Front Cover
 Title Page
 Table of Contents
 List of Tables
 Method of procedure
 The results
 Concluding remarks
 Back Cover

Group Title: Circular
Title: A simple comparison of the cash and futures markets for finished beef cattle between 1968 and 1977
Full Citation
Permanent Link: http://ufdc.ufl.edu/UF00084339/00001
 Material Information
Title: A simple comparison of the cash and futures markets for finished beef cattle between 1968 and 1977
Series Title: Circular
Physical Description: iv, 16 p. : ill. ; 28 cm.
Language: English
Creator: Van Blokland, P. J
Florida Cooperative Extension Service
Publisher: Florida Cooperative Extension Service, Institute of Food and Agricultural Sciences, University of Florida
Place of Publication: Gainesville Fla
Publication Date: 1979
Subject: Beef cattle -- Marketing -- Florida   ( lcsh )
Genre: government publication (state, provincial, terriorial, dependent)   ( marcgt )
bibliography   ( marcgt )
non-fiction   ( marcgt )
Bibliography: Includes bibliographical references (p. 16).
Statement of Responsibility: P.J. van Blockland.
General Note: "7-200-79"--P. 4 of cover.
 Record Information
Bibliographic ID: UF00084339
Volume ID: VID00001
Source Institution: University of Florida
Rights Management: All rights reserved by the source institution and holding location.
Resource Identifier: oclc - 82684659

Table of Contents
    Front Cover
        Front Cover
    Title Page
        Page i
        Page ii
    Table of Contents
        Page iii
    List of Tables
        Page iv
        Page 1
        Page 2
    Method of procedure
        Page 3
        Page 4
    The results
        Page 5
        Page 6
        Page 7
        Page 8
        Page 9
        Page 10
        Page 11
        Page 12
    Concluding remarks
        Page 13
        Page 14
        Page 15
        Page 16
    Back Cover
        Page 17
Full Text

Circular 467


P.J. van Blokland


Florida Cooperative Extension Service
Institute of Food and Agricultural Sciences
University of Florida, Gainesville
John T. Woeste, Dean for Extension

The Institute of Food and Agricultural Sciences is an Equal Employment Opportunity-Affirmative Action Employer authorized to provide
research, educational information and other services only to Individuals and Institutions that function
without regard to race, color, sex, or national origin.

1968 AND 1977


P. J. van Blokland


The essential purpose of this paper is to compare the results of
short hedging each contract in the live cattle futures market with selling
in the cash market over the ten-year period between 1968 and 1977. The
paper underlines the neglected point that the futures market transaction
involves three prices, rather than two and quantifies the different re-
sults from using the usual two price concept with the realistic three price
situation, as well as quantifying the cash and futures market performance
over this time period. These quantifications are presented in terms of
feedlot services margins.

The paper shows why the futures market cannot always provide satis-
factory returns for hedgers and suggests that even a superficial knowledge
of price trends and inventory will demonstrate when a hedge can prove suc-
cessful. The major emphasis involves the futures contract close out price.
While the paper does not deal with hedging strategies per se, it intimates
that their relative success basically depends upon this closing out or buy
back price.

Key words: futures market, hedging, live beef cattle, feedlot services
margin, price, cash market, buy back, farmer.










. . . . . .

. .................

. . . . . . . . . .


S. .................
. .o o .lo e o o o o e o o o


. . .




The difference between the true futures feed-
lot services margin and the cash feedlot ser-
vices margin, for every 100 lbs. of liveweight
gain, in bi-monthly intervals, 1968-1977......



1 Feedlot Services Margin per cwt. Liveweight
Gain . . . . * ............

2 Choice Omaha Steer Prices ($/cwt. liveweight)

3 Number of Cattle on Feed in 23 States (1,000
head). . . . . ... . * * *






P. J. van Blokland

Futures market prices are interpreted differently by different people.

