Iowa Farm Outlook. New Data Indicates Lower Retail Meat Prices

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1 Iowa Farm Outlook November 1, 2002 Ames, Iowa Econ. Info New Data Indicates Lower Retail Meat Prices As part of the Mandatory Price Reporting legislation in 1999 Congress directed USDA to develop a new method of reporting retail meat prices. The USDA Economic Research Services has released a new retail price series for beef, pork, poultry, and lamb based on grocery store checkout scanner data. Retail prices have been collected by the Bureau of Labor Statistics using a monthly survey of grocery stores. Both the old and new prices will be reported for at least a few months and perhaps replace the BLS series completely. The new data can be found at The key advantage of the new series is that it includes prices on meat cuts and calculates a volumeweighted price. Because larger volumes of meat are sold on features and at sales prices, the weighted average price of retail meat may be lower than what has been reported using the BLS food price data. It is also more variable than previously thought. Retailers do run specials and consumer do respond to the lower prices. The data set reflects information from stores representing 20 percent of supermarket sales and is the only data set based on point-of-sale scanner transactions for meat. Data are included from supermarkets that: 1) Process their receipts by electronic scanners, 2) Sell products through the traditional supermarket fresh meat department, and 3) Voluntarily provide their data to commercial data firms. Scanner data does not include sales from fast food shops or restaurants, butcher shops, warehouse clubs, convenience stores, at institutions, through mail order, or by food distributors that choose not to provide their data for commercial use. Data from individual point-of-sale transactions are aggregated into categories: Beef 18 products including ground beef, steaks, and roasts by grade Pork 10 products including bacon, ham, and chops Poultry 7 chicken and turkey products All veal and all lamb totals for each As seen in the table below, the new series has averaged less than the old series from January 2001 through August 2002 for two classes of beef and for pork. Perhaps more interesting is that at times the new prices are higher and significantly lower (see table and following graphs). The Choice beef reported in the new series is consistently below the old series. Also note that there is more variability in retail prices that reported under the old series that was based on a survey of grocery stores. The new retail price series will also result in a new Farm-to-Retail price spread series that is narrower and more erratic than in the past.

2 Retail Meat Prices: New Scanner Data Series and Old BLS Survey Data Series, January 2001 August All Beef Grades All Choice Beef All Pork New Average ($/lb) Old Average ($/Lb) Average % Difference -1.4% -15.8% -2.9% Largest New Month Decline -11.8% -21.6% -19.3% Largest New Month Increase 6.3% -12.2% 7.4% $/Lb. $3.30 Retail Prices, All Beef All Grades, Jan 2001-Aug 2002 $3.20 $3.10 $3.00 $2.90 $2.80 $2.70 $2.60 $2.50 SEP NOV New ERS Old BLS

3 $/Lb. $3.70 Retail Prices, All Beef Choice Grade, Jan Aug 2002 $3.50 $3.30 $3.10 $2.90 $2.70 $2.50 SEP NOV New ERS Old BLS Retail Prices, All Pork, Jan Aug 2002 $/Lb. $3.00 $2.90 $2.80 $2.70 $2.60 $2.50 $2.40 $2.30 $2.20 $2.10 $2.00 SEP NOV New ERS Old BLS John Lawrence

