The futures markets for live cattle and feeder cattle experienced a sharp price decline in the last quarter of 2024. Although price weakness was influenced by nearby fundamentals, deferred livestock and feeder cattle contracts also trended lower. In this article, I will discuss market behavior called “price constellation.”
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The price constellation occurs when the deferred livestock futures behave and move in lockstep with the nearby contract. There is a difference between this behavior in the cattle and grain/oilseed markets as cattle are theoretically non-storable. Understanding this behavior can be extremely valuable in the decision to move forward prize-fed cattle. It is also valuable for background workers and cow-calf producers when it comes to purchasing price insurance.
In the grain/oilseed futures markets, the price spread between the near contract and the deferred contract is largely determined by storage and interest costs. When the nearby contract expires, the function of the next contract month is to move to where the previous month expired. This is often referred to as load collapse. Traders often say that the carry charge is disappearing from the market. A larger spread between the near and postponed months is reflected in a broader base. In theory, a spread should not be greater than the full cost of storage and interest, but it does occasionally happen. A broader base is seen as pessimistic in grain markets. This is confusing for many farmers. When the deferred contract is higher, farmers assume the market should strengthen, but that actually signals the opposite. The market is asking the farmer to sell now with delayed delivery. The market doesn't want your product now, but later.
In contrast, a narrower spread between the near month and the postponed month in the grain/oilseed markets results in a stronger base level. A narrow base is typically viewed as a bullish signal for the futures market. In the grain and oilseed markets, if the nearby contract is higher than the deferred one, the market encourages the farmer to sell now and deliver the crop immediately instead of storing it.
The Fed and Feeder futures contracts are unique because cattle are theoretically non-storable. Fed cattle can be maintained for a period of time but must eventually be brought to market. Feeder cattle can be kept for a longer period of time, this is known as semi-storage. For example, a 500-pound calf can be kept until it weighs 700 or 800 pounds if the owner desires.
In this article I refer to the table below which shows the December 2023 Live Cattle Futures and the April 2024 Live Cattle Futures. Supply and demand in the final quarter of 2023 was significantly different than supply and demand in the first quarter of 2024. However, when December 2023 live cattle futures began to decline in late September, the April 2024 live cattle contract came into effect in tandem with the December contract . Producers who fed market-ready livestock in January, February and March 2024 were confused by the price trend. I received calls asking why the April 2024 contract was trading in parallel with the nearby October and December contracts. Shouldn't prices be higher later in spring than in fall 2023? This is where the misunderstanding comes into play.
The nearby live cattle contract is used to determine the price for the entire live cattle complex. The spread between December and April live cattle futures reflects how supply and demand changes between the two periods.
For example, in the third quarter of 2023, US GDP was 5.2 percent (seasonally adjusted annual rate compared to the previous quarter). U.S. GDP for the fourth quarter of 2023 should be just two percent and the first quarter GDP should fall to 1.5 percent. Strong demand in the third quarter actually pushed deferred months to higher levels. Note that live cattle contracts peaked simultaneously in December 2023 and April 2024. Feeder cattle supplies were expected to be tighter in April compared to December, causing April 2024 live cattle futures to trade at a premium of $5 to $8 to the December 2023 live cattle contract. The rally in late summer 2023 was primarily a demand feature. As demand waned, the overall complex began to decline.
Given this knowledge, it was prudent to be more aggressive in futures contracts for the fourth quarter of 2023 and the first quarter of 2024. Of course, the live cattle futures are the feed cattle futures five months in advance. Background workers and cow-calf producers must keep an eye on live cattle to determine when to purchase their price insurance or pre-order their calves and yearlings.
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