However, it is generally held that the futures price for storable commodi-

ties broadly reflects a cash price and a carrying charge for storing, in-

terest and transportation, usually determined by market circumstances [6,

pg. 1254-1262]. This interpretation is, perhaps, not so easy to apply to

the non-storable commodities. Their futures prices are ordinarily considered

to be a current forecast of the eventual cash prices [4, pg. 372-380]. Yet

the implication of both these opinions is that the futures market does pro-

vide a forward pricing mechanism for both storable and non-storable commod-

ities [3, pg. 271-279]. But despite this apparent advantage, it is evident

that farmers are often less than enthusiastic in using the futures market,

particularly those farmers producing non-storable commodities. Many of

these farmers have tried this market and then returned to their traditional

marketing methods without realizing quite what went wrong.

This paper, therefore, has two main goals. One is to show why the

futures market has not always provided satisfactory results for feedlot

operators attempting to hedge their cattle. The second is to indicate that

there are times when this market should not be used. The method of analysis

to meet these two goals is to compare the financial results from hedging

every contract for live beef cattle for the ten-year period between 1968

Dr. van Blokland is an Assistant Professor in the Department of Food
and Resource Economics.,

and 1977 (i.e. 60 contracts) with the results of selling in the cash market

over the same period, and to combine these figures with time series data

on the number of cattle on feed. This approach helps in identifying the

right and wrong times to use the futures market, and also quantifies the

results of continuously hedging, regardless of market circumstances.


Futures market trading is usually presented as involving two markets

and hence two prices. The two market concept is correct. Beef producers

use the futures market to forward price by trading paper, and maintain

their normal livestock cash markets to trade cattle. But the concept of

two prices is incorrect. There are three prices that the farmer has to

consider. Once he decides to produce fat cattle, he is then concerned with

the price for his finished product in the cash market. This is the one

and only price in this market. But in the futures market there are two.

One is the price at which he sells his contract, usually at the time he

purchases his feeders. The other is the price at which he buys back his

contract, generally just prior to selling his finished cattle.

It is this latter price, the buy-back transaction, which has probably

resulted in the disappointing performance by many individuals. And it

is not entirely their fault. Much of futures market literature illustrates

the myth of the perfect hedge. Thus market proponents neglect to inform

potential practitioners that, because this third price exists, it is simply

not possible to lock in a profit, or even a final price. Hence a trader

new to the futures market is often surprised to discover that he has to re-

purchase his contract some time later at considerably more than he sold it


Method of Procedure

This investigation relies on the following assumptions:

(1) that the feedlot operator purchases and finishes six groups of

feeders a year,

(2) that 600 lb. Choice feeder steers are purchased at Kansas City

prices and sold as 1000 lb. Choice fed steers in the cash market

at Omaha prices; or that the price differential of Kansas City

550-750 lb. purchased feeders and Omaha 900-1100 lb. sold fat

cattle is a reasonable representation for any feedlot planning

(otherwise it would pay to arbitrage),

(3) that the feedlot operator will use either the cash market only,

or the futures market only between 1968 and 1977, and

(4) that the cattle contracts) are sold when feeders are purchased

and the contracts bought back five months after the initial pur-

chase of feeders in the month prior to contract maturity (it is

usually a wise rule for hedgers to stay out of the delivery month

when trading because this is a volatile time when the large specu-

lators attempt to profit by matching longs and shorts)[1].

These assumptions provide the background for the investigation. The

ensuing procedure relies on historical data in comparing the cash and fu-

tures market transactions from the start of 1968 to the end of 1977, using

the months of the live cattle futures contracts, namely February, April,

June, August, October, and December. Consequently, there is a total of

sixty observations.

The futures price for selling is the closing price on the twelfth day

of the month the feeders were purchased for the futures contract maturing

six months hence. The futures price for terminating the contract is the

closing price for that contract on the twelfth day of the month prior to
the delivery month.

