Average retail prices for beef have been brutal to most household budgets, with a February 2014 price of $5.58 for choice beef and $5.28 per pound for all fresh beef (according to the USDA). The effect on consumers is pretty obvious, but what is the effect on investors?
Let's take a look at the factors that brought us to this point.
The decreasing cattle supply shouldn't be a great surprise, as herd numbers for both live and feeder cattle have been declining for eight years now.
For years, cattle producers have been hit with a wicked double whammy of raising feed prices and difficult conditions in their own operations caused by widespread drought. Some operators could not afford to fully sustain their herds, sending more to the slaughterhouse and producing a relative temporary increase in the supply of fresh beef. Unfortunately, that set the stage for an even tighter supply in the near term. It also disrupted the natural economic flow as producers sold on an inability to feed their stock instead of the market price.
While areas of Texas are still in significant long-term drought, 2013 produced a more normal rainfall pattern, and thus more reasonable feed prices. Feedlot operations are thus starting to turn around with higher prices for feeder cattle, bringing them back into the black.
Texas is not the only feed producer, of course, and other southwestern states – especially New Mexico and California -- remain in drought. However, if the weather cooperates at all this year, producers may be in position to increase cattle throughout the supply chain. Unfortunately, it takes several years of increases in the feeder cattle herd to raise the supply of fresh beef – so even if the weather does finally turn favorable, a tight supply and high prices are with us for the short and intermediate terms.
Prices for live cattle on the Chicago Mercantile are continuing a reasonable rising linear trend from a 2009-2010 trough through the first quarter of 2014. There is little reason to expect this to change — with the possible exception of lower demand. How much can the price of beef rise before demand starts to fall and prices readjust? There is no clear consensus on this point.
Even if domestic demand falls, foreign demand is expected to stay strong. February 2014 beef exports surpassed 10% of the total U.S. production thanks to demand from countries like Mexico, Japan and Hong Kong. Mexico's increase is due to their own declining herds, and demand in Hong Kong and Japan is probably not driven by the lower end of the market (thus it is probably less price sensitive). In April, the USDA raised the total 2014 export forecast to 2.515 billion pounds of beef.
How does all this information affect investors?
If you are invested further down the chain, such as in the corporate holders of restaurant chains that use significant amounts of beef, you can expect higher prices. Thus, profit margins will shrink, and sales may drop if higher prices are passed on to consumers. It will be interesting to see the long-term effects on fast-food value menus, and whether they survive with slightly higher prices or smaller portions, or give way to other strategies. Supermarkets offer alternatives, so effects on them should be mixed.
If you are buying cattle futures or hedging, things look pretty good for you based on the high likelihood of continued price increases – except for the wild card of demand. Even if domestic demand begins to turn, the foreign demand is likely to stay strong.
Unfortunately, if you are not normally in the beef market, the continuing rise in prices means you may have to start treating that prime steak as an investment.
To see how the price of beef affects you as a consumer, see "Beef Prices on the Rise."
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