Buyers and sellers are looking for ways to reduce risk in the volatile beef category.
By Mike Neal
Have you ever been paralyzed by indecision as a buyer or seller because the market price of the product kept changing? During the last few years buyers and sellers in the beef industry have faced this price volatility everyday, making it harder than ever before to obtain the best prices to meet their goals. More then ever before they just end up waiting for the spot market, which can lower margins and reliability of supply.
Given that price volatility is already high and still continues to increase, beef buyers and sellers are looking for ways to reduce their risk. One way to accomplish this is to “see the market.” There is a lot of money in seeing the future of the market. For example, if I think prices are going to get stronger four to six weeks out, as a seller I may be a little less flexible in my forward pricing, and as a buyer, I may be willing to pay a little bit more now to get a position in that forward period. Conversely, if the forecast is that prices are going to get a little softer, the seller may push harder to get a position in place now for that forward period, and the buyer may be able to secure product at a favorable price while also satisfying the seller’s objectives. Having a forward position has value for both sides as a hedge against price volatility, and is a good way for retailers and foodservice distributors to ensure adequate product supply.
The beef industry is very seasonal in that value moves around the carcass through the year in predictable ways. In the summer, strips and grinds are more valuable, while around Christmas ribs and roasts are in demand and most expensive. At Mother’s Day, everyone wants a prime rib dinner, so ribs are precious. All of this can be modeled mathematically—allowing buyers and sellers to predict the direction of the boxed beef market.
The best way to predict boxed beef prices is by using “ratio forecasts.” A ratio forecast in the beef industry is an estimate of the relationship between the price of the specific boxed beef item and the price of the cattle from which it comes. For technical reasons, the way to maximize forecast accuracy with boxed beef is to use the ratio technique, rather than forecast the item prices directly.
For instance, to determine the price per pound of Choice Lip On Rib Eye 10 weeks out, the ratio needs to be forecast and then multiplied by a forecast of the price per pound of the live animal in that same forward period. The easiest and most defendable forecasted price of a live animal is based on futures contracts from the Chicago Mercantile Exchange (CME), specifically taking the price per pound from the CME cattle futures contract for the nearest month to the future week in question. The expected price per pound for that forward period is determined by multiplying the CME fed cattle price by the forecasted ratio for the Choice Lip On Rib Eye.
What if buyers and sellers of beef had an objective third-party forecast of future prices before they got on the phone to discuss a trade? Better yet, what if they could look at this information and do the deal completely online, not having to get on the phone? This kind of marketplace would not only give buyers and sellers access to more trading partners, but it would also reduce, or eliminate, the opening spread between bid and quote, as each would be anchored by the objective price. Such marketplaces have existed in other commodities markets and are now emerging in the beef market.
Using objective price forecasts to trade out front can make a big difference for both buyers and sellers. While an exchange is not required, it is becoming increasingly important to employ strong analytical tools like a solid ratio forecast to support and inform the process. A third party marketplace can create the optimal platform for all trading partners. Companies not using analytical approaches and electronic market places in these times of volatility and uncertainty run the risk of being at a competitive disadvantage.
Mike Neal is CEO of ForwardTrade, meat industry marketplace for boxed beef trading. He can be reached at email@example.com.