Ep. 2 Price Discovery Issues in the Fed Cattle Market

[0:19] John Anderson: Hello, I’m John Anderson, director of the Fryar Price Risk Management Center of Excellence here today with my colleague James Mitchell. James is an assistant professor in the Department of Agricultural Economics and Agribusiness at the University of Arkansas and an extension economist with the University of Arkansas System Division of Agriculture. James, thanks for joining me today.

[0:39] James Mitchell: Thanks for inviting me on, John.

[0:41] John Anderson: So, we’re talking today about the cattle market, and I would say, James, there’s probably been no topic in the ag sector generally that’s been more active, might be a good way to put it, more interesting than the cattle market over the last couple of years. And I know you keep up with the cattle market very closely, do a lot of research on cattle market issues. Give us a brief rundown on what the current situation is in the cattle market.

[1:14] James Mitchell: So I’d say kind of coming into 2020 to the general outlook for the year and certainly the past couple of weeks has been a positive outlook relative to where we’ve been the past couple of years and now where we’re continuing to go into a situation where supplies are getting tighter. A few years of contraction generally will mean fewer cattle are going to market, and that generally starts to reflect with higher prices. And we’ve certainly seen that in our fed cattle markets. We’ve seen that in our Arkansas feeder cattle markets. You know, next week is going to be a pretty important week for our markets. So next week, USDA will release the January Cattle on Feed report, and they’ll also release the January one Cattle inventory report, which gives us just an overall estimate of the size of the U.S. cattle herd. Everything from, you know, beef cattle numbers to calf crop size to feed our cattle supply. So really is an important week in terms of getting import information on what this year might look like for our markets. When we start thinking, OK, well, what? where have we come from the past couple of years? You know, it’s been, it’s been a battle with COVID. Certainly, I should say too, you know, right now, if I was to say there’s a more recent negative kind of outlook for the market, it is that the Omnicom variant is starting to have some of that impact on slaughter capacity for both cattle and hogs. And we’ve seen that the past week or two and in fed cattle prices. The expectation is to work through those issues relatively quickly, though. So nowhere near the disruptions that we saw in 2020 and in some of the lingering issues in 2021 that were hanging around, you know, dealing with. You know, really just the issue of slaughter capacity from a, you know, labor shortages, packing plant, disruptions from COVID, logistical issues, just trying to simply get beef from packing plant to retail consumer was a challenge. So all those things really weighed heavily on markets the past few years. But we are running into a more positive outlook for 2022, and we are starting to see that in prices.

[3:12] John Anderson: So kind of a. Kind of a paraphrase. Fairly good fundamental position in the market now compared to where we’ve been the last couple of years: improving fundamentals, mostly on the supply side, certainly on the supply side. But that’s coming at the end of a couple of pretty rough years. From a cattle producer perspective, certainly,

[3:37] James Mitchell: Yeah, I mean it was tough for a lot of people, certainly tough for cattle producers. You know, COVID threw a wrench in things. You know, we starting 2020, we were, you know, starting to see some contraction in the herd and we were starting to think that those tighter supplies would show up with stronger prices earlier in 20 2021. COVID disruptions just kind of really disrupted, you know, market fundamentals. It was hard to anticipate what COVID 19 would do to cattle markets. And then we just kind of been, you know, learning as we’ve gone on and we started to get a better handle on those types of issues with COVID. And I think that’s also been supportive is that, yes, it’s here, but we kind of know-how to manage it better than we did when it really started, right?

[4:20] John Anderson: Hopefully.

[4:20] James Mitchell: Yes, exactly.

[4:22] John Anderson: But if we think back over the last couple of years, say back to the latter part of 2019, James, there have been kind of a succession of issues in the market that have created quite a bit of discontent, I think, among cattle producers. Maybe a better way to put that would be some real dissatisfaction with market outcomes. You’ve mentioned some of those events. COVID, obviously was the big one when we get into early 2020. You go back into 2019, we had the Holcomb plant fire in Kansas that disrupted the processing sector and had these upstream effects in the cattle market. What were some of the issues that producers really were upset about as they saw those kinds of negative market outcomes, more than just low prices? What were some of the issues that sort of fueled this dissatisfaction?

