Featured Article

How Do You Stop a Cattle Stampede?

Don Dawson

And the answer is – you put a picture of Live Cattle eating alfalfa and a headline under it stating “Beef Prices Headed Higher.”  Normally this type of article would not have much market impact nor would it have caught my attention.  However, it was February of 2012 and I remembered that the Live Cattle market had been in a very strong, sorry I have to do this – bull market.  Figure 1 will show the uptrend in Live Cattle starting in December of 2009 at approximately 80 cents per pound.

Figure 1

In February 2012, when I saw this article prices were trading for $1.30 per pound.  Not only was this an extended trend in beef prices it was also lifetime highs for beef products.  Live Cattle trade for $400 per cent (full point).  Some two years and $20,000 per contract later a newspaper article is coming out suggesting higher beef price.

Understanding when to follow the fundamentals of a Commodity market is just as important as knowing how to read a chart.  I am going to highlight some of the bullish fundamentals that this newspaper article (name of the newspaper is not important, any news service can and will do this) wrote about and then you can look back at Figure 1 and see if this was a case of “a little too late.”

2012 Live Cattle supplies are expected to be low and will lead to higher prices.  Consumers love to eat beef and most consumers were dealing with the high unemployment rate and if they were working, received only modest wage increases.

Each month the United States Department of Agriculture (USDA) releases a Cattle on Feed report.  For the agricultural markets this is a highly followed report much like the monthly unemployment number is watched by financial traders.  This report was released a few days before the newspaper article.  It stated that there were about 91 million head of Live Cattle on January 1, 2012.  Year over year this report was down 2% showing the tighter supply of Live Cattle.  The next line read like this “and this was the lowest level since 1952.”  Maybe because I was aware that Live Cattle was already overextended (markets had already priced this news in), I did not get the urge to buy.   I tremble to think how many traders actually called their Commodity brokers that day and instructed them to buy Live Cattle contracts.

Since Live Cattle Futures prices are tied to the cash market you should expect to see retail prices for beef up 4% – 5% this year and that is after a 10% increase for all of 2011, which is more than double the inflation rate for all food.

Weather was another issue the article addressed.  Last year residents of Texas and Oklahoma experienced the worst drought in 50 years.  This caused grass to burn up and a large water shortage, two essential products for raising livestock.  With these two resources scarce, ranchers were forced to sell the majority of their herd to feedlots and slaughterhouses earlier than they had planned.

To add to these problems ranchers were already faced with all time high Corn prices – primary feedstock for Live Cattle.  Herds were already being reduced to compensate for high feed prices, thereby reducing supply of Live Cattle.

And of course we cannot forget about the export demand for United States beef.  With excessive demand from Canada, Japan, South Korea and Hong Kong, beef exports jumped 22% last year.   One of the contributing factors to this international demand was the falling Dollar allowing foreigners to purchase our Commodities for less money.

Another interesting comment was that the Live Cattle market had already rallied 20% over the last 12 months.  At some point you just have to ask where is this new money going to come from to make prices go higher?

Another section discussed an interview with a rancher who was replacing his tractor, installing new water tanks and purchasing steel fencing for the corral all thanks to the double digit increase in profits for ranchers.  A red flag to traders looking to buy Live Cattle after reading this newspaper article was that this same rancher now plans to increase their herd size, as more supply of Live Cattle = lower prices.  Stock market investors could use this type of information to find companies that manufacture, process or ship these products that ranchers will need in the near future.

The last portion of the article addressed how the meat packers and retailers of beef had a hard time passing these increases onto consumers due to the economy.  Many of the packers and retailers actually subsidized the price to keep prices down for retail consumers.  There were expectations that these same packers stand to lose about $312 million this year.  If you are an aggressive trader in Stocks you could research some of these meat packing plants and other companies associated with them and look for shorting opportunities on your charts, perhaps.

You can see that for a trader who is trying to make trading decisions on fundamental news like this newspaper article that they could easily be buying the top of the Live Cattle uptrend.  And when prices make a sudden drop after they buy you can probably hear them ask: “Where’s the beef?”

Is the information in this newspaper article useless?  Absolutely not!  The fundamentals that the author wrote about are all excellent  observations about the Live Cattle market.  Since long term trends (months to years) are driven by fundamentals in the Commodity markets, the points in the newspaper article are still very valid; they were just not timely.

Unfortunately, traders who try to trade off of fundamental news from the media are usually stopped out of their positions before the trend resumes.  There is just too much leverage with Commodity Futures contracts to “buy & hold” like an Equity trader might do.  This is why technical analysis is so important for a trader to understand.  Anticipating where a market might turn and resume the trend with little risk and great reward should be your goal setting up any trade.

I still see many of these fundamentals holding up in the Live Cattle market for 2012, but prices need to re-adjust to lower levels to offer a better entry for a long position.  Once these prices do drop as we see they are doing in figure 1, we can then look for strong fundamentals to support our technical levels on the charts.

The problem with getting your fundamentals from the media is that once prices drop in Live Cattle, the media will be talking about how bad the fundamentals are for Live Cattle.  Just by their nature the media is usually 180 degrees out of phase with market fundamentals.

I had a student write me with his view on fundamentals and I would like to share that email with you, as he really made it clear about media news.

Don, we were talking about fundamental analysis and news earlier today and I remembered a good analogy between news and the markets.  The market is like an organism, it needs food to grow and change.  This food comes to the market in the form of news (media).  However, by the time you get the news the market has already digested it and we all know what digested food is!

 Trade the charts – then the fundamentals.

This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.