As we look to the coming year for pork producers, the futures market suggests that lean hog prices will be substantially higher than last year and this is leading to the outbreak of cautious optimism by many producers. I spoke to one yesterday who just finished his 2010 cash flow and he believes that this year could be his best year ever based on having fixed his feed prices for the year and watching futures prices for hogs inch up. I hope he’s right but before you dust off those deposit slips it’s a good idea to take another look or two or three at your future’s price screen on the monitor.
We know now that there is no such thing as a high hog price anymore, at least relatively speaking. With the volatility that can emerge on short notice from the grain markets, you really have to have three or four eyes on the screen to assess your coming year; one on hogs, one on corn and one on the bean meal complex. A fourth eye would also be useful. Since all of the previously mentioned goods are commodities, their prices will be affected not only by their own supply and demand and the supply and demand of their substitutes, but also by the supply and demand of U.S. dollars and inflation.
Since corn prices are now tied to oil prices and oil prices are valued in U.S. dollars, anything that affects the price of oil or the value of the dollar will be potentially felt in your feed costs but may or may not affect hog prices. On any given day, as you watch the futures prices of hogs rise, you are also likely to see the futures prices of corn and bean meal rise enough to remove your initial rush of optimism from all those green arrows on the lean hog price screen. This is why many producers are charting the “hog crush” each day (the expected change in return over feed cost implied by changes in the corn, bean meal and lean hog contracts). If the value of the dollar falls against other currencies and/or inflation begins to heat up in the U.S. economy, oil and other commodities like corn and hogs get “re-priced” to reflect these changes in underlying value.
Most economists believe we have inflation in our future. The root cause of this future inflation is really two possible sources and there is disagreement on which one (or if both) will play a major role. First, the dramatic easing of monetary policy (low interest rates to encourage borrowing) has flooded new money into the marketplace. This can cause inflation since a flood of new dollars makes each one less valuable as long as the total money supply in the economy increases. The offset to this flood, however, has been the destruction of wealth and so-called deleveraging that is taking place as home and other asset values plunge all across the U.S.
Think of your bathtub faucet running full blast with the drain wide open. The tub may gradually fill if the drain doesn’t keep up with the inflow. The fed is watching our tub and believes it can turn down the faucets (raise interest rates to slow borrowing, for instance) if the water starts rising in the tub. Inflation happens when the flood coming in exceeds the disappearance of wealth that is draining from home values, 401k’s and business balance sheets etc. and that drain has been so significant, the flood has not resulted in rising water levels.
The second source of inflation has to do with the level of debt the U.S. government has taken on. In order to pay it down, government income has to rise or government expenditures need to fall. Neither seems likely in the current environment. Countries like China and Japan who lend us a great deal of money know that if inflation begins to take hold, the dollar value of debt will not change but the purchasing power of the dollars they are repaid may be substantially decreased. The hedge against this future loss of value is to demand higher interest rates to lend the U.S. more money so interest income offsets the declining value of the principal dollars repaid.
When the cost of repayment of our debt mountain rises with rising interest rates, we could easily be caught in a vicious cycle of raising taxes to increase government income, which will dampen business growth and household spending and since we will need to borrow to pay even the interest on our debt, new debt holders will demand higher interest payments to loan us money and I think you get the picture. Hog prices will head straight up but so, alas, will all the costs of production.
As you scan your monitor for signs of hope in 2010, make sure you are looking at it with many eyes and are calculating expected profits rather than looking at hog prices or total revenue alone. And while you are at it, keep an eye on the tub for rising water.
Editor’s Note: Dr. Dennis DiPietre is a swine consultant in Columbia, Missouri.
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