Currency risk

This past week I was interviewed by a newspaper report who was trying to write an article on the economic outlook for the pork industry in the coming year. Of course she was wanting me to quote prices and give firm opinions and numbers.

As we discussed the coming year, I found myself going into a long discussion with her of the many variables that will impact our profit picture next year. The one sure thing is that our industry’s destiny is set as far as pig numbers goes. Sows that are bred this week will have the resulting pigs on the late October and early November market. Thus, the sow inventory on the December 1 USDA Hogs and Pigs report and the upcoming January 1 Canadian report is the basis for our production and that can’t be changed rapidly.

On the cost of production side, USDA estimates that 36% of the 2010 corn crop will become ethanol. Another 36% will be used as livestock feed (by all species combined) with the remainder going for industrial uses, human consumption, etc. Carry out going into the 2011 harvest is expected to be less than 1 month’s worth of inventory. This means lots of volatility in grain prices. We’re seeing this already with the impact of dry weather in Argentina on our corn prices. When it rains ½ inch or more in Argentina, our corn may drop $0.15-0.30/bu and when there are reports of continued dry weather, prices rise.

I saw an article a few days ago where someone associated with the ethanol industry stated that using 36% of the US corn crop for energy was not a cause of rising food prices. I would like to have asked the person how this could be. If we have to pay more for corn (or it’s substitute DDGS) for our diets, our cost of production must go up, even as we continue to improve our efficiencies. If it costs more to produce, we must get a higher price long term to break even. If we get a higher price, that ultimately has to translate into higher prices for the buyer of our products, either the consumer or the export market.

The continued weak US dollar relative to other currencies is a positive for our industry as it makes the US a favorite supplier of pork because of both price and quality. We now export 20+% of what we produce, with some estimating that this will grow to 22% in the coming year. Even with rising costs of production and higher prices paid for our product in US dollars, the cost to our foreign buyers is still cheap compared to what it costs them to produce pork or what it costs to buy from our main export competitor Canada.

Long term, it looks like we could be moving towards 25-30% of our production entering the export market. As long as the US dollar is weak (cheap compared to other currencies), this is a positive as it provides a home for our product beyond what our domestic market will take up. The down side, if the US economy finally strengthens and the dollar strengthens, demand for our product will decline as many buyers will price our pork relative to the same product from Canada. As the Canadian industry has learned in the past few years, there is hell to pay when your industry is based on a weak dollar and your dollar gains strength.

The challenge for US producers – putting in place the right risk management tools with regard to these new risks and understanding when the risks are changing. In the past 10 years we have gone from an industry that relies on the US consumer for almost all of our sales to an industry that has 20+% of our sales with other countries and these sales are accompanied by a currency risk that must be in every producers risk management considerations.

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