The Market's Fine Print

Wasn't it Confucius who first said, "When one is found in a hole, the honorable ditch digger bows toward wisdom by breaking his shovel?" On the other hand, it might have been Ed Norton ruminating from the bowels of the New York sewer system.

Whoever deserves original credit for this invaluable pearl, it's been long commandeered by analysts and investors attempting to describe either oversold conditions or market-bottoming potential. In fact, this week's tentative bounce in cattle futures has got me thinking about the old saw. Have bearish excavators finally exhausted themselves in the summer heat? Are enlightened specs and commercials at least ready to stop digging and break the shovel?

For those who haven't particularly dirtied themselves in the cattle trenches since Memorial Day, let me briefly review the market's rather aggressive shift in topography through the first half of the summer.

Between June 10 and Monday's low of 142.25, the August live cattle contract was buried by no less than 1,215 points. Over the same time period, August feeder futures cratered by as much as 1,973.

Dirt flew as aggressively from the cash side of the dig. After topping close to $161 around mid-May (already $5 below the early spring peak), the 5-area steer somehow found itself last week sprawled on a soft basement floor of $145.48. While those in the feeder trade were slower in grabbing a shovel, they've rooted like bionic terriers since late June. Specifically, the cash feeder index tunneled from $231.30 on June 24 to $214.89 on July 28.

Of course, hole-digging of this sort is rather seasonal work when it comes to the tail-end of the second quarter and the shank of the third. What should we expect when producers maneuver the last large troop of fed calves past the year's best cluster of beef holidays, marching into the dreaded dog days of summer like General Custer toward his doom?

But just because it's par for the course doesn't mean you have to like the course. Feedlot margins have deteriorated from "ugly" to "catastrophic" over the last two months, from losses close to $100 per head just before Memorial Day to gut-shots right at $300 per head last week.

Given such a dangerous equity drain within the cattle feeding sector, it's not surprising that so many bloodshot eyes in the country brightened at Tuesday's promising reversal in live and feeder futures. Although I'm painfully aware that technical cards remain stacked against bottom formation, let me suggest there's more potential in the air than wishful thinking and desperate cries for market help.

Start with an honest look at the calendar. Historically speaking, late July and early August tend to be the elephant graveyard of bear markets. The combination of more manageable fed supplies, pre-Labor Day demand, school lunch biz, the possibility of cooling temps, and diggers rethinking the risk/reward equation typically works to turn the high tide of selling and set the stage for a significant price rally into the last third of the year.

If you're not one who puts a great deal of stock in seasonality (frankly, it's been a tough year for seasonal factors and patterns), I think you can still be optimistic about a near-term bottom by considering how far the feedlot trade has already fallen from its spring high. In nearly 90% of all markets since 1980, the cash break from spring high to summer low was no more than 17%. Since early April of this year, the 5-area steer average has faltered by nearly 16%.

Yeah, I know. Past performance is no guarantee of future results. My stockbroker almost breaks his neck with this mantra every time I call him. Still, you can't get out of bed in the morning without at least an initial roll of the dice. And the early risers in the cattle business are not exactly known for their risk aversion.

For what it's worth, I think the question of a market bottom is relatively easy: The cement has either already been poured or will be within a week or so. Shovel handles are cracking with blades set for rust.

The tougher bit is exactly what lies beyond the imminent market corner. "Higher prices" is the easy answer, but many start to mumble when pressed for details. Since I don't anticipate a great deal of beef production change through the balance of the third quarter, the specific strength of the pending recovery will probably hinge on demand.

Over the last 10 years, the 5-area steer high for the July-December market period has averaged $8.45 over the July monthly average. In the 2010-2014 period, the second-half high has averaged $11.35 above the July average. With July just slipping into the record book, I estimated this month's average price will total close to $149, suggesting a late-year top somewhere between $157.50 and $160.50.

For more from John see www.feelofthemarket.com

Follow John on Twitter @Feelofthemarket

(VM/CZ)

Copyright 2015 DTN/The Progressive Farmer. All rights reserved.