[5:20] James Mitchell: Yeah. So you mentioned, you know, Holcomb plant fire, COIVD you know, cyber-attacks, all sorts of what would appear to be quote black swan events as we like to call them, as economists that.

[5:33] John Anderson: I even forgot about the JBS cyberattack. Yes, that was.

[5:37] James Mitchell: There’s many more. So black swan events again, hard to anticipate. Hard to predict. And when they happen, it’s impossible to predict the outcomes of that. That in itself was frustrating. You know, looking at markets, looking at prices and seeing that things are just not going great was certainly a source of disruption. But those two events were very different events. But the economics of those events were very similar and in what was happening, right? So, both resulted in just not being able to get cattle through the system as quickly as we would like to and as we’d want to. And so part of that frustration was, you know, we’ve got all these cattle backlogged in a feedlot and we just can’t get them through the system quick enough. We can’t process them in a timely fashion because of these disruptions from

packing plant fires and COVID. And that was a big source of frustration because, you know, the economics of that is if you can’t, if you’ve got, you know, a labor shortage from COVID or you’re down a packing plant, that’s 5% of total national processing capacity that results in, you know, a decrease in derived demand for fed cattle. Right. So lower prices for fed cattle because you just can’t process as many as you would normally. At the same time, you’re not producing as much beef as you would normally if you can’t process enough cattle quick enough because of the packing plant fire or COVID 19. And so that results in higher beef prices because of a decline in supply. And so both of these events were really a, you know, the outcome was higher beef prices, but at the same time, lower cattle prices and why, you know, we can sit here and certainly explain why that happened in economic terms, that doesn’t, you know, reduce the frustration associated with both of those events.

[7:26] John Anderson: Right. Cattle producers seeing low prices for their product at the same time that wholesale prices for beef were at record levels at a time in 2020. And I think that’s a good summary. If you can’t turn fed cattle into beef, you end up short on beef and long on fed cattle, and those prices diverge. And you know, we talk about that price spread or that marketing margin all the time. And in economic terms, that’s the marketing margin. You know, everything that goes into turn in that farm product into a consumer product. And those marketing margins really did blow up a lot in 2020.

[8:00] James Mitchell: Oh, yes, yeah, yeah, definitely. I would say, you know, you made a good point on that, though, that, you know, turning cattle into beef and so beef are not cattle. Cattle are not beef, right cattle, labor facilities, capital and lots of other things to make beef in the same way you could say, you know, fed cattle and feeder cattle are not the same things. You need bigger cattle, you need pen space. You need feed, labor again to turn that into another product. So they are, you know, markets that are in a sense, certainly linked. But at times they are separate markets. And so when things diverge, you know, it happens for economic reasons, but it is frustrating.

[8:41] John Anderson: So this fairly prolonged situation, I think it’s fair to say, in the cattle market, particularly the fed cattle market has led to some policy proposals to try to remedy or to try to remedy these perceived problems that we’ve had in the market, and this has been a conversation that’s gone on now for, actively for a year I would say. The roots certainly go back a little further than that. But as we sit here and record this podcast, kind of the live policy instrument that’s being discussed right now is the Fischer Grassley bill. Give us a brief summary of the Fischer Grassley bill, if you don’t mind.

[9:26] James Mitchell: Yeah. So I think the problem at hand and the problem that’s trying to be answered and solved in a sense is, do we need more negotiated trade in the fed cattle market? So negotiated cash, negotiated grid, do we just need more negotiating volume in the fed cattle?

[9:45] John Anderson: And let me let me rephrase that in a way that I think matches the context the last couple of years. And you tell me if this makes sense, if this what we’re dealing with. Would more negotiated trade have made the problems that we dealt with over the last couple of years less severe. Would it have made the price impacts less severe, would it have made the marketing margin impacts less severe. I think the policy prescription is, hey, if we had this, things wouldn’t have been as bad the last couple of years. Is that where this thinking is coming from? I know we’re speculating a little bit here on motives?