The two markets are compared using the concept of "feedlot services

margin" or FSM. The FSM is the difference between the value of the fin-

ished cattle and the purchased cost of the feeders. For example, if 600

lb. feeders were purchased at $50 per cwt. and later sold as 1000 lb. fed

cattle for $45 per cwt., the FSM is I (45 x 1000/100) (50 x 600/100)], or

$150, or $37.50 per cwt. of liveweight gain. This feedlot service margin or

FSM is only known when the cash market transaction is completed. So the

producer who uses the cash market alone will have little idea of his returns

until the cattle are sold. In contrast, the futures market does provide some

idea of the final margin before the cattle are sold, through its forward pricing

mechanism. The margin for those producers using both the cash and the

futures market is the "futures feedlot services margin", or FFSM, while the

margin for producers who use the cash market only is the "feedlot services

margin", or FSM.

The futures market does reduce the risk of marketing at an unknown

price, but it still involves risk because the price of buying back a con-

tract is unknown. Hence, the FFSM is treated in two ways. The first

method simply uses the contract selling price and the cost of the purchased

feeders. These figures are known before the fattening period starts, and

are perhaps the main cause of user dissatisfaction with the futures market,

particularly when the user is told (incorrectly) that he is locked in to

a price. The second method, therefore, does include the difference be -

tween the selling price of the contract and its buy-back price. This

second procedure provides the true results from using the futures market

and the margin is, of course, unknown when the feeders are bought (only if

the basis stays the same will the first and second futures market methods

provide the same result).

For example, assume that 600 lb. feeders were bought for $40 per cwt.,

and at the same time a live beef contract was sold at $47 per cwt. which

was later bought back at $49 per cwt. Then the first method would show a

FSM of $170 and the second $150.3

There are, then, three feedlot services margins which will be examined.

These are:

(1) the cash market FSM

(2) the misleading FFSM (method one in the futures market)

(3) the true FFSM (method two inthe futures market)

The Results

Figure 1 summarizes the basic data in terms of dollars per cwt. live-

weight gain. It shows that a feedlot operator using the cash market only

between 1968 and 19g7.got better results than if he always used the futures

market. In fact, the futures market (i.e., the true FFSM) out-performed

the cash market only twenty-four times in this ten-year period. Thus the

cash FSM line is nearly always higher than the two FFSM lines. It also in-

dicates that the true FFSM was usually less than the misleading FFSM (the

'"misleading" FFSM is referred to as the "chosen" FFSM in the figures). Thus,

the operator is led to believe that the futures market is better than it

actually is.

Table 1 compares the cash FSM and the true FFSM over this time period

in dollars per 100 lbs. of liveweight gain. It shows what an operator

would have gained or lost for every cwt. of liveweight gain by using the

futures market rather than the cash market. If the number is positive, then



a 0.

*~ I I

E~~c~to 0 00


Table l.--The difference between the true futures feedlot services margin and the cash

feedlot services margin if dollars per cwt. of liveweight gain, in bi-monthly

intervals, 1968-1977.


1968 19

February -4.13 -7.

April -2.70 3.

June -5.83 6.

August -6.80 -5.

October -15.40 -6.

December -22.55 1.

Total over the year

e FFSM minus

69 1970

87 3.44

75 11.61

11 6.03

57 -10.12

58 -7.25

52 -13.18

cash FSM per cwt. liveweight gain

1971 1972 1973 1974

-5.27 -9.74 -32.27 25.84 -3

-5.81 -7.22 -2.45 28.87 -3

-13.30 -1.95 24.83 -5.77 -1

-17.02 -29.58 45.27 31.93

-10.89 -31.47 28.45 10.60 -

-19.83 -22.22 36.40 -24.63

-57.41 -8.64 -9.47 -72.10 -102.18 100.23 66.84 -69.25





























.104.31 -64.45 -112.12

the futures provides a better price than the cash market. Conversely,

if the figure is negative then the cash market is better.

This table shows that the futures market provided better results

than the cash market in only three out of ten years given the four assump-

tions listed previously. It also records that a continuous hedging strate-

gy over this time would have lost the operator $112.12 for every cwt. of

liveweight gain, compared with the simpler cash market only transaction.

