Numbers crunched on a cattle swap through the market plummet and rise

Analysts have made the point this year that the cattle market has been the most volatile since records began.

Quarter one 2024 has seen the largest price increase in the Eastern Young Cattle Indicator on a quarterly basis since 2000 but the quarter before it saw the largest decrease in that period.

A swap is a financial derivative where producers are able to lock in a future price for cattle.

Ripley Atkinson, livestock and commodities manager with StoneX, which offers a feeder cattle swap that settles against the northern feeder cattle index published by Argus Media, has run analysis on utilising the swap in the falling market of 2023, and also in the rising market that is following.

The analysis was based on actual prices in 2023 from May to October on a six-month trade for flatback steers bought and sold in Queensland saleyards.

If a seller made a physical sale of 50 head of steers without the swap in the 2023 scenario, on a 180-day trade of buying weaners, growing them out and selling as feeder steers, he or she would have incurred a loss of $17,000 on a gross margin basis due to the fall in price on feeder steers over that time.

If the swap was used to manage the price risk on this trade, the producer would have made $18,500 outright, as the profit on the swap would have offset the loss of the sale on the physical cattle.

"The swap in this instance was used to lock in the revenue that is generated from growing out the cattle to feedlot weight. Even though the physical cattle incurred a loss on their sale, the swap user still makes money in a falling market," Mr Atkinson said.

When the market moves upwards during the time frame of a swap, money is lost on the swap.

Mr Atkinson's analysis in a rising market takes 500 head of restocker steers, 300kg, at today's price of $3.70/kg live weight.

The feeder price forward curve for September is currently $3.55/kg.

If the spot market price in September ends up being $4, the money lost on the swap is $90,000. The money made on the physical cattle is $326,200, so the net gain is $236,200.

"There is a balance between locking in a margin, using the swap, and foregoing the opportunity cost in a rising market," Mr Atkinson said.

"The loss is offset by the price the physical cattle will be able to be sold for in the future. This enables the backgrounder to lock in the margin that the weight gain will provide over the six months."

Mr Atkinson said it would not be expected that users of swaps hedge 100 per cent of the animals they have to buy or sell.

While in a rising market, a return is still made on the weight put on, 'potential' profit is not realised.

How much appetite people have for foregoing that potential is a business decision but increasingly agents are talking about producers wanting to iron out market peaks and troughs and build consistency in order to plan longer-term.

"It's clear the swap has a wide-ranging benefit to both buyers and sellers across the beef supply chain and its integration into businesses protects margins and, importantly, ensures a smooth, consistent level of return benefitting budgeting, cash flow and the long term sustainability," Mr Atkinson said.