Using, not buying, livestock gross margin for cattle
Source: Matthew A. Diersen, Professor, Department of Economics, South Dakota State University
While visiting with agriculture bankers in recent weeks, several asked about feeding margins and what their customers could do to manage margins. Protecting the margin is a common concern of cattle feeders too. One way to monitor the margin is to use the format from Livestock Gross Margin (LGM) insurance. The margin in LGM acts like a “cattle crush”, where one sells live cattle and buys corn and feeder cattle. By tracking a specific margin, one can see its track record and decide if the margin is large enough to protect. Some of you may recall the textbook advice to use selective hedging for livestock. The reason for selective hedging is that always hedging livestock in a feeding setting will result in returns similar to always being in the cash market.
Consider the LGM margin for yearlings that are six months from marketing as fed cattle. In November, that expected margin coverage would have reflected a 1250 pound steer to be sold in May of 2014. The expected margin would have been what was left over after buying a 750 pound steer in December of 2013 and 50 bushels of corn in March of 2014. There is a formula that takes futures prices of either the contracts for those months or their surrounding months. In November, that expected margin was $181 per head, down from $207 per head in October. The actual margin will be computed based on the eventual feeder prices in a few months, corn at the end of March, and live cattle in six months. If a producer had purchased LGM in November, that is the margin covered and any combination of live cattle futures decreasing and corn or feeder cattle futures increasing would change the actual margin.
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