Market Price Risk Over Time and Across Markets

In this the second installment of the Marketing 101 series based on the university bulletin “Livestock Marketing and Risk Management,” I will outline the volatility of markets over time.  I will also outline the volatility between markets.  Finally, I will look at methods to reduce price uncertainty.

Volatility over Time 

Ranchers make decisions on their individual cowherd size.  They also make decisions to raise or purchase replacement heifers.  The returns from those decisions are really based on market prices and costs over time.  Therefore, long-term price volatility is a concern for cow calf producers.  

Prices at the Salina, Utah auction were analyzed from 2007-11 for 500- to 600-pound steer calves. Price variability within a year varied from about $12 per hundredweight to over $23 per hundredweight and averaged $20 per hundredweight over the five years.  That is a difference of $100 per steer calf for a 500-pound calf.

Most 500-pound calves in Wyoming and other nearby states are sold in October and November.  

For the first three years, October and November prices were the lowest prices for the year.  However, in the last two years, October and November prices were above the annual average price.  

The final observation is that in the last three years, October and November prices have varied from $92 to $138 per hundredweight. This is a difference of $46 per hundredweight, or about $240 per head for a 525-pound steer calf.  

That kind of price volatility makes it very difficult to know how much you should pay for a replacement heifer.

Volatility Across Markets

In addition to varying over time, prices also vary across markets.  

Prices from two auctions in Wyoming, one in Colorado and one in Montana are all displayed in Table One.  The prices are for 550 to 600 pound, medium-large frame, Number One feeder steers for three different weeks in the fall of 2011.  In two of the weeks the difference between the highest and lowest price that week is over $11 per hundredweight, or about $63 per head.  

It is also the case that each week a different auction has the highest price and a different auction has the highest rank. In fact, three of the auctions have the highest price one week and the lowest price another week.  

The point of this is that this variability in prices across markets adds to a producer’s risk.  No one market will always have the highest price or the lowest price, and the market with the highest average price overall never had the highest price in the three weeks that were chosen.

Uncertainty

So we know that there is variability in price over time and across markets.  However, not all price volatility is price uncertainty.  

Many prices move in somewhat repeatable seasonal patterns.  It is also the case that regional or local prices may be consistently above or below national price levels.  If these national price levels were known in advance, then local prices could also be predicted or forecasted ahead of time and this could reduce price uncertainty.

Seasonal patterns

Seasonal price patterns can be determined by calculating monthly seasonal index values.  This is done by dividing monthly average prices by the annual average price and multiplying by 100.  If you do this for five years and take the average for each month, you have an estimate of the historical seasonal price pattern. 

These monthly seasonal values can be used to make short one to six month price forecasts.  If it were July and you wanted to predict the November price for a 550-pound steers, then you would take the current July price and divide by the July index and then multiply by the November index.  

For example if the price in July was $135 per hundredweight and the July and November indexes are 100.51 and 96.89 respectively then the November prediction would be $130.14, calculated by first dividing $135 by 100.51, then multiplying by 96.89. 

Basis

Research has shown that for many agriculture commodities, the most accurate forecast for local cash price is to adjust the futures market price by the historical basis. Basis is defined as your local cash price minus the futures price for the same commodity.  

For example, if the price in June was $127.72 for 500- to 600-pound steers and if the August Feeder Cattle contract averaged $130.70 in June, then the basis would have been $2.98, figured by subtracting $130.70 from $127.72.

Beefbasis.com is a website that actually does the price forecasting for many different auction markets, including two in Wyoming.  The Beef Basis website also incorporates other feeder cattle characteristics to try and more accurately predict what you cattle will actually bring at a sale.  In this manner, some of the lot volatility discussed above can also be reduced.

In the next article in this series I will look at a number of marketing alternatives and their relative advantages and disadvantages.  Remember if you are interested in looking at the full bulletin, go to uwyoextension.org/ranchtools, then click on “Fact Sheets” and selecting “Livestock Marketing.”

SIDEBAR:

Data are from the USDA-AMS weekly market reports for each auction.

Table One – This table shows the prices at four different markets over three different dates in 2011, as well as their weekly rank, for 550- to 600-pound feeder steers. Bridger Feuz table