In my opinion, the cattle market has produced a tiger trap... A tiger trap is a very deep hole, covered in weak branches and leaves with a bait dangled over the center. When the tiger attempts to reach the bait, they fall in. I think this analogy fits the cattle market with the positive basis spread creating the hole and cattlemen leaping towards the bait, the high-priced cattle. There are Punji sticks in the trap to of input costs. Feed and fuel costs are now sharply higher over just a few weeks ago. Throw in the tremendous rise in retail interest rates and it appears that once again, some of the most expensive beef is being produced today. The risk increase of the positive basis is that if futures are sold at a discount, and the index does not move lower, the futures will move higher to converge with the index. The other side of risk is that the positive basis creates a discount for cattle in the future for which the cash premium may never be achievable. I discussed the ways and means to hedge in this difficult positive basis with these three examples. If using futures, you will achieve the highest price possible at the time, with risk of convergence of basis to the upside by the spread amount, as well as discount for the index to have to fall before futures begin realizing profits at expiration. Next would be the long-put option. Here, risk is limited to premium paid for option, but places the minimum sale floor at strike price minus premium that could produce as wide as a $20.00 spread before downside projection becomes applicable. Lastly, there is the fence options spread. Here you would buy the at the money put, and sell the $10.00 out of the money call. This produces a futures position above and below the two strike prices and has an unlimited risk and unlimited profit potential. The advantage is that it would allow for upward movement of the futures to converge with cash, but no further advances above the short call strike price. The disadvantage is that it just about splits the difference between width of basis of the long put and futures to the downside. While this factor of the positive basis does not produce a higher or lower trade, it is a wide trap that could be fallen into without knowledge of. However, now you know. Just this knowledge should help you make a more informed decision.
The staunch division continues between bulls and bears. Increases in open interest continue to reflect the desire to be long or short. I expect a tremendous amount of volatility over the next few weeks as the basis spread will cause a great deal of fluctuation, in a very wide price expanse. Factors to move the market are seemingly Mexican cattle, chomping at the bit to come across the border, the consumer, dealing with increased inflationary aspects, a potential decline of population by the millions, and most of all, input costs for production rising sharply. Other than that, as long as the consumer continues to spend at current levels and cattlemen assume this risk, cattle and beef should be okay. With boxes having rallied sharply through the holidays, now softening, we may be starting to see the consumer question current spending habits.
Corn continues to move higher and is presenting farmers with an opportunity to market physical inventory. I recommended this week for farmers to buy the December $5.00 corn calls and the $11.00 November soybean calls. This is a sales solicitation. Why would a farmer buy calls? To produce the courage to make difficult cash sales with fewer consequences. While this will not help in marketing if prices move lower, but if higher, you can market physical inventory at the levels of the strike price and still be long the market. Fundamentals will most likely have changed dramatically were prices to near or achieve the strikes. This could cause hesitation in marketings for fear of missing out. With the ownership of the calls, you can remain long grains all the while having marketed physical inventory. Energy was higher with spot crude trading over $80.00 this week. I expect energy to continue higher. Seemingly beneficial to all might be the meeting between President Trump and China's President Xi Jinping. With China in a recession, any spur of stimulation could push beans and energy sharply higher. This is on my front burner. Interest rates continue to be high. I may not have mentioned on this commentary, but made several references in other comments from the last Fed meeting that lowered rates. That being, the spread between the Fed window borrowing and retail rate lending made for a huge spread for banks. This week's Goldman Sach's earning's reflected that with earnings up over 40%. As usual, the world is spinning a little faster now and those who assume risk are urged to manage it like no other time.
Christopher B. Swift is commodity broker and consultant with Swift Trading Company in Nashville, TN. Mr. Swift authors the daily commentaries "mid day cattle comment" and "Shootin' the Bull" commentary found on his website @ www.shootinthebull.com
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