Forward contract profitability requires benchmarks

By Paul Marchand

Editor’s note: Paul Marchand is Senior Risk Management Analyst, h@ms Marketing Services. He can be contacted at ‘’

This article does not reflect the official position of the h@ms Marketing Servies management team. Observations and personal opinions on market developments do not guarantee future events and should not be considered financial advice. Producers should always consult with their trusted professionals before making any financial decisions.

Since the beginning of the year, lean hog futures – the commodity underlying Canadian forward contract values – have been trending upward. While we were of the view the upside potential was, and is, limited, the general tone in the marketplace was that the trajectory higher would be maintained and that the ‘top’ had been yet to be determined.

That all changed on April 10. On that day, the futures market sold off about three per cent, which is a huge one-day move. On April 12, another more than three per cent drop in lean hog futures developed with the June contract reaching the daily limit low and halting the trading of that contract for the day. Sow supplies are tightening. Export volumes remain excellent. The net value of the cutout was approximately 25 per cent higher than year-ago, as of this writing. Cash is trending above last year too. What gives?

Inflation continues to create pressure

The Consumer Price Index (CPI) remains elevated, creating impacts across supply chains.

External market factors pressured almost all asset classes on April 10 as investors finally came to grips with the idea that the U.S. Federal Reserve will not be lowering interest rates anytime soon.

That was triggered by a slightly higher Consumer Price Index (CPI) relative to expectations in the U.S. The 3.5 per cent March CPI was only 0.1 per cent higher than expectations but clearly moving in the wrong direction and almost certainly taking the widely debated interest rate cut in June off the table. The net result was a sell-off in many investment classes, including lean hogs.

But aren’t the fundamentals supposed to be strong as noted above? Yes; all those things are true, but as we have been suggesting in the ‘Hog Market Outlook’ (our daily producer newsletter), there is (or was) a lot of institutional investing in lean hog futures and the moves lower on April 10 and 12 almost certainly proved it. Lean hog futures had risen in the weeks leading up to April 10 almost in concert with ‘Managed Money’ traders increasing their long positions (a buy activity). While this was happening, key technical resistance levels were being reached: the market became overbought for days on end (a technical term, not an opinion of value), technical chart resistance was being met (Fibonacci retracement), new life-of-contract highs were being reached, and all investors needed to take profits was a reason.

The reaction to the March CPI number provided that reason, and the market corrected lower. Even with the Canadian Dollar falling about one cent over two days (it too came under pressure), the net result in a forward contract price was a loss of approximately $7 CAD/ckg for a summer month contract by the end of the week. It is a constant reminder that markets can and do change rapidly – oftentimes without warning – and sometimes it has absolutely nothing to do with hogs or pigs, supply or demand.

Year-over-year improvements provide optimism

Better productivity may help explain why U.S. sow liquidation is being offset by higher hog numbers this year.

It is very admirable to be optimistic in this industry, but sometimes we shouldn’t let opinions cloud better judgement. As of mid-April, there was still good value in Canadian forward contracts, albeit not at the highs.

While a deep dive on input costs will not be discussed here, we know, anecdotally, that feed costs have decreased compared to last year, or even months ago. Producer margins have improved, and the producers who are willing to share their motivations for locking in prices during March and April cite higher profit margins compared to previous years as rationale. This is an example of classic risk management. Locking in at a profitable margin is one way to decide to hedge. But we all want to capture the best possible price, so what about the other market watchers who say hog futures could be above the $120 USD/cwt range this summer? The July contract on April 12 was approximately $104 at the close. That is massive speculation in this author’s opinion.

On March 28, the U.S. Department of Agriculture (USDA) published the ‘Quarterly Hogs and Pigs’ report – a much-anticipated update on live hog numbers in the U.S. which, occasionally, can change market sentiment in the lean hog futures. While the focus is on hog numbers in the U.S., Canadian producers are very interested in the report because of the way market hogs are priced north of the border. That is, the price for hogs in almost all of Canada is based off regional U.S. prices through its ‘Mandatory Price Reporting’ (MPR) cash price and the CME Group lean hog futures for Canadian forward contracting. The ‘Quarterly Hogs and Pigs’ report is a supply-side estimate which inevitably is one half of the fundamental picture. As such, it has the potential to change marketing dynamics and price outlooks in the U.S. and Canada for months at a time.

