Wednesday, May 06, 2009
Why Did Hog Markets Crash So Hard Because An Influenza Strain Was Blamed On Swine?
At $25 per head, the pork industry has suffered the worst from the fall out of the H1N1 influenza problem. At the outset it was mislabeled Swine Flu, and both the media and governmental health authorities convinced the public that hogs had something to do with the health issue. Consumers quit buying pork, foreign countries began banning US pork exports, and the bottom dropped out of the cash and futures markets for hogs. Although a hog was never found to have the virus until some caught it from a Canadian farm worker, the damage was already done. But how did the news translate into falling market prices.Over the years there have been many scares that public health would be jeopardized by animal health maladies. Subsequently, the livestock futures traders manage their risk by selling contracts and the price plummets. It is not quite as simple as that say agricultural economists Amy Hagerman and Yanhong Jin who coincidentally published a research paper on the market impact of foot and mouth disease at the same time livestock futures were impacted by the H1N1 virus. Their research examines the market volatility and the rationality of traders to the uncertainty about the spread of an animal disease.
The economists use the rumor of foot and mouth disease that originated in a Kansas Sale Barn in early 2002, which turned out to be false, but took $50 million out of the cattle industry overnight. The parallels with the alleged swine flu can be closely compared. Hagerman and Jin report that uncertainty plays an important role in futures prices and trading volumes and those increase the implied volatility of the stock. While the reactions may not be irrational they suggest, it can lead to over or under reaction by traders. At that point herd mentality sets in, traders think other traders have very accurate information and will follow their lead. Hagerman and Jin say that leads to price distortions, in part from foreign investors moving in and out of US markets.
The economists say that once the information uncertainty has cleared up, such as dispelling a rumor, then the herding disappears and prices adjust. But if prices continue to fall, then the market has shifted into a new mentality of momentum trading. Hagerman and Jin label the traders as “newswatchers” who trade with current or past information and “momentum traders” who rely on prior trades to set their forecasts. They believe the momentum in the market results from traders looking at the overall market direction instead of fundamentals based on supply and demand information.
Looking at the timing of how the foot and mouth rumor got from the Kansas Sale Barn to the Chicago trading floor, authorities are uncertain, but believe an Iowa radio station had reported the potential outbreak of foot and mouth disease and when that got to the traders, the market nose dived. It could also have been conveyed by a cattle buyer to a floor broker. While some market manipulation has been speculated, there was no confirmation following governmental investigations.
The economists say lean hog futures were the most volatile, followed by pork bellies and live cattle, with feeder calves the least. All moved together during the rumor period, and although feeder cattle and lean hogs continued to fall after the rumor was dispelled, they soon recovered. They say the pattern indicates herd mentality, and while momentum trading does not imply herding, it may aggravate the effects of herding. Their analysis indicates “The incident may well have been a trigger for the downward price cycle earlier in the year than expected. However, the incident was not found to have a significant impact on prices of pork bellies contracts.” And they go on to say, “analysis would seem to reveal herding behavior in feeder cattle, live cattle and lean hog livestock futures and momentum trading for live cattle and lean hog livestock futures. A more formal econometric analysis of herding behavior leads to evidence of herding behavior in live cattle and lean hogs.”
The economists say, “It could be argued that the rumor of FMD gave traders a reason to sell; however, even if the market was primed for a seasonal downturn the rumor appears to have caused the downturn to be steeper than expected or reasonable under ordinary circumstances.”
Summary:
The current drop in hog futures and cash markets is the result of the influenza strain erroneously blamed on hogs. Nevertheless, the marketplace loss tens of millions of dollars in value, which can be explained by research based on a 2002 rumor of foot and mouth disease in US cattle. Some traders sold the market short based on what they saw other traders doing that they thought was the right thing to do. Once the market momentum headed down, other traders also sold, because that is where the market was moving. Some contracts prove to be more resilient than others, but market volatility will spread to many related contracts.
Posted by Stu Ellis on 05/06 at 01:06 AM | Permalink
Comments
Posted by: Daniel Spalding at May 6, 2009 7:07AM
These things are always heartbreaking to read about,and so hard on producers. It seems that if you take one normally rational person, add fear,then multiply; you end up with pandemonium.
Me? I still love my bacon and beef!
Posted by: Rhonda Daniels at May 6, 2009 1:01PM
How would the market makers react if they knew that all hog barns and schools were protected by ozone? Ozone kills bacteria within a few seconds by a process known as cell lysing. Because of this, microorganisms cannot develop ozone resistant strains; thus eliminating the need to change biocides periodically. (Franken 2005) See: “The Application of Ozone Technology for Public Health and Industry” November 2005
By Laurence Franken. Food Safety & Security at Kansas State University.
Complete document at: http://www.GooneybirdsLLC.com/Franken.htm