Jan 9, 2021
🥓 Your Guide To Investing In Lean Hogs, Pork Belly & Pork Cutouts. Yup, Bacon Trading Is A Thing
Brief Background
Lean hogs, pork bellies & pork cutouts are all financially traded commodities, believe it or not. These were initially created to manage the risks of pig farmers & pork producers, protecting them from price volatility in the markets as well as providing transparent pricing. Here are the differences between them:
🥓 Pork Belly. Pork belly futures came into financial markets on the CME (Chicago Mercantile Exchange) in 1961 & became a popular niche market for traders & analysts alike. Pretty self-explanatory, these are frozen cuts of meat from the pig’s stomach, standardised into 18,000kg or 40,000 pound contracts. However, it became delisted in 2011 because of its extreme volatility due to hedgers & speculators, & was no longer fit for purpose as a hedging tool for those in the pork industry. The CME has, however, introduced the Fresh Bacon Index in 2019 as there is more consumer demand for it, a transparent weekly price reference for fresh pork bellies.
🐽 Pork Cutouts. The CME recently introduced pork cutout futures in November, 2020, to give those in the pork industry more risk-management tools specifically on the different cuts of pork. These cutouts include the loin, ham shanks, belly, spareribs, & more. Contracts are eventually cash-settled using the CME Pork Cutout Index prices when they expire, and complement lean hog futures.
🐖 Lean Hogs. The longest surviving swine-related commodity still traded today, lean hogs futures contracts were introduced in 1966, also for 40,000 pounds or 18,000kg of wholesale pigs. Lean hogs contracts, like pork cutouts, are also cash-settled using the CME Lean Hog Index prices when they expire. This newsletter will focus mainly on lean hogs than the others.
The main difference between pork cutouts & lean hogs is that lean hogs deal with the whole carcass whereas pork cutouts deal with, well, different cuts of pork. This means that there could be a spread between the two, for example, in a situation related to slaughterhouse capacity. Should capacity be limited, slaughterhouses won’t be able to take on more hogs from producers. At the same time, the amount of pork being processed is fixed. This may lead to a situation where lean hog prices are lowered because of increased supply, while pork cutout prices trade higher because of limited supply.
What Can It Do For You
🧺 Portfolio Diversification. As always, adding commodities to your portfolio can help diversify and lower risk. Bundling lean hogs with a number of other commodities to your portfolio can be a good way to diversify your portfolio since it acts differently to other asset classes. It can also be a good hedge against inflation since food is a necessity, & that food prices are almost certainly to go up should inflation rises.
💰 Profit. Lean hog prices are pretty volatile, creating huge price swings due to a number of factors. That being said, the main participants in this market are industry players looking to secure prices & profits during volatility. China makes up almost half of the world’s pork consumption, which means you’re essentially betting on an increasing Chinese demand.
What Affects Lean Hogs Prices
The lean hogs market is extremely volatile. There are several key factors that are involved in moving the price of lean hogs:
- 🇨🇳 Chinese Supply & Demand. As you can see from the table below. China produces & consumes almost half of the world’s pork. As China continues the grow, demand for pork may increase, since pork is a key ingredient in Chinese cooking. Nevertheless, any changes in either Chinese supply or demand can potentially have an impact on prices.
- 🌽 Feed Prices. The majority of the costs that goes into producing pigs goes into buying feed. So, price changes here can certainly have an effect on lean hogs prices, though not how you might think. When these grain prices rise, farmers take their pigs to the market early to save costs. This sudden increase in hog supplies can potentially lower depress prices.
- 🌧️ Weather. Weather can affect both supply & demand. In terms of supply, when the weather is pretty warm, the hogs don’t tend to be very active, which can result in fewer births, leading to a short supply and therefore higher prices. In terms of demand, pork consumption tends to be higher during the summer months.
- 🔄 Substitution. Pork competes with other animal products like chicken, beef, lamb, fish, etc. If pork prices rise too high, consumers might want to switch to these other options.
The Case Against Lean Hogs
Like some of the other soft commodities, the livestock market is no exception when it comes to extreme volatility in the markets. All the factors above (including a number of other unlisted ones too) create sudden price swings. Furthermore, health, environmental & animal cruelty concerns all can contribute to a decrease in demand overall,
The Case For Lean Hogs
Lean hogs still can act a tool for portfolio diversification and can act as a hedge against inflation.In the long run, as the Chinese economy grows, demand for pork may increase, also partly because pork is a key ingredient in Chinese cuisine. Furthermore, due to substitution, should beef prices go higher, consumers may choose alternatives like pork, increasing demand here as well.
Popular Ways To Invest In Lean Hogs — Pros/Cons of Each
Because you’re dealing with raw meat, you’re pretty limited in how you can invest in lean hogs. If you’re still confused about how any of these work, refer back to our basics newsletter for a refresher.
- Lean Hogs ETF/ETNs. You’re pretty limited here, but you can invest in ETN/ETFs that invests directly in lean hogs, or invests generally in livestock, including lean hogs (remember, ETNs don’t buy the assets, but instead, follows price indexes & pays its shareholders on returns). They’re traded on stock exchanges, so they’re very easy to buy and sell. Depending on which broker you go with, you may be charged with trading commissions. ETNs also charge an expense ratio, or management fee that gets taken out of their total holdings and is then reflected on your account. Remember that ETNs have unique associated risks since they’re not dealing with the actual assets. Just be sure to read the fine print.
- Lean Hogs Futures Contracts. A binding agreement traded on futures exchanges between two parties where they agree to buy/sell lean hogs at a specified time in the future with an agreed-upon price. These futures contracts can be settled with physical delivery or with cash after the contracts have expired. The minimum contract size is 40,000 pounds of lean hogs! Because you are using a significant amount of borrowed money, even small price changes in lean hogs can either lead to massive profit, or massive losses beyond what you paid for, potentially leaving you in massive debt. They are certainly high-risk and not recommended for beginners. Further, fees associated with futures trading include broker commissions, and exchange/clearing fees.
TL;DR — Is It The Right Investment For You?
As always, it depends on what your aims are. Lean hogs is an extremely volatile & relatively illiquid market, partly because of the factors mentioned above, and partly because the majority of the participants involved are pork industry players looking to hedge & secure prices. Like other commodities, lean hogs can bundled up with a number of other commodities to diversify your portfolio & to protect against inflation and a weak dollar. In the short term, prices can fluctuate seasonally due to weather affecting both supply & demand. In the long term, it’s finding the right balance between either growing Chinese demand or those with health, environmental or animal cruelty concerns that could decrease pork consumption.
🧺 If you are considering bundling up lean hogs with a number of other commodities to your existing portfolio, you may want to consider doing dollar-cost averaging (regular investments over time) to build your lean hog position so you can take advantage of the volatility in the market.
💰 If you are considering adding lean hogs for speculation and profit, you may want to monitor the factors that affect lean hogs prices mentioned above, especially pork production & consumption in China. The US Department of Agriculture (USDA) releases a quarterly report on global production, consumption & stock levels so you can stay up-to-date with supply & demand. In addition to monitoring the factors mentioned above, you may also want to consider performing some technical analysis on lean hogs’ price chart to help consolidate trends and patterns to help with your decision. That being said, its prices can swing unexpectedly, so be prepared and have an exit plan in place.
As always, if you are unsure, check in with a professional financial advisor before making any moves.
Thank you for reading! Let us know if you found this helpful. You can connect with us @VNewsletters, or check out our website for more information @ vaultcomms.com.