No single contract month is apparently much better than another in

the comparison. However, the April contract did provide somewhat higher

prices than the cash only strategy in five years out of ten, while the De-

cember contract only managed this for three years. The other contracts

all recorded higher futures gains in four years. The total results

of each contract over this ten-year period may initially appear signifi-

cant, in that the April, June, and August contracts have out-performed

the cash market. But some reflection should suggest that this interpre-

tation is not particularly satisfactory. For example, the operator would

have to wait eight years before gaining in the April contract, which is

the best of the threecontracts.

These conclusions have, so far, been rather simplistic. One of the

basic objectives is to find the times when the futures market should be

used and when it should not. Simply recommending the April contract is

probably not a good conclusion. How, then, can a feedlot operator know

what to do?

The basic answer involves looking at cattle prices and the number of

cattle on feed. Figure 2 presents the pattern of Choice steer prices in

Omaha from the beginning of 1968 up through mid-1978, in dollars per 100








1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978
Figure 2 -- Choice Omaha Steer Prices ($/cwt. liveweight)

lbs. of liveweight. Without attempting a technical examination, it is

still possible to discern six main movements in this pattern [5, pg. 1].

These are:

(1) From early 1968 to the end of 1970, prices remained fairly steady,

albeit showing a slight rise, with a 10% variation around the

mean price of $30. This stable period lasted two-and-one-half


(2) Then, from the beginning of 1971 up to the end of the summer of

1973, prices rose continuously and much more sharply, from a low

of $27 to a $63 peak. This two-and-three-quarter years' trend

therefore doubled prices.

(3) After August 1973, prices generally fell for around 18 months,

dropping to $35 with two brief corrections in early and late

1974. By the spring of 1975, prices had fallen by one-third.

(4) Then came a nearly six-month correction which increased prices

into the low $50s.

(5) Prices then resumed their falling pattern, bottoming out in the

high.$30s, with an average price during this period of around $40.

(6) Finally, in the summer of 1977, prices started to climb and by

June 1978 had grown by 50%.

What caused these movements? The obvious answer is that prices gener-

ally fall when there is a large supply of cattle, and they rise when cattle

numbers fall. Figure 3 illustrates this answer in presenting the number

of cattle on feed in the 23 major feeding states. The number of cattle on

feed rose from around 10.5 million head at the start of 1967 to about 14

million by the end of 1972. This inventory build-up could only be sold at

when futures market is
better than cash market

of Cattle


Figure 3 -- Number of Cattle on Feed in 23 States (1,000 head)

lower prices. Hence farmers began to reduce the numbers on feed after

this date, and they fell to nearly 9 million at the turn of 1975.

Prices follow the same broad pattern. Farmers will generally in-

crease the number of cattle on feed if prices are rising. The numbers

followed prices up to the August 1973 peak. Then came the staggered price

fall, triggered by a successful consumer boycott of high beef prices and a

synonymous consumer switch to cheaper meats (annual per capital beef consump-

tion fell in 1973 for the first time since World War II). This situation

was exacerbated by a historically high number of cattle on feed. These

could only be sold at lower prices, so numbers followed cattle prices down,

bottoming out in late 1974 and early 1975.

Then, after brief upward correction, prices resumed their downward

trend so that in January 1977 the number of cattle on feed was about the

same as in January 1969. Yet beef consumption had increased 14 lbs. per

head during that period, and population had expanded by approximately 12

million and real income by 7%. So prices had inevitably to rise. That

they have considerably further to go is suggested by the January 1978

cattle numbers which are similar to those in 1970.

The futures market generally performs better than the cash market

when prices are falling, due to the sell and later buy-back transaction.

In other words, the later buy-back price is less than the earlier sell

price, producing a gain on the futures transaction. There are, therefore,

two main periods in this historical sequence when the futures market out-

performed the cash market. These were mid-1973 to late 1974, and mid-1975

to early 1977 (both with the exception of one month), and they correspond

to the two main times of falling prices in the fat cattle market.