[10:21] James Mitchell: But I think that’s certainly a reason why we’re seeing a lot of this policy and a lot of this discussion about this policy. You know, from an economist answer in a, you know, in a sense, it’s hard to go back and try and, you know, live in a world that doesn’t exist with a policy happening with these big disruptions. But in general, from an economic perspective, the short answer is no. This bill is dealing with something that’s very different from what those market disruptions were about. So this is this bill is largely trying to address, you know, what the issue is of price discovery. You know, do we need more negotiated trade in the Fed cattle market, which is a price discovery issue? The issues of COVID 19 and packing plant fires were matters of just supply and demand issues. So COVID 19 caused labor shortages, supply chain, logistic issues, all sorts of things like that. Those are a matter of supply and demand that impacted fed cattle prices. Which is a separate but related issue to Price Discovery, which is really what this bill is trying to get at. So my quick, short dirty answer is I don’t think that this bill would really have much of an impact on fed cattle prices wouldn’t have had much of impact on beef marketing margins. You know, if we had more negotiated trade packing plants would still have been short on labor. They still would have struggled with logistical challenges of getting beef from packing plant to retail. They still wouldn’t be able to process cattle as quickly and as efficiently as they would normally like to. The bill wouldn’t have fixed those fundamental issues that were going on at that time.

[12:04] John Anderson: So that’s, I think that’s a great summary, James, of this issue. And as economists, we talk a lot about price determination and price discovery and price determination relates to those supply and demand fundamentals and how that affects the general level of prices. Price discovery — let’s talk about that a little bit. So price discovery really relates to the mechanisms by which buyer and seller come to the terms of trade, how they establish price and other terms of trade. So it’s related to how buyers and sellers come together in the market and in the Fed cattle market, pricing takes place in a variety of ways. Give us a brief rundown, if you don’t mind, on some of the ways that prices are established in the Fed cattle market how price discovery takes place and how that’s changed over the last couple of decades, really.

[13:00] James Mitchell: Yeah. So you know, a quick answer to the price discovery part of that is if you want price discovery, you need to trade cattle. There are four ways of doing that. Some of them contribute to price recovery. Some don’t. So negotiated trade is, you know, for example, you and I would sit here and try and negotiate the price of a pen of cattle or something, for example, right? That’s negotiation. Negotiated grid is the same thing where we negotiate a base price for delivery at a future date, where you get a grid structure attached to the carcass later, and that gives you a net price. Again, that’s contributing to price discovery because there was negotiation involved in that transaction. So we used negotiation to arrive at a transaction price. That’s what Price discovery is about. It’s about transactions-level prices and how we get to that transaction. There’s forward contracts is the third way to trade and price cattle where we establish a price today for cattle that would be delivered way out in the future. So we’re not negotiating the price when those cattle are actually going to be slaughtered. And then there’s what’s called formulas or formulas, which would be anything other than negotiated trade, negotiated cash or grid or forward contracts. And again, that doesn’t involve any negotiation for us arriving at a transaction price. And so the longer term trend the past 20 years is to as we’ve moved, not away from, but there’s been a decline in the amount of negotiated trade that goes on in the Fed cattle market. At the same time, there’s been an increase in the amount of formula trades that we have in the Fed cattle market. And we get to this in a minute, if you’d like. That didn’t happen by accident. There are really solid economic reasons why this market has evolved to way and looks the way it does today.

[14:49] John Anderson: Right. So these formula pricing arrangements or AMAs, alternative marketing arrangements, you know, these really kind of came to the fore in the 1990s. There were a lot of advantages to AMAs, I think, for both sides of the market. And let’s talk about that for a second. From a packer perspective, what are the benefits of an AMA versus negotiated trade?

