For a long time, when I told people that I was a futures market analyst, I was routinely asked, “What’s a pork belly?” Of course, I explained that a pork belly is a side of bacon; it’s been trimmed to a flat slab about 12 inches wide and 18-24 inches long, thereby readying it for cutting into smaller pieces for resale and/or into slices of bacon. Although I realize that advances made by both pork packers and grocers rendered it obsolete. Still, I miss the pork belly futures market despite the fact that the sharks in the CME pork belly pit never gave anyone an even break, which helped kill the goose that laid golden eggs for them.
Ultimately, belly futures served the very good function of fostering storage of frozen bellies during fall, when the market was glutted and prices were in the tank, so those same supplies could be used to supplement production the following summer, when the belly situation routinely became quite tight. And while pork belly futures are now a fading memory, those in the ag industry should be aware of the wholesale bacon market’s influence over the hog and pork complex during summer.
That is, if spring-summer pork belly supplies fall short of consumer demand, the resulting price rally can give the hog market a major boost during mid-to-late summer. Conversely, an oversupplied belly market can weigh heavily upon the hog and pork complex as Labor Day looms. Moreover, the behavior of wholesale bacon prices during the first half of the year can greatly influence market action during summer. The price action of the past two years, as illustrated by the preceding chart perfectly illustrates this point.
As readers will recall, anticipation of the spring-summer hog shortage of 2014 triggered a huge late-winter rally in hog and pork prices. Production at that time was well above normal early-to-mid-summer lows, but that did not prevent the market from leaping to highs far beyond all former records. The chart shows fresh pork belly prices blasted past the record high around 193.75 cents/pound posted the previous August to 206.69 cents/pound in early April (a time when the hog and pork complex is typically quite weak). Such strength at that time suggested the market might soar past 250 cents in August, when the market typically peaks. Instead, after suffering a major mid-spring dive, the fresh belly market posted an early-July peak that came much earlier than normal and fell far short of the April high.
In contrast, belly prices plunged far below norms implied by the 10-year average during the February-April 2015 period. Supplies were certainly very plentiful at that time, which clearly weighed upon the market, but that weakness was quite extreme by recent standards. Why then did the market later proceed to soar as spring turned to summer, with bacon prices essentially matching the summer 2014 peak despite the big production surge.
I believe demand fluctuations in response to price signals perfectly explain these shifts. My research has long suggested an approximate 10-week lag between major wholesale market shifts and their impact upon consumer costs at the retail level. Thus, the February-April 2014 wholesale price spike sent meat case costs faced by consumers soaring just as BLT season got underway in late spring. That almost surely curbed consumer demand and truncated the usual summer rally in hog and pork prices, although it’s rather hard to call hog values at record highs ‘truncated.’ Still, the July 2014 peak in the CME lean hog index at 134.17 cents/pound topped the April high by less than four cents.
The extreme price highs experienced during the February-July 2014 period apparently stifled demand through the balance of that year and through much of 2015, thereby weighing heavily upon prices across the hog and pork complex. That was most apparent in the pork belly market. For example, the early-April 2015 fresh market low at 69.90 cents/pound fell almost 40 cents below the 10-year average for that date. In contrast to the previous year, the timing for grocers planning to push bacon during BLT season could hardly have been better. Those greatly reduced prices spurred consumer bacon buying far above year-prior levels, thereby helping power the huge wholesale price rally in the face of much larger supplies.
Actually, the size of pork belly stocks probably played a significant role in the contrasting 2014 and 2015 situations as well. The second chart below illustrates this point. Concerns about a potentially extreme bacon shortage caused the industry to boost belly storage totals in late 2013 and early 2014, thereby pushing those holdings well above normal. However, with skyrocketing prices having stifled demand, those supplemental supplies became burdensome in late summer.
Conversely, spring 2015 belly stocks were quite normal by historical standards, and later proved largely inadequate to meet the demand. They fell far below the 10-year mean during late spring and early summer, with the September low dropping to approximately 10 million pounds. Those developments testify to the relative shortage seen last summer.
The preceding discussion lays the groundwork for a look at the outlook for the summer 2016 BLT season. At this point, it seems likely to prove rather mediocre. As the first chart showed, early-spring belly prices were rather elevated, but have declined significantly of late. The decline is probably ‘too little, too late’ to power a repeat of last year’s big surge. That is, grocers are unlikely to pass the early-spring wholesale price decline on to consumers for several more weeks, which suggests bacon consumption will get off to a relatively slow start. Things may pick up somewhat as those reduced costs come into play, but I suspect the belly market won’t mount a serious challenge of the summer highs of the past two years.
That suggests hog carcass values and those for animals on the hoof will also disappoint industry bulls. CME lean hog futures had recently priced the July and August contracts above those for their June counterpart, but the latest price drop has brought them back to near par. Given the current belly situation, I tend to think mid-to-late summer hog values will fall short of likely spring highs.