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Agricultural News


Peel Says Old Rules of Thumb Can Be Misleading

Mon, 09 Feb 2015 15:33:52 CST

Peel Says Old Rules of Thumb Can Be Misleading Derrell S. Peel, Oklahoma State University Extension Livestock Marketing Specialist, writes in the latest Cow/Calf Corner newsletter.


It's a new world of cattle prices and some of the old rules of thumb that have been used for years need to be modified. I still hear folks talking about a $10/cwt slide for calf prices-the idea that calf prices should decrease by $10/cwt. or 10 cents per pound as weight increases. This evolved from historical prices. For example, from 2000-2006, the average price difference between 4-500 pound steers and 5-600 pound steers in Oklahoma auctions was $10.66/cwt, i.e., the $10 price slide. However, the price slide is not a constant absolute dollar amount as much as it is a constant percentage. The price slide for calves is typically in the range of 8-10 percent of the calf price. The price slide for the period 2000-2006 was 8.9 percent.


The average price slide for 4-500 pound steers from 2012-2014 was $20.07/cwt-about double the old $10/cwt. rule of thumb. In percent, the price slide for this period was 9.3 percent. In 2014, the average price slide for 4-500 pound steers was $26.35/cwt. with a slightly higher percentage, at 9.7 percent. The old rule of thumb needs to be modified from "$10/cwt" to a percentage level, say 9 percent of the calf price. Thus, at a 450 pound calf price of $325/cwt, the price slide would be roughly $29.25/cwt. The same idea applies to heavier feeder cattle with the price slide for 5-600 to 6-700 pound steers averaging 6-8 percent and steers above 650 pounds averaging 4-6 percent. This would suggest, for example, that a 550 pound steer price of $280/cwt would have a price slide of approximately $19.60/cwt and a 650 pound steer priced at $250/cwt. would have a price slide of roughly $12.50/cwt.


There are factors that change price slides for feeder cattle. The most important factor affecting feeder cattle price slides is the feedlot cost of gain, i.e., grain price, relative to cattle prices. All else being equal, higher feedlot cost of gain will reduce the price slides for feeder cattle by weight. For example, in the period 2007-2011, feed cost increased dramatically relative to cattle prices and the 4-500 to 5-600 pound steer price slide for this period averaged 7 percent. It is the relative relationship between feed cost and feeder cattle price that matters. In fact, an increase in feed cost with constant feeder prices or a decrease in feeder prices with constant feed prices will both have the effect of reducing the feeder cattle price slide. The overall average price slide for calves from 2000-2014 was 8.4 percent, including the extraordinarily high feed prices (i.e. reduced price slides) in 2007-2011. A general average of 9 percent is probably more typical for calves.


The price slides discussed above, which are adjustments in feeder prices at specific weights, add up to the total price rollback between purchase and sales prices that stocker producers commonly evaluate to determine the feasibility of a stocker enterprise. Sometimes these are also expressed in absolute dollars, as in, "the price rollback must be less than $50/cwt. (or $40/cwt. or $30/cwt., etc.) for a stocker enterprise to work". In reality the value of gain for stockers is a function of both the price rollback and the feeder price level. Consider the example of a $300/cwt purchase price for a 500 pound beginning weight and $250/cwt sales price for a 750 pound final weight. The value of gain in this example is ($1875-$1500)/250 or $1.50/pound of gain. As an example from a time of lower prices, assume a purchase price of $150/cwt. for 500 pound beginning weight and $100/cwt. selling price for a 750 pound ending weight. The value of gain in this example is ($750-$750)/250 or $0. In both cases, the price rollback between purchase price and sales prices is $50/cwt. but the value of gain is very different. The first example has an implied average price slide in $/cwt. (over 250 total pounds of gain) of 6.7 percent of the purchase price, consistent with the price slides discussed above. In the low price example, a 6.7 percent price slide would result in a $25/cwt. rollback over the 250 pounds of gain and would produce only half the value of gain of the high price example. It would actually require that both the purchase and selling price be at $150/cwt (i.e. no rollback) to generate the same value of gain, ($1125-$750)/250 at the low prices, compared to the high price scenario with a $50/cwt. rollback. It is important to not judge price rollbacks in absolute dollar terms but to evaluate carefully at various price levels. A rule of thumb based on a dollar value of the rollback can be very misleading.


A final example is the steer to heifer price differential. It is common to think of heifer calves being priced $10-$15/cwt. back of the steer price. Indeed, in the period 2000-2006, 450 pound heifer calf prices averaged $10.95/cwt. lower than comparable steers. This was a price discount of 11.3 percent from the steer price over that period. In 2014, the average difference between 450 pound steers and heifers was $29.99/cwt., which was an 11 percent discount to the steer price. Over the entire period from 2000-2014, the average heifer calf discount was 12 percent. For feeder weights above 650 pounds, heifers tend to be priced at 7-7.5 percent below steers on average. As with price slides, the heifer discount to steers is much more constant in percentage terms than in absolute dollar levels.


I had a professor in graduate school who admonished us to remember that the abbreviation for "rule of thumb" is ROT-as in rotten; meaning that they can be misleading. As a practical matter, rules of thumb are very useful for managers to facilitate decision making, especially for frequent and repeated decisions. However, the discussion above reminds us that it is important to understand the basis for those rules of thumb in order to be sure they are applied correctly in dynamic situations. Feeder cattle price relationships expressed as percentages are much more robust than rules of thumb stated in absolute dollar values.






 

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