[15:21] James Mitchell: Well, I’d say, to back up, the benefit for both groups of just the transaction as a whole, right? So. You know, negotiating and arriving at a transaction price is, you know, an activity that isn’t free, right? It’s costs involved with arriving a transaction, hence the name transactions costs. So that’s the cost of your time and your effort of negotiating and arriving at that transactions price. And really, what’s happened in the last 20 years or so moving towards these AMAs is really for both feedlot and packer, it’s a less costly way of arriving at a transaction price. It’s not the value of that time and effort. It’s not as costly to do business through formula arrangements. And so, for both Feedlot and Packer AMAs reflect a lower cost way of pricing fed cattle.

[16:23] John Anderson: That’s a really good point that that certainly simultaneously affects both sides of the market. And again, for a little context on this, these really became, these arrangements really became popular when grid pricing arrived on the scene in the 1990s. Because if you think of the all of the elements of a grid. For those of you who aren’t familiar with grid pricing, that’s a system in which individual animals are priced according to their individual carcass merits. There’s a base price that maybe applies to all the cattle in a group, but then each animal’s price is adjusted for its carcass merits, primarily quality grade yield grade and carcass weight. It’s also some adjustments for maybe some off quality characteristics like dark cutters or hard boned cattle or things like that. Cattle folks listening, I’m sure, understand that. For those who aren’t cattle folks, I think it’s sufficient to understand that grid pricing

involves individual animal pricing. But it would be very costly to negotiate all of the elements of a grid and a base price every time you did business. And so formula pricing was a way for that, that individual pricing mechanism, which was a really big innovation in the market at the time, right? It was a way for that kind of transaction to happen quickly and efficiently and not have to negotiate every element of that deal every time.

[17:43] James Mitchell: Yeah. So it has the same benefits of a grid in that, you know, if you’ve got a superior carcass, you’re rewarded for that. Carcasses that don’t perform as well or don’t look as good on the rail are discounted for those inferior carcass traits. And so you’ve got the benefits of a grid and you’ve also got the benefits of being able to do so and transact in a less costly, more efficient way of doing business. And so, you know, at the same time, AMAs were becoming a very prominent way of price in cattle, you know, it was really a really big benefit for packers to better align things like beef quality and beef consistency with the signals they were getting from consumers. That, you know, allowed them to communicate better. You know what kind of traits do consumers demand? And then they can use AMAs and grids to secure supplies of that and to really get cattle to fit into that, that bucket of what U.S. consumers want in their product.

[18:38] John Anderson: So clearer signals of the factors that contribute to value, those could be, those signals could be transmitted more clearly up the supply chain with the grid pricing system, which again ties into the AMA use.

[18:54] James Mitchell: Yeah. And so like what packers are, while packers are able to, you know, better align their product with consumer demand through those signals, it also is a benefit to feedlots, because now they’re rewarded for cattle that are meeting the mark on quality.

[19:08] John Anderson: Right.

[19:09] James Mitchell: I mean, they’re really rewarded for being able to do so. And so that’s again, another benefit to the feeder is, you know, I’m putting all the work in on trying to produce a quality product. And, you know, through an AMA, I can be rewarded for that in a very timely, efficient manner.

[19:26] John Anderson: Right. And that that produced benefits for the industry as a whole because product quality improved. And I think we see that if you look at, say, the percentage of cattle that grade choice now versus 20 years ago. Very different.

[19:39] James Mitchell: Oh, it’s a linear trend of the past 20 years of getting being able to hit, you know, markets with, you know, 80 plus percent that is grading choice or higher coincided with when AMAs were starting to become a big part of the market. I mean, you know, an easy way to say this of how what the benefit of AMAs is to the whole industry. You know, if you’re being rewarded for quality, you’re going to be willing to pay for quality. Right. And so the feedlots being rewarded for quality cattle, they’re going to be willing to pay for quality feeder cattle and so on and so forth all the way up the supply chain. And so those benefits have really been transmitted all the way through the supply chain, all the way back to the very beginning of even seed stock operations.

