Sizzling U.S. hog futures market braces for leaner times

Mon Sep 30, 2013 5:59am EDT

* Managed money help fuel record open interest

* Pig virus, Smithfield buyout feed bullish outlook

* Bears look to big hog supplies, cheaper corn

By Theopolis Waters

CHICAGO, Sept 30 (Reuters) - The hottest commodity trade of the summer is facing a lean winter.

Over the past six months, Chicago lean hog futures have surged by more than a third as hedge funds and big speculators laid on record bets; open interest surged by half, exceeding live cattle as the biggest livestock contract.

Many factors fueled the rally, which began in May: Hog farmers downsized their herds after last year's Midwest drought shriveled crops and drove feed costs to record highs. A potentially deadly swine virus turned up in the United States for the first time. A Chinese company bought out top U.S. producer Smithfield, stoking bullish views about global demand for pork.

But there is growing evidence that the hog price rally may soon be over for traders who have been living high on the hog.

Open interest, the number of futures positions in circulation, fell in the latest week after rising to a series of record highs. This suggests some bulls are pocketing profits as momentum behind the latest rally in September has faltered.

On Friday, government data showed the U.S. hog herd as of Sept. 1 was unchanged from a year ago as sows produced a record number of piglets despite the deadly virus that has menaced U.S. hogs for months.

Dan Norcini, who trades hog futures electronically from his home in Idaho, began shorting the market in early September. It has been a tense few weeks for him as he braces for what could be a dramatic conclusion to a long summer rally.

"When the party ends, it's going to be scary," he says.

On Friday, before the USDA data was released, the Chicago Mercantile Exchange's (CME) hog contract for October delivery settled at 92.925 cents, just off a high of 93.750 cents per lb touched on Wednesday.

MANAGED MONEY FLOW INTO HOGS

Signs of a fattening hog market emerged around mid-May when some money managers, frustrated with the poor performance of the neighboring live cattle market, pulled up stakes and landed in the hog pit that showed more promise.

Don Roose, an analyst with U.S. Commodities in West Des Moines, Iowa, said his firm changed trading strategies as record-high beef prices stirred concerns about consumer demand.

"We were spooked by sky-high beef costs hurting demand and at the same time the hogs looked more competitive," Roose said. "We are momentum traders, and once things start to move, we start to look for fundamental reasons to move also."

Last summer's historic drought in the U.S. Plains hurt crops, forcing hog farmers to downsize. The move resulted in fewer hogs for packers to draw from now. The number of hogs slaughtered in the United States is down 4.6 percent from a year ago since the first week of August, data show.

In May, the Porcine Epidemic Diarrhea virus (PEDv), a virus fatal to baby pigs, was reported in the United States for the first time ever, fueling fears a further decline in hog supply by the middle of autumn.

With the new flow of business came rising open interest, which represent the total number of long and short positions in the market. It reached a record 335,916 contracts on Sept. 18, up 53.3 percent from the low this year of 219,182 on Feb. 20.

That exceeded open positions in live cattle for the first time since both markets traded alongside each other in 1966.

Big speculators accounted for a lot of hogs' new-found appeal. So-called "managed money" traders increased their net long position in the market from 78,028 for the week ending Aug. 6 to a record 95,076 the week ending Sept. 17, according to Chicago Futures Trading Commission data.

"This market has got to burst," said Chicago-based Archer Financial Services broker Dennis Smith.

SMITHFIELD MERGER

Bearish factors are now accumulating. The U.S. government's September hog report showed signs of producers gradually rebuilding their herds after the price of corn, the main ingredient in livestock rations, halved since last summer.

With a bumper fall harvest on the way, feed prices are falling. And hogs tend to pack on pounds more quickly during cooler weather as they chomp on new-crop corn that has more nutritional value than older feed that has been in bins.

The prospect of rising demand from China looms large. This week, after Smithfield Foods shareholders approved a $4.7 billion takeover by China's Shuanghui Intl, senior executives touted plans to expand the top U.S. pork producers' global reach.

But some view potential Chinese demand growth as a long-term factor, not something that will add legs to the latest rally.

"It's friendly news but I'm not wildly bullish about it," said Norcini. "Smithfield has been sending pork to China for years. Because it's a new company and will take time for those exports to work through, I have more of a show-me attitude."

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