Most cattle farmers are, of course, aware of national price trends.

But the basically simple fact that the futures market will provide greater

rewards than the cash market alone in times offalling prices has apparently

been overlooked. As price movements do tend to move in one direction or the

other for a reasonable length of time (admittedly with problematic correc-

tions), it should not be too difficult to take advantage of these movements

in deciding whether to place a hedge or not. In this historical time

series there have been two major periods of price falls. One lasted for

about two years and the other lasted nearly a year and will apparently

run on for some time [2, pg. 23-25]. Table 1 suggests the advantages that

might have accrued from selecting between the cash and futures market al-


Concluding Remarks

The evidence from 1968 to 1977 shows that a farmer who used the cash

market only would have done better than a farmer who used the futures

market only. There were just two periods during this time series when

the futures market transaction was preferable to traditional cash marketing.

These were approximately from mid-1973 to late 1974 and from mid-1975 to

early 1977. The reason for the better performance is simply that the fu-

tures market transaction itself resulted in a profit because the buy-back

price was lower than the original sell price. The reason for this profit-

ability, in turn, is that these were times of falling cattle prices, due

to an oversupply of cattle.

But how can a farmer exploit times when trends are not so clear? An

answer to this question requires involvement with hedging strategies, and

particularly with timing the buy-back decision. It is not the purpose of


this paper to investigate these strategies, though there is some good re-

search available. The main purpose has been to show what can be accomplished

by using the basic simple tools of cattle prices and cattle numbers.

These are the tools that matter, and provide the essential data for

developing strategies and charting techniques. More importantly, they

provide the basic information for sensible marketing, and most important

of all, it is knowledge that the farmer may already possess. This un-

doubtedly inchoate paper is intended to show just that.


1These price relationships can also be discussed in terms of basis
movements, where basis is the difference between the Chicago futures
price and the local cash price, including some additional adjustments.
However, as many people have some difficulty with the concept of basis,
and as this paper attempts to avoid futures markets techniques and terms,
it was felt that a price presentation would prove clearer (however, any
potential traders must realize that a thorough knowledge of basis is essen-
tial to a successful trading).

2There is nothing significant about using the 12th day of the month.
One day is essentially as good as another.

3Both methods are included to show, in the first method, the price
at which the farmer decides to enter the futures market and, in the second-
method, what was the true result of using this market (transaction costs
are ignored).

4This conclusion ignores the possibility that the farmer may, indeed,
sleep more soundly if he has lowered his market risk by hedging, and there-
fore be compensated for lower returns in the futures market.


[1] Hieronymus, T. A., "Economics of Futures Trading", Commodity Research
Bureau, Inc., Newy York, 1971.

[2] Jacobs, V. E., "Cattle Rally: A Mid Year Assessment", Commodities,
June 1978, p. 23-25.

[3] Leuthold, R. M., "The Price Performance on the Futures Market of a
Non-Storable Commodity: Live Beef Cattle", American Journal
of Agricultural Economics, Vol. 56, No. 2, May 1974, p. 271-279.

[4] Tomek, W. G. and R. W. Gray, "Temporal Relationships Among Prices on
Commodity Futures Markets: Their Allocative and Stabilizing
Roles", American Journal of Agricultural Economics, Vol. 52,
No. 3, August 1970, p. 372-380.

[5] Waugh, F. V., "Graphic Analysis: Application in Agricultural Eco-
nomics", Agricultural Handbook 326, Economic Research Service,
Washington, D.C., November 1966, particularly page 1.

[6] Working, H., "The Theory of the Price of Storage", American Economic
Review, Vol. 39, December 1949, p. 1254-1262.

WA~Y 30 1991 2JgZ 21 4 --


(Acts of May 8 and June 30.1914)
Cooperative Extension Service, IFAS. University of Florida
end United States Department of Agriculture, Cooperating
K. R. Tefertiller, Director

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