4 Market Signals & Grain Storage Economics The basis (cash-futures price differential) for both corn and soybeans has been extremely strong this fall, and is even stronger in processor bids for January delivery (see charts below). Also, the carrying charge in the futures (December-July spread for corn) is much smaller than in recent years and for soybeans (November-July) is negative. These two features of the grain markets provide important signals to producers about how to market grain. The market is signaling that it wants producers grain now or this winter, rather than in the spring and summer. Grain users are unwilling to pay farmers the full cost of storage, especially if the grain is stored at the elevator. Another signal implied by these price relationships is that producers wishing to retain ownership may want to consider doing so with call option purchases instead of physical grain ownership. Own the grain or own the call options? Let s examine these conclusions in more detail. On October 31, Central Iowa grain elevators were bidding about $2.26 per bushel for immediate delivery of corn. That was $0.21 under nearby futures and $0.31 under July 03 futures. Normally we would expect Cash prices in this area to be about $0.29 under July in late May and early June. Allowing for a stronger than normal basis next spring and using a planning basis of $0.25 means the market is offering corn growers approximately a $0.06 per bushel gross return for storing corn until late May. On-farm costs for storing corn from late October until May, including interest, in and out handling costs, extra drying and shrink to 13% moisture, and a 1% quality deterioration and storage shrink, would be about $0.18 per bushel. For hedged corn storage on the farm, the prospective net return thus is about -$0.12 per bushel. For elevator storage, the potential hedging loss may be -$0.28 or larger, depending on the storage and extra drying charges. If grain is stored unpriced and the market declines, these costs are incurred along with reduction in price. One alternative to storage is to purchase call options. Calls allow a corn grower to participate in sharply higher prices later in the marketing year, if prices rise. The maximum risk exposure in case of declining prices, with calls, is the up-front cost of buying them. At this writing, a $2.60 December corn call would cost about $0.16 per bushel, including a discount broker commission. With a $0.50 rise or $0.30 fall in July futures prices, the net effects of storing corn in town vs. selling and re-owning with calls would be approximately as shown in Table 1. Approximate net returns from storing in town would be $0.14 larger than storing at the elevator. With the $0.50 rise in July futures prices, storing on the farm would be slightly more profitable than the call options purchases, but with a $0.30 decline in the July futures prices, call options purchases would provide a larger net return than farm storage. For soybean storage vs. call options purchases, the conclusions are similar, as shown in Table 2.

5 Table 1. Potential Returns From Corn Storage Until May 2003 or July Call Options Purchases, with a $0.50 rise and a $0.30 fall in July Futures Prices. Store corn in town Own with $2.60 July calls Initial July futures price, 11/1/02 $2.55 $2.60 (5 cents out of money) July futures price in May, +$ Gain in cash price or July call with $0.05 basis improvement Less storage related or options costs Net return Net with $0.30 drop in futures from 11/1 & 0.05 basis gain Table2. Potential Returns From Soybean Storage Until May 2003 or July Call Options Purchases, with a $0.50 rise and a $0.50 fall in July Futures Prices. Store corn in town Own with $5.60 July calls Initial July futures price, 11/1/02 $5.54 $5.60 (6 cents out of money) July futures price in May, +$ Gain in cash price or July call with $0.00 basis improvement Less storage related or options costs Net return Net with $0.50 drop in futures from 11/1 & 0.00 basis gain Alternative call options positions An alternative to the call options purchase strategy shown above is a vertical call spread. It involves buying a call option at or near the underlying futures contract price and then selling a call option at a higher strike price. Sale of the higher call option allows the seller to collect the premium, which can be used to offset part of the cost of buying the call at the lower strike price. When selling the call option, the seller agrees to allow the person on the other side of the transaction to buy corn from him/her at the chosen strike price, no matter how high prices go. Lets say that you establish this type of call options position by purchasing a $2.60 July call option and selling a $3.00 July call option. At November 1 premiums, you would pay about $0.145 for the $2.60 call, would receive about $0.055 from selling the $3.00 call, and would incur small brokerage charges. The July futures price at that time was $ These quotes for call options and futures prices can be found by going to our web site, and clicking on Commodity Charts in the left-hand column. After selecting the commodity you want, click on quotes. The net cost of this position on November 1 was about $0.09 per bushel plus brokerage-related expenses, which would vary depending on whether you use a full-service, discount, or on-line brokerage service. Brokerage costs might range from about one to four cents per bushel. This position would let you retain ownership at about $0.05 less cost than just purchasing call options. The options expire in late June and would let you participate in a major corn price rally up until that time. The maximum amount of possible gain with this vertical call spread would be the difference between the two strike prices, less the net purchase cost. If prices move above the $3.00 strike in this example, gains from the $2.60 purchased call would be approximately offset by losses on the $3.00 call that was sold. Losses on the $3.00 call would be reflected back to the seller through margin calls that would need to be paid to the broker almost immediately. With a call purchase only (and no call sale), there would be no limit on potential upward price flexibility, but the cost of the position would be a little greater. In establishing a vertical call spread, it is

