March 16, 2011

Markets operate off of reality, occasionally on perceptions of reality, and often on expectations of the future.  While it is the reality of supply and demand conditions here and now that determine prices today, it is expectations for the future that drive producer decisions about production.  This is particularly true and important in agricultural markets where there is generally a long lag between production decisions and the resulting product.  The beef cattle industry is a prime example of this because of the long biological lags and the tradeoff between the immediate value of a heifer as a feeder animal compared to her investment value as a breeding female.

Cattle prices generally strengthened throughout 2010 reaching current record levels in the first quarter of 2011.  The market is clearly trying to encourage cow-calf producers to rebuild cow herds.  Yet there is no definitive indication that producers are retaining heifers at this time.  Why has the beef industry been so slow to rebuild the cow herd?  The answer is that producers don’t have the expectations yet that supports the investment in saving heifers for cows. 

Producer reaction to the current record prices seems to fall into two categories.  The first is a certain excitement about current price levels combined with a general skepticism that these prices will last.  There is often a perception that the current prices are a short run aberration which will be followed soon by a market correction. This is despite the fact that the supply fundamentals providing much of the current price support have been building and evolving for several years.  Domestic beef demand, though not recovered from recessionary weakness is moving in the right direction, albeit slowly.  Export markets are strong and have every indication of remaining strong.  There is considerable reason to believe that the current market situation is not a short run phenomenon.

The second general producer reaction is that input prices will continue to increase thereby erasing the gains from higher cattle prices.  There seems to be a certain fatalism that no matter what a producer does, there is limited or no profit potential in cattle.  While I agree that input costs are a challenge, there is surely opportunity in record cattle prices.  Certainly high feed prices will likely be a challenge for the foreseeable future and energy costs are rising with all the associated impacts, especially higher fertilizer prices.  However, agricultural producers have always had more opportunity to influence profitability by managing costs than changing market prices for the products they sell and the situation is no different now.  Rising input prices mean that producers must make adjustments; sometimes by changing the level of input use and sometimes by changing the entire production process.  Cattle have enormous flexibility to adjust the production process in the face of changing input costs.  It takes a willingness to think a bit more broadly and recognize that many of the old rules of thumb may not apply anymore.

The basis for cattle industry expansion is solid and I expect the market to continue offering incentives to cow-calf producers in the form of high calf prices.  Eventually, producer expectations will change and producers will make the investment in heifers.  Producers who act sooner rather than later will enjoy more of the value the market is offering now.

Source: Drovers Cattle Network