Mr. Market Miscalculates: Howard Marks, co-founder and co-chariman at Oaktree Capital, is renowned for his regular memos regarding financial markets. His most recent memo, Mr. Market Miscalculates, is especially insightful. And while he’s writing primarily to equity investors, the principles apply to cattle producers.
There are too many great observations to include here, but several are pertinent to this discussion:
1. …in good times, investors obsess about the positives, ignore the negatives, and interpret things favorably. Then, when the pendulum swings, they do the opposite, with dramatic effects….
2. Rarely do investors realize that (a) there can be a limit to the run of good news or (b) an upswing can be so strong as to be excessive, rendering a downswing inevitable.
Futures Make No Sense: Let’s now return to my previous column about futures markets. As review, I received an email from a reader complaining about the market. He included an anecdote about a backgrounder who was selling his calves, “because the futures made no sense to them.”
My discussion detailed Mr. Backgrounder’s opportunity to favorably hedge those cattle along the way (or purchase puts or LRP or forward contract). He did none of those things; he willingly became a price taker subject to the whims of Mr. Market.
Speculator: Assume Mr. Backgrounder likely purchased calves during the spring with the intent to sell in August or September (regardless of the anecdote about the futures market).
· Now consider his broader risk profile from just two straight-forward aspects: Corn: Mr. Backgrounder has effectively assumed all risk associated with the ’24 corn crop. In other words, he’s betting everything goes right with the crop—most importantly, gets through the summer unscathed by weather. Moreover, none of that happens in isolation in the U.S.; he’s also subject to what occurs in South America.
· Fed Market: Assume Mr. Backgrounder’s calves weigh 750 lb on Sept. 1. Most purchasers will likely pencil a breakeven based on feeding period of ~190 days – therefore, purchasing them against the April ’25 live cattle contract. Mr. Backgrounder purchased his calves this spring (’24) – thus, he’s now subject to all of the potential influences on the fed market an entire year later.
That’s a sizeable bet on a lot of variables over which he has zero control.
In other words, he, too, is a speculator. As pointed out in the previous column, “he’s long the physical market in hopes of profiting from market fluctuations (the very definition of a speculator). He’s betting on the come and a willing participant in bearing that risk.” While the complaint is the “futures made no sense to him,” apparently all of those other factors did. That’s difficult to reconcile.
Emotion vs. Analysis: Back to the top. Mr. Backgrounder, absent any price protection, is subject to the upswings and downswings. But is that the market’s fault? The market is just being the market. He made himself a price taker bearing the full brunt of both long-run (the items above), and short-run (time, location) risk.
What’s the lesson here? Higher prices means the business now carries more equity—or value-at-risk (VaR) than ever. Meanwhile, there are any number of variables than can turn against you at any time (after all, things that never happen, happen all the time). And when those work against you, the reaction is understandably somewhat emotional.
But that’s precisely Marks lands in wrapping up his memo. That is, he encourages his readers (and the principles apply to cattle producers, too) to move away from assuming too much risk (being a speculator)—and increasingly adopt a more proactive approach to understanding all the potential pitfalls of the business, the market and ultimately protecting their equity. He ends the memo with this admonition: “Emotion? No. Analysis? Yes.”
Nevil Speer is an independent consultant based in Bowling Green, KY. The views and opinions expressed herein do not reflect, nor are associated with in any manner, any client or business relationship. He can be reached at nevil.speer@turkeytrack.biz.
