All data points seem to indicate that we are now in the expansion phase of the "Hog Cycle". We received the first significant clue when the H&P report showed the breeding herd was 3.68% higher than one year ago. I completely ignored this very important number!

Another important number is the December to May farrowing intentions at +3.5%. It appears that the PED virus problem is somewhat controlled. If piglet losses are subdued, we may end up with something like 5% more market hogs. I say that because the USDA pegged the farrowings for September-November at +3.3% but we have seen the kill rate for the past four weeks jump by 4.98%. The September - November farrowings should now be coming to market.

Either producers have even more sows than shown in the H&P report or else the PED virus problem is much less or some of both.

It seems to me that high hog prices and lower feed costs late last summer and early fall set the stage for significant expansion. Both the kill rate for the last four weeks and the last H&P report are confirming that expansion is happening.

Production Cycle Theory states that:

1. Producers act as if their decisions will not influence future prices.

2. Producers will expect the existing market price to continue indefinitely into the future.

3. The price adjusts in each period so that supply and demand are equated for that period.

4. Irrevocable production decisions are made in each period on the basis of current expected price.

5. Production initiated in one period is only and wholly available in the next.

Hog Producers have now made their production decisions for the next six-months to a year. We don't know exactly what their decisions are but all indications are that it is higher than last year by something in the range of +3.5% to +6.0% or more. The price will adjust so that supply and demand are "Equated" during the next six to twelve-month period.

How much change is price going to have to make so that demand equals supply?

I don't know but I think the price change is going to be "Down" rather than "UP". For the past time period leading up to the expiration of the GGGs, the GGGs dropped 19.575 from the day the last H&P report came out until the GGGs went to cash settlement.

So far the MMMs have dropped 9.525. If the MMMs are to drop an amount similar what the GGGs dropped, the MMMs would need to shed another 10.05 between now and cash settlement.

Currently the MMMs are premium to the Index by 17.59. It is not beyond the stretch of the imagination to suppose that the Index could rally by 7.50 and the MMMs would then need to cough up 10.05.

Over the long weekend I began wondering what usually happens to the Index between mid-February and the MMMs going to cash settlement in mid-June. The following is the change in the Index from Mid-Feb to MMM Expiry since the Lean Hogs began trading in 1996:

1996 +12.75
1997 + 7.480
1998 + 11.010
1999 + 7.600
2000 + 13.860
2001 +19.360
2002 (5.680)
2003 + 18.820
2004 +15.160
2005 (0.850)
2006 +19.070
2007 + 4.810
2008 +14.680
2009 (1.760)
2010 +10.470
2011 +5.740
2012 + 6.800
2013 +15.900
2014 +28.730

Maximum Gain 28.73
Maximum Loss (5.68)
Average +10.73
Average of "Up" Years 13.27
Average "Down" Years (2.76)
Current "Gap" 17.59
Number of times Change Exceeded Current "Gap" 4
Number of times the Change was Less than Current "Gap" 15

If we get an "average" year of +10.73 in the CME Index, the MMMs will need to shed 6.86. If we get an "average UP year" of +13.27, the MMMs will need to drop 4.32.

Only four times in the last nineteen years has the CME Index tacked on more than the 17.59 "Gap" that we now have between the MMMs and the Index. The supply/demand dynamics this year do not seem to be lining up in a manner needed to give the Index a bump-up of +17.59. Additionally, from the afternoon reports the model is projecting that the component on Friday's kill will take another hit of -0.75 to -1.05.

CONCLUSION:

Producer expansion may have caught us traders napping and we have been too bullish the MMM futures. If technical/emotional factors push the MMMs limit tomorrow, I will load my already over-loaded boat with a bunch more MMMs.

Best wishes,

dhm