat boosted feed consumption and U.S. government mandates and subsidies promoted the use of grain-based ethanol. Cattle futures gained just 31 percent over the period, and cash prices rose 16 percent.
  • A 1,250-pound (567-kilogram) steer in the U.S. is worth about 4.2 times the cost of the corn he consumes over five months to reach slaughter weight, down from almost 12 times in December 2005 and the lowest since June 1996.
  • Cattle may not remain cheap for long. Prices jumped 6.5 percent last month, the most since August 2006, and there are signs of reduced supply from U.S. producers.
  • As the incentive for producers dwindles, demand for U.S. beef exports will jump 14 percent next year, the USDA said. Sales will increase because of a declining dollar, rising global incomes and a relaxation of bans imposed after a case of mad-cow disease in 2003, the USDA said.
  • U.S. beef exports in the first quarter rose 29 percent from a year earlier, data from the USDA show. Increasing beef shipments to Russia, South Korea and other emerging economies will help push up prices in the U.S., JBS's Batista said.
  • Global demand for beef, pork and chicken may grow as much as 50 percent by 2020 as the population increases and incomes improve,
  • ``We are witnessing the globalization of meat as incomes rise,' (this sound sound VERY familiar to blog readers)
I keep repeating myself. We are in a global competition for resources. While our government leaders drag these CEO's up to Capital Hill to grill them for price gouging; Economics 101 continues on. In the end those with cash will prosper; those who live on debt will suffer. One day American leadership will begin to understand this - in our narcissistic world, the rest of the world continues to just be a footnote. We'll continue to report the reality here.

iPath DJ Livestock ETN (COW) is not a 'fast money' play, but I expect a nice growth curve over the coming year(s). So please stock up your freezer...

Long iPath DJ Livestock ETN in fund; no personal position

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