[20:21] John Anderson: So let’s, a little bit more on AMAs and we’ll move on. But this is the Relevant Risk podcast. So let’s talk a little bit about risk specifically related to AMAs. And, you know, from a — and these really generated in the history of this — and I’m old enough to remember a lot of this history, unfortunately — but these really generated on the seller side of the market on the feeder side of the market out of this desire to capture value for superior animals. And there was a lot of work back in the 1990s about how do we improve beef quality and not just quality, but consistency? How do we improve the consistency of the eating experience for the consumer? Well, we need clear signals coming from the consumer back all the way back up the supply chain, and the grid pricing was a way to get those signals. AMAs was way to reduce the transactions costs associated with that. So there were clear benefits there that really the impetus for this came from the feeder side, primarily. In terms of risk, what are some of the benefits to the feeders as a risk management instrument from AMAs?

[21:25] James Mitchell: Yeah. So, you know, risk is a big category that can involve many things. There’s price risk, right, where you know the realized price differs from your expected, what you expect price to be. There’s also production risk where you know what you’re expecting to produce doesn’t come to fruition and isn’t realized and so AMAs in a sense were a way to kind of manage both sources of risk from a production perspective. You know, it’s– there’s a lot of risk if you have to wake up every day and know that you’ve got to negotiate a lot of cattle and get a lot of cattle out of a feedlot, and you’ve got to do it with buyers and you’ve got to, you know, do your home — you don’t just show up and negotiate, right? There’s a lot of work involved, a lot of prep work, time, effort, et cetera. And so having AMAs, knowing that you’ve got a buyer, you generally know, you know what the terms of the deal are in terms of base prices and whatever grids there are. And so simple risk management of being able to, you know, commit supplies into the future and knowing where they’re going and knowing who’s buying them is certainly a big way to manage risk in a sense.

[22:31] John Anderson: Right. And knowing that with a particular buyer, you had the potential for premium if you delivered the right kind of cattle.

[22:36] James Mitchell: Mm-Hmm. Absolutely.

[22:38] John Anderson: From the Packer side, a big risk for packers is that they don’t get the number of cattle they need to run a plant efficiently. And AMAs certainly help them to manage that aspect of their risk.

[22:50] James Mitchell: Yeah, I think the best way to explain that would be with like a quick example. So you can say, let’s say there’s a packer that solely produces beef that goes into, you know, beef programs like Certified Angus Beef or Certified Hereford Beef, or now the NHTC program right, they only produced…

[23:10] John Anderson: Non-hormone treated cattle.

[23:11] James Mitchell: Non-hormone treated cattle. So programs like that, right? There’s a very specific animal that they need for beef to match the requirements of that program, right? And if you were negotiating and you needed to negotiate and find the right type of cattle to fit the Certified Angus beef program and you have a negotiation, the amount of time and the costs involved in doing that would be huge. So AMAs are a really a way to, you know, match cattle to their best destination, in a sense. So if I’m a packing plant that’s only producing beef for Certified Angus beef program, for example, AMAs allow me to quickly and efficiently get the supplies that I need of the right type of cattle, reward the feeder for giving me that type of cattle in running them through and matching those cattle to that beef program.

[24:03] John Anderson: Which is extracting the most value out of the consumer market. Because you’re targeting a specific segment of that consumer market that’s willing to pay for that product.

[24:13] James Mitchell: So it’s, you know, again, it’s just a way of managing supply, which is a source of risks. So supply chain management type risks that you had if you didn’t have AMAs.

[24:23] John Anderson: So that’s a lot of positives there about AMAs. And the point of that conversation is not necessarily just to highlight those positives, but to provide some background on why the market looks like it does today. Why AMAs account for roughly two-thirds of fed cattle transactions nationally, much more than that in the southern plains. We have a lot of big feeders that use AMAs. So that’s the background that’s that kind of explains or helps to explain, I think, the lay of the land. But a lot of industry participants are not necessarily happy about widespread AMA use. And again, these concerns about what, what, what might it do to prices, what might it do to marketing margins? Let’s talk for a second about what might it do or what concerns are that it might do to price discovery. You’ve mentioned price discovery, this this this interaction between buyer and seller to arrive at a specific transaction price. What’s the potential negative effect on price discovery of expanded AMA use?

