Lean hog futures (HE) and Live Cattle futures (LE) are two types of livestocks that are traded on the Chicago Mercantile Exchange (CME). Both contracts are used to hedge the price risk of pork and beef, respectively. However, there are some key differences between the two contracts.
In this post, we will delve into the nuances of these futures products, highlighting their differences and exploring the correlation between them.
By the end of this post, you will have a good understanding of lean hogs futures (HE), live cattle futures (LE), and the dynamic relationship that exists between them.
Understanding Lean Hogs Futures (HE) & Live Cattle Futures (LE)
Lean hogs futures (HE) represent the hogs that qualify for processing at approximately 275 pounds.
In the US, hogs are primarily produced in the Midwest states of Iowa and southern Minnesota, as well as in eastern North Carolina. The carcass of a market hog weighs around 200 pounds, yielding approximately 155 pounds of lean meat, which forms the core of the lean hog futures contract.
Meanwhile, live cattle futures (LE) represent the full-grown cattle that are ready to be sold to meat processors, having reached a weight of between 1,200 and 1,400 pounds.
The contract specifications for both HE and LE are as of below:
| Lean Hogs (HE) | Live Cattle (LE) |
|---|---|---|
Exchange | CME | CME |
Contract Size | 40,000 pounds | 40,000 pounds |
Minimum Tick Size and Value | 0.025/cwt, worth $10.00 per contract. | $0.025/cwt (0.025 cents per pound), worth $10.00 per contract. |
Trading Times | Lean hog futures trade electronically on the Globex® platform Monday, 09:30 a.m. U.S. ET to 2:05 p.m. U.S. ET. | Live cattle futures trade electronically on the Globex® trading platform Monday 9:30 a.m. U.S. ET to 2:05 p.m. U.S. ET. |
Principal Trading Months | Principal trading months for lean hog futures include February, April, May, June, July, August, October, and December. | Principal trading months for live cattle futures include February, April, June, August, October, and December. |
Delivery | Lean hog futures contracts are settled in cash at expiration. | Live cattle futures contracts can be settled in cash or by physical delivery of cattle. |
Correlation between the lean hogs market and live cattle market
Historically speaking, the lean hogs market is correlated with the live cattle market, albeit to a different extent for different periods of time.
For the past 2 decades, there have been three distinct periods where we can observe the different correlation strengths between the lean hogs market and live cattle market:
Year 2000 - 2009: Lean hogs price rose by 11% while live cattle price increased by 30%. (Correlation: 0.42)
Year 2010 - 2014: Lean hogs price rose by 32% while live cattle price increased 52%. (Correlation: 0.61)
Year 2015 - May 2019: Lean hogs price dropped by 8% while live cattle price dropped by 28%. (Correlation: 0.28)
There are some fundamental reasons why these 2 livestocks are correlated:
Pork and beef, both being meat products, compete for consumer spending. If the price of one meat rises, consumers may opt for the other, causing a decline in the price of the former.
Hogs and cattle, both raised on feed such as corn and soybean, face the cost of production influenced by feed prices. An increase in feed costs results in higher production expenses for both pork and beef, consequently leading to elevated prices for both products.
However, the correlation between lean hogs price and live cattle price is not perfect.
Sometimes, the two prices can move in opposite directions. For instance, a disease outbreak that affects hogs but not cattle can drive up hog prices and drive down cattle prices.
Does the lean hogs market's seasonality differ from the live cattle market?
Despite being livestock, lean hogs and live cattle markets can differ in their seasonality.
The lean hogs market tends to display high prices in early and mid-summer (June - July), and begin to decline at the peak of summer (August) through the end of the year:
On the other hand, unlike lean hogs, the live cattle market tends to start trending higher starting in August towards the end of the year, and weakens after that.
It is interesting to study why that is the case:
(i) Difference in demand:
Lean hogs display higher prices in summer (June, July) due to an increase in demand, especially for BBQ activities. Ham, a byproduct of pork also has high demand during holiday periods like Thanksgiving, Christmas, and Easter.
According to CME Group, some retailers could also find steaks more in demand during Memorial Day.
(ii) Differences in biological processes (supply):
| Lean hogs | Live Cattle |
|---|---|---|
Location | Primarily produced in the Midwest states of Iowa and southern Minnesota, as well as in eastern North Carolina. | Primary operations are concentrated in the Great Plains region but are also located in parts of the Corn Belt, Southwest, and Pacific Northwest regions. |
Calving/Farrowing | As a result of seasonal trends in farrowing, there is an abundant supply of lean hogs in the market in November and December relative to the rest of the year. This tends to drive the price down. | The majority of calves in the US are born after winter - during February, March and April. As weather improves the new born calves have a better chance of surviving and fresh grass in pastures helps both mother and calf recover quickly. |
Weather to livelihood | Hogs spend their time indoors but hot summer weather can be just as miserable for hogs as for people, it affects their ability to eat and carcass weights decline.
| Beef cattle spend the last six months of their life outdoor in feedlots. Extreme cold weather can take its toll on cattle weights and affect the supply of beef coming to market. |
Influence of export activities to Lean Hogs and Live Cattle markets
Compared to beef, hog markets are more susceptible to the impact of international politics and disruptions in trade flow.
This is because a larger proportion of U.S. hogs is exported. In fact, over the past decade, the export share of domestic pork production has consistently ranged from 20% to 26%, while for beef and veal it has only been between 9% and 12%. These figures highlight the significant influence of international factors on pork markets.
The reliance on international markets makes livestock prices highly susceptible to various factors. One such factor is disease: African Swine Fever (ASF), for instance, has significantly disrupted trade in international hog markets in recent years. Notably, a considerable portion of U.S. domestic pork is exported to China, where policies and domestic demand can change swiftly.
As such, it should come as no surprise that the price of Lean Hogs tends to be more volatile (bigger swings up and down) when compared to the Live Cattle market, as seen in the weekly price (2010 - present) below:
Verdict: Understand the differences between Lean Hogs and Live Cattle markets to make better trading decisions
In conclusion, understanding the differences between lean hogs futures and live cattle futures is essential for traders to make more informed trading decisions. By being aware of the seasonality, correlation, and market dynamics of these contracts, traders can make more informed decisions and enhance their trading strategies.
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Disclaimers
Any of the information above is produced with my own best effort and research.
This post is produced purely for sharing purposes and should not be taken as a buy/sell recommendation. Past return is not indicative of future performance. Please seek advice from a licensed financial planner before making any financial decisions.
Leverage is a financial tool that comes with its advantages and risks. Please learn and understand both the upsides and downsides of leverage before using it for trading.
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