Some hog numbers, particularly ‘All Hogs and Pigs,’ ‘Kept for Marketing’ and the ‘December to February Pig Crop,’ were higher than year-ago, up 0.6 per cent, 0.8 per cent and 1.9 per cent, respectively. This seemed counterintuitive to the relatively aggressive and ongoing sow liquidations that began months earlier. How can we get more pigs from fewer sows? The U.S. hog industry is in contraction with sow liquidation presently at the second-highest year-to-date pace on record. Ultimately, more pigs can come from better productivity, and that is the underlying assumption supporting higher hog numbers for 2024. Multiply the present farrowing (and intended) population by the present ‘Pigs Per Litter’ estimate (11.53 in the most recent report), and you will get slightly more pigs than last year. It’s just math.

Whether one agrees with the March ‘Hogs and Pigs’ report or not is irrelevant, and the futures market will respond one way or another. What we are attempting to do is map out an objective marketing strategy that attempts to mitigate against speculation (the Funds’ record long position), opinions on the ‘Hogs and Pigs’ report (or China) for example, and external market shocks like a high CPI that triggered the selloff in April. Markets are unpredictable, occasionally volatile, and there are no guarantees.

Are the futures in your favour?

Considering 2014, 2021 and 2022, this year’s outlook is less exciting, but lower feed costs could make the difference.

When deciding when to take price protection, producers should consider their costs of production, benchmarks to assess value in the forward contract and how futures contracts are performing against historical cash seasonality.

Costs of production are very farm-specific. No two producers are alike. Some of the more efficient producers will have lower costs of production while other operations will be higher. Determining an accurate cost of production for your operation is critical. If you already know it, great! If you do not, make it a priority. A high hog price does not necessarily mean an operation will be profitable, and we only need to look at the 2022 marketing year as an example of squeezed margins amid high hog prices.

After production costs have been established, the next step is to determine if there is ‘good value’ in a forward contract. This is a bit trickier because market views vary, and two out of the past three years have seen incredible cash market performance leading some in our industry to expect the same sort of price profile in subsequent years. Producers who attend h@ms Marketing meetings already know that we consider the 2021 and 2022 marketing years to be outliers, and that we do not expect those higher levels to represent a trend moving forward. To be clear, we do expect higher prices relative to pre-2020 seasonal histories, and even last year, but a revisit to price levels immediately following the two post-pandemic marketing years is a very ambitious position to take. The 2023 marketing year proved that, when a post-Easter lull in cash pricing developed for the first time in three years.

This year, that pull-back has not (yet) materialized, and with the cutout about 25 per cent higher compared to the same marketing week last year on April 12, we think cutout supports cash and a steadier trend higher is possible. But will it outpace forward contract values presently offered? All that matters is that producers pick achievable benchmarks, and to that end, we would suggest the three-year cash average which does include 2021 and 2022 in its calculation.

The final step is to observe current lean hog futures values to historical cash seasonality. We do this to determine if there is good value in the futures. Isn’t that the same as the previous step? Yes and no. In the previous step, the intent is to determine how Canadian forward contract prices are performing relative to Canadian cash histories, because it contains Canadian dollar exchange values in the calculation. In this step, we are looking at U.S. cash historical seasonality and comparing it to the lean hog futures spreads. And we do this by observing the percentage of movement in the current lean hog futures compared to the per cent moves in USD/cwt cash base prices.

In this sense, we can see that even though 2014, 2021 and 2022 cash and futures were much higher than present values on a dollar basis, seasonal cash per cent changes remained intact. The difference in value between the July and October National cash base in USD/cwt in 2014, for example (-20.9 per cent), was very similar to the five-year average per cent change over the same timeframe (-19.5 per cent); last year, cash moved 27 per cent lower between July and October.

Therefore, if the futures are pricing in a premium or discount relative to the historical spreads, we can determine if the futures market is bullish or bearish relative to history. If the futures are outperforming the historical spread, that could also be a hedging signal. Less optimistic futures may imply it could be better to wait for the next opportunity.

Hog price versus production cost: keep it simple

If an operation locks in a price that is higher than production costs, the Canadian forward contract is outperforming the Canadian cash history, and the current futures in USD/cwt are performing better than historical cash seasonality, this is considered a good hedge.

It does not mean it is the highest price one can achieve (and which we only know in hindsight), and it does not guarantee that the forward contract will be ‘in the money’ when the contract concludes. But it is an objectively determined approach to hedging against volatility, like was seen this past April, and another tool producers can use to effectively manage profitable margins in a market rife with rampant speculation.