[25:24] James Mitchell: So what I said a few minutes ago, right, is if you want price discovery, you need to negotiate, right? And so the concern is, if you move towards more and more AMAs, those AMAs are using some reference price to establish value. Usually, they’re referencing a price that came from a negotiated market where there are people negotiating prices for cattle, right? And so if you’ve got fewer and fewer negotiated transactions, you know, there are concerns about what we would call the quality of price discovery. And really, what I mean by the quality of price discovery is do these transactions prices reflect correctly the information about the commodity that’s being traded? Do they accurately reflect the market conditions, the supply and demand fundamentals of that market? So do fed cattle transactions prices accurately reflect the supply and demand fundamentals of the fed cattle market. And if you’ve got fewer and fewer negotiations, you can lose confidence in how accurate those transactions are at reflecting the underlying value of the commodity. And so that that’s a concern that happens and we call that an issue of thin markets. And so if you’ve got negotiated transactions that are thin and those transactions aren’t accurately reflecting, you know, the information about the supply-demand fundamentals of fed cattle, and then you’ve got 70% of the industry using AMAs, which use those transactions prices as a base, then you’ve got a compounding issue in terms of what the potential implications are for losing quality-price discovery.

[27:06] John Anderson: So if you don’t have accurate price discovery in the negotiated market — you’re pricing inefficiently, we would say, as economists — and then you leverage that information that that that that incorrect or that that unreliable information into two-thirds of your transactions through AMAs, you’ve multiplied the effect of that inefficient pricing.

[27:33] James Mitchell: Yeah, that’s exactly right. And so that’s where the concern comes from about, you know, we’re getting fewer and fewer negotiated transactions. What’s the implication for the quality of price discovery? And we’re compounding the issue for using those as a base. And there’s also, you know, economists have studied that issue specifically for, you know, what seems like forever.

[27:54] John Anderson: Yeah, well, so I was going to say that the nice thing about this conversation about about about this specific topic within our conversation is that price discovery is a researchable question. The quality of price discovery is a researchable question that’s been researched a lot for a long time.

[28:12] James Mitchell: By a lot of people too; a lot of smart people. And a lot of the research, you know, the issue is we’ve got fewer and fewer negotiated trades. Do we still have quality price discovery? And so the research question becomes, OK, how much negotiated trade do you need to have quality, you know, price discovery that you have confidence in.

[28:34] John Anderson: So you used a keyword a second ago. I wanted to highlight it and kind of pull you back as you go on with your answer. You use the word information. Talk about information going into prices. And so price discovery really is about how the market assimilates information. So talk about that from a research perspective, how that plays into the research on price discovery.

[28:58] James Mitchell: Yeah, so it’s about, you know, looking at these prices and saying, you know, do they move in ways that you would anticipate given market information? Are prices moving erratically that, you know, don’t make sense at all? Or are they accurately moving as new information arrives? Right? So prices reflect information. So prices tell us something about those markets and it’s do they accurately reflect the information that’s being realized?

[29:27] John Anderson: So if positive information comes in the market, do prices go up? If negative information comes into the market, do prices go down? And do they do that within appropriate timeframes, which is in competitive markets should be close to instantaneous?

[29:40] James Mitchell: Yes. I mean, that’s that is the researchable question. So a quick example would be: a question that we’ve researched, for example, is, you know, what do cattle prices do you know when cattle on feed reports come out? So if there’s very bullish, unanticipated information that’s in a cattle on feed report, you’d expect to see positive movement in transactions prices. If there’s bearish unanticipated information that comes out in the cattle on feed report, you would expect there to be a negative movement in prices. You can research that question, and the answer that we find is that, yes, prices move as they should with new information that arrives. They’re reflecting that information. They’re trading and moving on that new information. And not only that, but all of the markets are consistently doing that. It’s not just one market that’s functioning appropriately, it’s all of the markets are behaving as they should with this information.

[30:38] John Anderson: So you said all of the markets. Give a little context there for the listeners, all of the Fed cattle markets.

