Market Commentary - 09/24/2010 > Beef Basis

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Friday, September 24, 2010

Market Commentary - 09/24/2010
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January feeder cattle futures are trading higher than November. That may seem reasonable, considering the recent bearishness of the feeder cattle market. Bears often sell the market by spreading, selling the front months while buying the back months. A closer look at market fundamentals, though, makes the January premium puzzling.

Steers that are 750 lbs in November will kill in April, while 750 lb January steers will kill in June. April live cattle futures are trading around $3 higher than June. When the margins between the two feeding periods are compared, January’s premium over November makes about as much sense as a cow giving birth to twin goats.

Below are the calculated margins for the two feeding periods, November to April and January to June, using futures prices from mid-morning Friday:

Apparently, the market expects cattle feeders to feed steers for $8/cwt less from January to June than from November to April. Considering that the price of corn is likely going to be lower from November to April than from January to June, and that corn is the primary variable determining the cost of gain, this leaves many feeders and traders alike scratching their heads.

Either November feeder cattle are undervalued, or January are overvalued.

But the market isn’t reflecting the conventional calculations on the front months of September, October, and November. These contracts suggest costs of gain between $88 and $91 per cwt. There appears to be no easy explanation for the discrepancy between January and the front months.

Does the January premium present a trading opportunity? Perhaps. Buying November feeder cattle and selling January, or buying June live cattle and selling April are two possible trades that would capitalize on the apparent inconsistency in the market.

But remember that the market can be wrong longer than a trader can afford to be right. In a volatile market, it is best for the producer to stick to hedging and leave the speculating to those who have the money to lose. Meanwhile, we can all scratch our heads and wonder what the market sees that we don’t.