Navigating disruptions to the cattle cycle
Follow cycle, market trends to help prevent market losses.
The beef cattle marketplace is large and relatively slow, and it takes a long time to change direction based on variables like supply and demand. But on occasion a “black swan” disrupts normal production and marketing cycles. The cattle cycle that takes 8-12 years to complete is a process in which cattle inventory shifts in response to adjusting demand and prices. It is slow and long because of the lifespan of beef cattle, as well as the time it takes producers to adjust herd size to match demand. For example, if demand is trending higher, it often takes years for producers to ramp up inventory to match it.
The cattle cycle is a primary factor determining the size of the U.S. cattle herd at any given time, according to a report from U.S. Department of Agriculture-Economic Research Service Agricultural Economist Russell Knight. “If prices are expected to be high, producers slowly build up their herd sizes. If prices are expected to be low, producers reduce their herds by culling older cows and keeping fewer heifers to replace older cows or add to their herd.”
In early 2020, the cattle cycle in the U.S. is at a turning point. Herd expansion has been underway since 2014; that trend looks to be ending this year as inventory plateaus. One of several black swan events could alter the likely trend toward a leveling off or slightly contracting herd size in the coming year.
When a black swan occurs
Black swans are major events that have the potential to fundamentally change how specific variables influence the marketplace. In the cattle cycle, a black swan can cause a trend to either reverse or accelerate, depending on the event and the direction of the cycle when it happens.
“A black swan event is something completely unexpected. When it occurs — like a literal discovery of a black swan — it changes everything we thought possible before,” said Darin Newsom, longtime market analyst of Darin Newsom Analysis Inc. “They can be major disruptions in the industry, but these events don’t always disrupt the present cycle of expansion or contraction.”
"In the grand scheme, major winter storms and the flooding that happened last spring did not cause an impact in overall numbers and influence the cattle cycle."Take the wildfires in California, and the harsh winter weather and spring flooding that severely impacted many cattle producers in the Northern Plains and Midwest in 2019. Though these events qualify as black swans in the context of general chaos theory, they did not cause major disruptions in the cattle cycle when they happened since the number of animals affected was relatively low in the context of the entire U.S. herd.
“In the grand scheme, major winter storms and the flooding that happened last spring did not cause an impact in overall numbers and influence the cattle cycle,” according to Oklahoma State University Agricultural Economist and beef market expert Derrell Peel.
“Those events were horrible for the producers directly affected. But the bottom line is that if 50,000 or 100,000 head are affected, it won’t impact the whole cycle on a national scale.”
Disruptive black swans
Other events do influence the cattle cycle, though the extent usually depends on the status of the cycle at the time of the incident. When the Tyson Fresh Meats processing facility in Holcomb, Kansas, caught fire in early August 2019, it shut down operations completely for weeks. The plant represents around 6% of the nation’s beef slaughter capacity, and though operations have mostly been restored (a full recovery is expected by early 2020), the immediate loss of that much capacity caused significant price response, according to American Farm Bureau Federation Economist Michael Nepveux.
“After the fire at the Holcomb facility, both the beef and cattle markets saw significant price movements, which led to historic gross margins for those involved in the beef packing industry,” he said. “Much of this movement is right in line with what one would expect under these conditions.” See chart below.
There was definite “market shock” with the plant closure. Though much of the price response has passed, it exposed the nation’s tightening beef processing capacity. Since the cattle cycle is gradually transitioning out of an expansion phase that’s been underway for about the last six years, a 6% setback in processing didn’t cause a reversal in the cycle. Instead, it fell in line with a transition already underway and expected to remain in early 2020.
Another potential black swan is African swine fever (ASF). This highly virulent disease has decimated groups of hogs in countries around the world where it’s prevalent, especially China, the world’s largest hog producer. ASF only affects hogs but could influence the cattle cycle if it is confirmed in U.S. hog operations given the interconnectedness of the overall protein market today. If the disease remains overseas, it could cause a return to domestic beef herd expansion, as demand for U.S. protein — pork, beef and poultry — will strengthen, especially from China, where an expected 80% of the nation’s hogs will have been lost because of the disease by early 2020. That could cause a premature upturn in the cattle cycle as producers grow inventory to match increased demand.
“The ASF disease is a big deal for the beef sector because it will positively affect our exports,” Peel said. “We have record production of all meats right now and the beef industry is counting on being able to export part of its supply to backfill protein demand in other nations.”
If ASF is confirmed in the U.S., pork exports could be shut off altogether, causing a general buildup of domestic protein supply that could cause a downturn in demand for all domestic protein sources, including cattle. While it seems intuitive that beef demand will increase amidst a protein shortage centering around hogs, the cattle cycle’s fundamental downturn in inventory and demand will likely accelerate. As with past instances like animal disease outbreaks, overall protein demand and therefore the cattle demand could decrease.
Looking for opportunities
What does all this mean for producers? Because it’s next to impossible to develop a marketing plan that accounts for the next black swan event in the cattle cycle, it’s important for producers to stick to what they can confirm and what they know. Knowing that the cattle cycle is entering a leveling-off period with contraction as a likelihood in the coming year or two will help with developing management and marketing plans.
“Don’t get crossways with the trend. Focus on spotting changes in trends and price direction over time,” Newsom said. “Let the market dictate your action and look for potential forward contracting opportunities at times when the market’s long-term trend is a toss-up, like right now. Keep a close eye on potential changes in trend for marketing opportunities.”