[30:42] James Mitchell: Yeah, there’s generally there are five main regional fed cattle markets.

[30:47] John Anderson: As reported by USDA.

[30:48] James Mitchell: Reported by USDA. So there’s the Texas, Oklahoma New Mexico market; there’s the Kansas market; the Nebraska market; Colorado market and the Iowa and Minnesota markets. So five regional markets. We get prices that are reported for those five individual markets, and each of those markets has different levels of negotiated trade. And so you can assess the role of each of those markets in price discovery, how price discovery is functioning and each of those markets. And so you can look at again these reactions to new information for these markets, and we tend to find that, we have found that, they all behave in a way that’s consistent with what an economist would expect to happen when you get information about those markets.

[31:32] John Anderson: They respond appropriately, let’s say, to new information. And that is the case in Texas, Oklahoma, New Mexico, where AMAs are sometimes 90% or more of the market. Pretty much the same as it’s happening in Iowa, Minnesota, where AMAs are about 30, 35% of the market.

[31:54] James Mitchell: Exactly. Different levels of negotiated trade but all markets are functioning appropriately with respect to price discovery. And the reason behind that is we — what we find in the research is that you know, if you’ve got transactions for cattle that are relatively reflective of that overall market, you don’t need to trade a lot of them to discover price efficiently, correctly.

[32:18] John Anderson: I think that’s a key point. I’m glad you bring that up, James, because I think a lot of people listening to this would say, you know, only 10%, 15% of trades in Texas, Oklahoma, New Mexico are negotiated. There’s no way that can be adequate price discovery. Yet, again, what would the research say about that? Maybe not just our research related to cattle market, but really 50 years’ worth of price discovery research. I interrupted you and you were going into that about representativeness.

[32:49] James Mitchell: So yeah, so it’s about, you know, you don’t need to transact everything to discover price. So long as you’ve got some few solid reflective transactions prices, you can discover price pretty well. An example that is unrelated to agriculture that I’ve used before is if we had a bucket with 100 black pens in it or 100,000 black pens, let’s say, would you and I need to negotiate the price for 50,000 of them to probably discover the true value of a black ink pen? Probably not. We could probably negotiate 10, 15 of them and get a pretty good idea of what that price is and be confident that that price is reflecting the value of that good.

[33:33] John Anderson: So the key issue there is the representativeness of those transactions.

[33:37] James Mitchell: Yes. And you know, there could be instances. You know, the concern is if they’re not representative, then price discovery is something we have no confidence in and it’s not accurately reflecting the value of that commodity. And we just find that you don’t need to trade a whole lot of fed cattle to get a representative set of transactions.

[33:59] John Anderson: And James, I’ve heard you talk about this before, and I think you make a really good point that we often talk about this as though there is some, some magic number. And honestly, the policy prescriptions that are being debated right now really approach the issue as though is there some magic number as long as we hit this magic number, this this this magic percentage of transactions being negotiated, we can have confidence in price discovery, but there’s probably a dynamic character to price discovery related to what’s going on with underlying fundamentals. Talk about that a little bit.

[34:33] James Mitchell: Yeah. So it’s not a constant rule of thumb number that you need in terms of the volume of negotiated trade have quality price discovery. Two that have been thrown out there would be 30%. So 30% of transactions need to be negotiated. There’s been the rule of let’s do 50%. 50% of transactions need to be negotiated. Those are really high numbers, and the real answer is not a constant number at all. It’s going to be dynamic depending on the market situation you’re in. For example, in 2020, when COVID happened, we actually had more negotiated transactions than we do today because there was more uncertainty in markets during COVID. And so with that uncertainty, you’re not sure about the supply and demand fundamentals. So you do need to transact more to try and discover price. Another example would be, you know, with the BSE case that happened in the US. We needed more negotiated trade with something like that happening because there is more uncertainty in the market. And so you need more transactions, right. During, you know, you could say, times of certainty where we have a pretty good idea of what’s going on in the market. You know, 2014, 2015, we had high cattle prices and we knew why — tight supplies; we knew what demand was. There was less uncertainty in the market. So we didn’t need to trade as many cattle through negotiation to discover price.

