Cash Conundrum

By Wes Ishmael

Rather than gasp its last, the cash market and what it represents may merely transform into something brand new.

The cash market is dead.  The cash market is poised upon the cusp of a renaissance.

Go ahead. Pick one. Proving the reality of either extreme amid evaporating spot markets and surging interest in alternate paths to value discovery is akin to painting a Hereford steer using only black or white. The truth exists in the shades of gray.

Trendlines Tell the Tale?
On one hand, an accelerating number of fed cattle continue to trade away from the cash market. As many as 45% of fed cattle traded away from the cash by the time the tally was finished on 2000. That's up a smooth 20% in four years, according to USDA's additional cattle movement statistics.

"The cash market at the moment is alive and well. We've still got more than half of the cattle in the U.S. selling on the cash market, by most everybody's estimates, but according to most everybody's estimates those numbers will continue to dwindle," explains Dr. Bill Mies of Texas A&M University.

Moreover, common sense makes it hard to deny the supposition that cattle sold in the cash market, on average, are of lower quality than they used to be.

"I would say the quality of cash cattle has deteriorated, and logic says the quality of cash cattle will continue to deteriorate," explains Mies. "As the volume of alliance cattle grows, the odds of packers getting better than what they pay for with an average price declines, so packers are pushing the grids." And, presumably, the gravy of the cattle mix is trading away from cash.

But, one way or another, prices derived from fewer cash cattle contribute to the value discovery of the remainder. For the sake of commodity comparison, Mies says, "The egg industry is the one that scares me. They sell 98% of the eggs in a value system and 2% in the cash market, and that 2% sets the value for the other 98%. That's the example that takes us to the edge of the ridiculous.

"Even given where we are now I think the cash market is a marginal opportunity to be used as a base price in grids. I think it represents a poor base price because of the quality it represents," says Mies.

And too, there's that damnable narrow weekly marketing window created by everything from instant communication to forcing the packer into a one-price-takes-all bargain way back when. Or was it the other way around? Doesn't matter much now.

"The cash market is still out there, but it does a poorer job than it used to of passing signals to the producer," says Paul Hitch, chairman of Consolidated Beef Producers (CBP) and president and chairman of Hitch Enterprises at Guymon, Okla. "The cash market used to send signals to the producer four days a week, now it's one. It used to send signals with a price spread, now it's one price. And, you could sell cattle. Now, it's more of a game of chicken and whoever blinks first loses."

Let's Hear it for Cash.
On the other hand, no one knows for sure just how deep the cash market needs to be for strength or exactly what the mix of cash cattle is. "What you have left in the cash market today is a mix of really high quality cattle, really average cattle and really low quality cattle," says Neal Odom, CBP vice chairman and manager of McLean Feedyard, Inc. at McLean.

Plus, mandatory price reporting apparently will allow negotiated grid base prices, such as those suggested by Consolidated Beef Producers, to contribute to price discovery, with base prices reported on the front end and net values after premiums and discounts on the back end. In that scenario, negotiated base prices could contribute to price discovery in the cash market, as well as on a live basis, although the prices won't necessarily reflect the cash market. Confused? Read on.

"Under mandatory price reporting, negotiated base prices will be a reportable price," explains Dr. Clem Ward, professor and extension economist at Oklahoma State University. "If CBP is successful at negotiating prices with the packer, it seems like that would strengthen the cash markets from what they are now."

Specifically, Gary Kaplan, CBP chief executive officer explains, "What we're looking to do is expand the test of the cash market with this 2.1 million head committed by our members. Our goal will be to sell cattle at a negotiated base price every day of the week."

Of course, the ultimate contribution of negotiated base prices to cash price discovery will likely be murkier than Sweet Texas Crude in a hog waller until the government's new price reporting takes hold. And maybe after.

According to John VanDyke, chief of grain and livestock news for USDA's Agricultural Marketing Service, negotiated base prices will be reportable, but since they represent the starting price of cattle that will be delivered further into the future and cattle that will end up with a different net value once premiums and discounts are applied, these base prices aren't precisely the same as reported spot market prices. Plus, he points out, as with hogs, the base price can start anywhere. Conceivably, premiums in a particular grid might be high enough that a seller would accept a lower than "market" base price. So, while deepening the cash test, the reported negotiated base prices might not truly reflect the cash cattle trade.

Spurring a Trail Weary Bronc?
No one ever said the cash market, new or old, was some inalienable right. "It's not the sacred cow people make it out to be," says Odom. "There hasn't always been a cash market. Prior to that there were the river markets, then the stockyards markets. It has always been evolving."
As far as Hitch is concerned, the market will decide the path folks will take to value. As chairman of CBP he explains, "Certainly, damaging the cash market is not a goal of ours, nor is saving it. Really, we want the best of both worlds."

Specifically, Hitch explains CBP members want to maximize the value of whatever they bring to market by negotiating a price, then taking advantage of defined value points within a grid. "The base price is more about price discovery, setting where you are relative to the market," explains Ward. "The premium and discounts of a grid then identify whether the value level you're at is superior or inferior."

But, Kaplan explains, "In order for there to be a grid, there must be a base price that is established and today that is the cash market. We're all searching for true value and the price discovery method that will get us there. It might be a resurgence of the cash market or that combined with use of the Chicago Mercantile Ex-change cattle futures."

No matter the pool used for discovery, though, Odom emphasizes, "I don't care if you're trading cars or cattle, the ultimate way to determine value is by discovering what the seller will accept and what the buyer is willing to pay, and the only way to do that is through negotiation."

Guarding the Essentials
Really, at the end of the financial day, the destination matters a lot more than the journey. "I'm guessing if you asked producers what they'd like, they say they just want to be rewarded for what they produce," says Ward.
With that in mind, there are a few components of price discovery to watch for as the system evolves. "It has to be simple and calculable by people on both sides of the trade or it won't survive. If both the buyer and seller can't arrive at the same price on a daily basis, it won't work," says Mies.

Obviously, that has been one of the rubs with formulas and grids thus far. Those that employ plant averages, as an example, are a one-sided affair in terms of everyone having all of the cards to play with. "If you have asymmetric information where one side has the information and the other one doesn't, I think it impacts price discovery," says Ward. He adds, "There needs to be competition for effective price discovery."

As well, Mies believes, "It has to be something routinely reported with enough volume to prevent any suspicion that it can be manipulated. Cash is out in the open where everyone can see it. Its replacement has to be visible."

Of course, that's not an easy task. Take the notion of tying prices back to boxed beef values. Mies explains, "When you show a packer a 735 lb, Choice, Yield Grade 2.5 carcass and ask him what it's worth today, his correct answer should be, 'It depends on who I'm fabbing it for because different fabrication specifications cause the same carcass to have different values.'

"The other issue is that fabrication styles are evolving as we speak. And, we already have two case-ready plants under construction in this country. Case-ready will change everything."

What is likely to remain unchanged, whichever markets cattle feeders use to value their cattle, is the need for information.

As the market continues to move away from commodity cattle toward value-added consumer eating experiences, Mies says, "Because risk management is the key to success, the only way to truly manage risk in feedlot cattle is to know how they will kill in order to know which risk management techniques to use. I can't go into it with zero knowledge base unless I'm willing to do it for zero margin."

Above all, Ward explains, "I think the whole industry has to be aware that things are changing, will change and, given what happened with hogs, might change faster than some people assume. Be open to change, because you may have to change very quickly."

Editor's Note--Wes Ishmael is a Fort Worth-based freelance writer.