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An Overview Of Feedlot Economics

We all remember the commodity meltdown last fall; cattle prices were not excluded as the overall economy moved into recession. While we like to think the worst is behind us, there are still many risks coming forward that will influence feedlot economics in the final quarter of 2009 and the first half of 2010. In this issue, I want to provide a brief overview of each factor influencing feedlot profitability.

Statistics Canada reported barley stocks as of July 31 at 2.84 million mt, which is 0.5 million mt above the 10-year average carryout. Given the larger carryout from 2008/09, there is more of a cushion on new-crop prices and less concern about the smaller barley production. Ethanol plants in the U.S. continue to run at full capacity resulting in a steady program of DDGS into major feeding regions of Western Canada. The stronger Canadian dollar will also increase buying power for alternate U.S. feed grains. At this time, the U.S. corn crop is in the final stages of development and there are many production estimates coming forwad. It is important to note that a small change in corn supply can have a large influence on price because of the ethanol component. Therefore, avoid becoming too bearish at the lows. Crude oil prices are expected to consolidate in the short term and then trend higher in the early part of 2010. This will drive all feed grain prices higher as we experienced in the 2007/08 crop year.

COOL is having an effect on the feeder cattle trade, especially in Manitoba and eastern Saskatchewan. While it is difficult to set a quantitative value on the market influence, feeder exports to the U.S. have slowed and will likely be down significantly from last year. In addition to COOL, lower demand can also be attributed to U.S. feedlots wanting age-verified calves. COOL and age verification go hand in hand. We will likely see larger numbers of feeder cattle pushed in Canadian feedlots due to the limited export movement. This will temper the upside in the feeder market, despite the lower-priced feed grains.

U.S. on-feed numbers will continue to trend below year ago levels but Canadian numbers are expected to be similar to last year. This is largely due to lower feeder cattle exports. Lowerpriced feed grains and poor margins in the feedlot sector usually result in higher carcass weights. This may cause beef production in the fourth quarter of 2009 and first half of 2010 to be similar to year ago levels. Secondly, lower exports will cause domestic beef supplies to increase. Therefore, the function of the beef market is to encourage consumption.

Beef demand in North America continues to struggle. Consumers are cash strapped and credit strained. Restaurant traffihas been declining for 13 straight months, keeping the choice select spread relatively narrow. Triple A values in Canada are also grinding lower into the fall period as the industry pushes larger beef supplies through retail channels. U.S. unemployment is nearing 10 per cent and growing while Canadian unemployment is running at 8.7 per cent. In Canada, there were 7.1 million women in paid employment in August, up 0.6 per cent from last year. More women working outside the home results in lower beef demand. Consumer expenditures and beef demand are also very highly correlated. Until we see consumer confi-dence increase for the average person, it is difficult to forecast higher beef consumption.

There is a general consensus among analysts that the U.S. dollar should continue to weaken into next year. At this time, the U.S. Fed fund rate is in the range of 0.0 per cent to 0.25 per cent while the Canadian rate is 0.25 per cent. Canadian interest rates are showing a small premium over U.S. rates which should cause the Canadian dollar to gain against the greenback. The weaker U.S. dollar should also be supportive for crude oil and commodities in general in the upcoming six to eight month period. Over the past year, there has also been a strong correlation between weaker interest rates and stronger equity values. It is important to note that cattle prices generally lag leading indicators such as crude oil and the Dow Jones Industrial average by approximately six to eight months in bullish markets.

Cattle feeders are usually eternal optimists but the overall environment is somewhat negative for the next six months. Feedlot margins will continue to struggle for the remainder of 2009 and into 2010.

Gerald Klassen analyzes markets in Winnipeg and also maintains an interest in the family feedlot in Southern Alberta. For further information, comments or questions, he can be reached at[email protected]or 204 287 8268.

The material contained herein is for information purposes only.

About the author

Columnist

Jerry Klassen

Jerry Klassen manages the Canadian office of Swiss-based grain 
trader GAP SA Grains and Produits Ltd., and is president and founder 
of Resilient Capital specializing in proprietary commodity futures trading and market analysis. Klassen consults with feedlots on risk management and writes a weekly cattle market commentary. 
He can be reached at 204-504-8339.

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