[36:01] John Anderson: And the market participants themselves are working through this.

[36:06] James Mitchell: Yes, it’s you know, negotiation is people, you know, interacting through negotiation, trying to discover value or price. And when there’s more uncertainty, you need more transactions to try and do that.

[36:20] John Anderson: There’s an incentive for them to get out and negotiate more to figure out what those contours of supply and demand are and where they can be confident that price makes sense.

[36:28] James Mitchell: But even during times when there is a lot of uncertainty in the market, you need a lot of negotiated trade. Well, the negotiated trade that you probably need during those times is still probably quite a bit lower than what’s being proposed as prescriptions.

[36:40] John Anderson: And that certainly would be consistent with the research that’s out there from a lot of different markets. I mean.

[36:46] James Mitchell: Yeah, I’ll just add to that. You know, it’s a dynamic number in that it’s, you know, every year, every week, every month, the market needs a different amount of negotiated trade to discover price. But the benefits of more negotiated trade on price discovery themselves are not a constant number. 50% negotiated trade does not mean better price discovery than 30% negotiated trade, right? So at some point, more and more negotiated trade is not adding anything to the market at all. It’s, you know, overkill.

[37:22] John Anderson: At some point, you’ve got all the information you need to be confident in prices and to be confident that information has been properly assimilated into those prices. Yeah, that makes sense. So and none of that is to say that negotiating trade isn’t a good thing. Obviously, price discovery is vital in these markets. The point, really, is that the amount of interaction between buyers and sellers that can accurately reflect information in the markets can actually be a fairly small amount.

[37:56] James Mitchell: Mm-Hmm. Absolutely.

[37:58] John Anderson: All right. So James, kind of looking ahead, we again, this is very much alive policy issue. We don’t know kind of how this is going to play out. There may be, there may be negotiated levels established. There may be other approaches to this. It’s very much an issue that’s fluid right now, and we’re not going to try to settle that in this podcast. But I think maybe to wrap up, what I would like to hear is aside from where we go with policy related to price discovery, what do you see for the cattle markets over the next year? You got into a little bit early, but let’s kind of wrap up. What do you think are going to be the major fundamental issues in the market as we look over the next, say, twelve to 18 months? And are you looking at generally supportive fundamentals or more challenging times?

[38:56] James Mitchell: So supportive fundamentals with a caveat. So fundamentals are going to be supportive of stronger prices, but at the same time, we’re having higher input costs. So from feed, fertilizer, everything. So those higher prices with good management would be a very positive year. Right. So there you know, profit is, you know, revenue minus cost, right? So prices are very supportive, but we still need to be careful to manage those costs, especially this winter when we’re feeding cattle would be kind of the negative side of what those financials are is it’s going to be an expensive year, but prices, in general, are supportive of prices in the next 12, 18 months. I mentioned there are two reports coming out next week. Those reports will give us a lot of information about what supply conditions should look like. The general expectation is to have another year of declining hard numbers. So declining supplies. And I think, you know, we work through the supplies that we’ve got right now in feedlots and we’re going to get into a much tighter situation and we should see positive price movement. I think if you look on the board at CME and you look at the deferred futures contracts for fed and feeder cattle, those markets would certainly agree with that expectation in terms of positive, more favorable supportive fundamentals in the coming months.

[40:10] John Anderson: So cautiously optimistic for higher prices, but very important to manage margins aggressively because the input costs are rising.

[40:18] James Mitchell: Yes, absolutely.

[40:19] John Anderson: And certainly, input price inflation is a live topic right now. A lot of interest in that, not just on the livestock side, really primarily on the crops side, but inflation in input prices is a topic for another podcast.

[40:38] James Mitchell: Absolutely.

[40:39] John Anderson: We will certainly pick that one up soon, but not today. So I think that that will wrap us up for today. This is the relevant risk podcast from the Fryer Center. Thanks for joining us.