6 important to be sure you understand the implications of selling call options, including potential margin calls. Also, it is important not to sell more call options than you have purchased, and to be sure the purchased calls are for the same delivery month as the sold calls. Tax treatment of gains and losses from options positions in some cases may be different than those from storing grain. If you decide to use these strategies, it is a good idea to check with your tax preparer for any significant tax implications. Although the numbers are a little different, the conclusions are similar for soybeans. Central Iowa cash soybean prices on October 31 were about $5.31 per bushel, with a basis of -$0.33 under November and -$0.20 under July. A normal central Iowa soybean basis under July in and early June would be about -$0.30 per bushel. What to do about grain already in storage? A number of corn and soybean processors are bidding 8 to 11 cents more for January delivery than for immediate delivery. For grain already in farm storage, this may be an opportunity to strongly consider. It will allow income to be shifted to next year for tax purposes, and should more than cover interest costs incurred in storing. Sealing the grain under marketing loans can minimize interest costs. Feasibility of storing grain in town for January delivery depends on the elevator storage charges. Risk in storing corn and soybeans? Limited farmer marketing s and the strong basis indicate that most farmers have been strong holders of corn and soybeans, and that farmer sales have been very limited. There appears to be widespread belief that both corn and soybean prices are likely to move significantly higher later on. However, farmers should keep some cautions in mind, especially for corn. The cautions center around three main factors: (1) a potential upward revision of the U.S. corn crop estimate, (2) lagging corn export sales, and (3) prospects for increased corn plantings next spring. On November 1, the F.C. Stone estimate placed the U.S. corn crop at about 43 million bushels larger than USDA s October 12 estimate. USDA will issue two more crop estimates this season, on November 12 and in mid-january. Also, official corn export projections are starting to look over-optimistic. The combination of a larger crop estimate and a continued lag in corn exports could easily push this season s ending corn carryover stocks up to or above 900 million bushels, despite increased processor demand. F. C. Stone s soybean estimate was up 69 million bushels from the October USDA estimate. The Stone estimate was a surprise to the grain trade, since many analysts had expected little or no change in the soybean crop estimates. It is a caution that soybean prices also may be slightly vulnerable to increasing crop estimates. Bean exports have performed somewhat better than corn, despite larger South American supplies in recent months than a year ago and projections for increases in Brazil and Argentina s production similar to those of the last few years. Season to date soybean exports and outstanding unshipped sales were down 5% from a year earlier, although USDA projects the marketing year total to be down 20%. Potential price trends October projections show the prospective August 31, 2003 corn carryover dropping to around 700 million bushels, or about a 3.6 weeks supply. However, for reasons just noted it appears likely that this projection will increase in the months ahead. An increase of 100 to 200 million bushels in the November and January production estimates is a good possibility. At the same time, the export projection may be reduced. This combination suggests that the August 31, 2003 U.S. corn carryover projection may well be raised to the 850 to 950 million bushel range by mid-january. That level of carryover stocks plus prospects for a 1.5 to 2.5 million acre increase in next year s corn plantings would be likely to weaken corn prices some by mid to late winter. Through October 24, combined U.S. corn exports and outstanding unshipped sales were 11% lower than a year earlier, even though official projections call for a 5% increase for the total marketing year. The harvest season and November-December typically are months of heaviest export sales. To confirm official projections, weekly exports should move consistently into the 45 to 50 million-bushel range through mid-december. That s about 1.1 to 1.25 million metric tons. Last week s 40 million bushels of sales, while well above recent weeks, still were not large enough to build a case for a strong rally in corn prices.

7 In contrast to corn, soybean exports and sales so far this season are above a level that can be sustained for the marketing year as a whole, even if the final crop report is in line with the F.C. Stone estimate. Soybean prices may move modestly higher between now and the end of the year, with substantial strength possible if there are serious weather concerns in South America. From late February onward, bean prices will have increased downside price risk because of the new-crop South American harvest. But the risk may be tempered by a decline in U.S. soybean plantings. Bob Wisner