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MARKET TALK – for Sep. 12, 2011

The equity markets have been quite volatile over the past month as we have seen the Dow Jones Industrial Average swing over 400 points quite regularly. I ve received many inquiries from cattle producers asking how this will influence cattle prices in the upcoming fall period. We all remember the stock market meltdown during the fall of 2008 and during the first quarter of 2009. Cattle prices followed the equity markets quite closely as the U.S. economy went into one of the worst recessions on record. Many producers are now wondering if the equity and cattle markets will experience a similar pattern. In this issue, I m going to discuss the relationship between the financial and cattle markets.

The U.S. Federal Reserve stated on Tuesday, Aug. 9 that they intend to keep its target lending rate in the range of zero to 0.25 per cent. Recent economic data suggests that the U.S. economy is very close to slipping back into a recession. GDP was a meagre 0.8 per cent during the first half of 2011 while consumer spending dropped to 0.1 per cent in the second quarter. Americans actually cut their spending for the first time in two years during June by 0.2 per cent. Cattle producers need to remember that a one per cent increase in consumer spending equals a one per cent increase in beef demanded. Consumer spending is also responsible for approximately 70 per cent of U.S. GDP.

Therefore, it is very important to watch these numbers and projections.

Last winter the markets were factoring in an interest rate hike for November and December of 2011 but now this has been delayed. The postponement of the further hikes provides a totally different economic environment from earlier projections.

Interest rates have a direct relationship with the U.S. dollar. The greenback has been hovering near historical lows which has actually been positive for U.S. beef exports. A low U.S. dollar results in greater demand for commodities. However, Canadian beef exports to the U.S. during the first five months of 2011 were down 26 per cent in comparison to 2010.

The Bank of Canada has set its target lending rate at one per cent. If the Canadian interest rate premium over the U.S. increases, this is bullish for the Canadian dollar and if the interest rate spread narrows, the loonie usually comes under pressure. A couple days after the Federal Reserve announcement, the overnight basis swaps started to factor in a 25 point decrease by the Bank of Canada. The Canadian dollar actually dropped under the par level for a brief time period and Alberta fed cattle prices jumped $3 to $4 around that time frame. Many economists are projecting a Bank of Canada interest rate hike in the first quarter of 2012. Mixed outlooks on the Canadian interest rates will continue to result in larger volatility in the Canadian dollar.

Interest rates have an inverse relationship with the equity markets. Low interest rates are considered bullish for stock market indexes because this is a stimulant for consumer spending and business investment. When the Federal Reserve lowered its rate to zero, the Dow Jones Industrial Average moved from a low near 6,500 in March of 2009 to a high in May 2011 of 12,876.

I ran a very simple exercise comparing the weekly futures close for the Dow Jones Industrial Average and the nearby live cattle futures. From January 2008 through December 2009, the correlation between the weekly close on the Dow Jones Industrial Average and Live Cattle futures was 0.65; from January 2010 to August 2011, the correlation jumped to 0.9. There is a very strong direct relationship between the Dow and Live Cattle Futures because consumer spending is responsible for overall U.S. economic strength and beef demand.

In conclusion, the U.S. Federal Reserve is committed to low U.S. interest rates. While American consumer spending contracted in June, lower rates for the next two years should result in greater consumptive demand for commodities. If the Bank of Canada also lowers rates, Canadian cattle prices should track closer to U.S. values as the Canadian basis strengthens.

GeraldKlassenanalyzesmarketsinWinnipegandalsomaintainsaninterestinthefamilyfeedlotinsouthernAlberta.Hecanbereachedat [email protected] or204-287-8268.

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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