HardAssetsInvestor

Written by Brad Zigler  |

September 20, 2010

When Pigs Fly, They Also Fall

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Real-time Monetary Inflation (last 12 months): -2.3%

School's back in session now after the summer recess, the lure of the gridiron is making a hash of "honey do" lists throughout the land and the barbecue season's winding down.

"Down" is also a word that describes the immediate prospects for live hogs. Hog prices actually topped out at the 87-cent-per-pound level in May after nearly doubling in an eight-month run-up. Since May, hogs' downward price trajectory has been slowed, in part, by backyard grilling demand in a typical summertime pattern.

Lean Hog Futures (Weekly)

Seasonally, hog prices break in early fall as the pace of slaughter picks up. This autumn, commercials are signaling their worries about weak prices by stepping up their hedging activity to near-record levels for the year.

At last count, commercials—that is, mostly producers—were net short 103,221 contracts. Buildups in commercial short positions typically precede price breaks in the lean hog market. In mid-January, for example, commercials were short more than 93,000 contracts just ahead of a 7-cent dip (a lean hog contract calls for delivery of 40,000 lbs, so a 7-cent decline means a value swing of $2,800 per contract). In late April, commercials boosted their net short hedges to more than 107,000 contracts before hog prices slid over 10 cents.

Commercial Net Short Positions (Lean Hog Futures)

If prices broke this week from their current congestion area, another 10-cent ride could be driven by bears to the 66-cent level.

A move like that is bound to have some effect on holders of agriculture exchange-traded products. There's an 8.5 percent dosage of lean hogs in the PowerShares DB Agriculture Fund (NYSE Arca: DBA). The GreenHaven Continuous Commodity Index Fund (NYSE Arca: GCC) gives more than 6 percent of its portfolio over to lean hog futures. Hogs make up 37 percent of the index tracked by the iPath Dow Jones-UBS Livestock Subindex Total Return ETN (NYSE Arca: COW).

The effect, of course, would be negative—more so for the COW note; less so for the ag ETFs. There are mitigating markets in the broader-based portfolios—such as grains and cotton—which could, if their bull trends are sustained, offset any weakness in hog prices. The COW note, however, has only live cattle as a cohort. But that's a story for another day. And another column.