In April of this year, Live Cattle futures broke 2014 all-time highs at $171.975. In prior articles and books, I've named this phenomenon, "blue sky", which occurs whenever an asset makes new all-time highs and there is no historical resistance on the chart (see chart below). Obviously, this is a bullish "set-up" and quite challenging for commercial hedgers who use technical analysis to aid in their hedging decisions. Since we have broken all-time highs what percent should hedgers hedge and over what time horizon?
Figure 1 – Monthly Live Cattle futures chart
One of my rules of thumb when advising hedgers is, "keep your powder dry." So yes, these are historically good prices and we'd like to be somewhat aggressive in our hedge, simultaneously we'd always like to allow ourselves to hedge more should higher price levels occur later on.
In determining our percentage hedged during "blue sky" bull trends the first thing we need to consider is the "shape" of the forward curve. Typically, when physical commodities make all-time new highs, it occurs in backwardated markets and this means we'd automatically be more aggressive in front month hedges and less in deferred months. That stated, every market trend is unique and Live Cattle futures move to all-time new highs has been an interesting one in which the initial "blue sky" move followed the backwardation pattern we'd expect: Settlement prices on April, 11th, 2023:
Apr, 2023 - 172.30
Jun, 2023 - 163.95
Aug, 2023 - 163.25
Given this backwardation of futures prices we recommended commercial hedgers use spot and front month futures charts to provide targets for increasing their percentage hedged in deferred month futures contracts.
For example, on April, 11th we recommended ranchers hedge 80% in April, 2023 futures and 75% in June and August. We also recommended that they use the April, 2023 contract high of $172.475 as a trigger to increase their hedge from 75% to 80% in June and August futures.
Interestingly, as of July 7th, 2023 we actually have a strong contango in Live Cattle futures as shown below.
July 7th, 2023 settlement:
Aug, 2023 - $177.00
Oct, 2023 - $179.375
Dec, 2023 - $183.175
Feb, 2024 - $186.75
Apr, 2024 - $188.25
This being the case we'd actually want to be more aggressive in our percentage hedged for 2024 (e.g., 85% hedged for April, 2024 futures) as opposed to near-month Live Cattle futures (e.g., 80% hedged for August, 2023 futures). The other nice thing about a contango market being accompanied by all-time highs is that now the back months can offer us targets for increasing our hedge in the lower priced front months. In this example, if August, 2023 futures rose to $190, we would increase our percent hedged to 85% and use the April, 2024 highs as our target for increasing from 85% to 90% hedged.