The pig cycle fails: what is the future trend of pig prices?
Since 2015, pig prices have soared sharply, driving overall inflation to keep rebounding. Lured by high profits, pig and sow inventories have nevertheless declined for 40 consecutive months, and the traditional pig cycle seems to have failed. What are the reasons behind the failure of the pig cycle? What is the future trend of pig prices? And what is the impact on overall inflation? Since pig prices have a very large impact on China's inflation trend, this topic will focus on discussing these issues.
The pig cycle: from normal to failing. The pig cycle generally includes a multi-year major cycle and a seasonal minor cycle, and both are affected by the monetary environment. Under the major cycle, rising pig prices stimulate farmers to replenish their herds; after supply continues to increase, pig prices fall; then the contraction of supply pushes prices up again, entering another new round of the cycle. The minor cycle is mainly influenced by the consumption habits of Chinese residents and shows seasonal fluctuations within a year. The changes in pig prices and inventories during this wave from 2014 to 2010 fit the characteristics of the traditional pig cycle very well. But from March 2015 to now, pork prices rebounded after hitting bottom, rising sharply from a low of 23.5 yuan/kg to a high of 32.5 yuan/kg, while sow inventories unusually fell all the way from a high of more than 50 million head to the current 37.52 million head, and pig inventories also dropped sharply from a high of 470 million head to a low of 367 million head. That is, even as prices rose sharply, farmers were cutting capacity on a large scale, and the adjustment mechanism of the pig cycle failed.
Why has this round of the pig cycle failed? Active capacity reduction: years of losses in pig farming. Because earlier high profit margins and increased government subsidies led to a relatively large increase in capacity, pig prices began to peak and fall in 2011. Pig farming profit margins also kept declining, and the loss-making state alone lasted more than 2 years, greatly reducing farmers' enthusiasm for production, with some even permanently exiting the market, which is an important reason for the decline in pig and sow inventories. Passive capacity reduction: higher environmental protection thresholds. Starting in 2015, policies such as the new Environmental Protection Law and the “Water Ten Plan” began to be implemented one after another. In order to meet environmental protection standards, provinces successively set up prohibited breeding zones and continuously shut down farms and specialized farming households within those zones. According to data from the Ministry of Agriculture, in 2015 alone, environmental protection breeding bans in just 10 provinces affected more than 20 million head of pigs sold, accounting for about 2.8% of the national total. Environmental protection breeding bans are an important reason for the sharp decline in inventories since 2015. Structural change: transformation drags down supply. In the past two years, due to greater reform efforts in large-scale farming and tighter environmental protection policies, the pig farming model has shifted from free-range farming to large-scale farming, and free-range households have exited relatively quickly. However, because of land-use approval, professional requirements and relatively high entry thresholds, the growth rate of large-scale pig farming has been relatively slow, so during the transformation of farming models, inventories showed a phased decline.
What is the future trend of pig prices? Major cycle: pig prices are at a high level, and the possibility of a downturn is increasing. First, consumer demand for pork is relatively stable, so the demand side generally does not become the main factor dominating the long-term trend of pig prices. Second, current pig farming profits are at a historic high, farming enthusiasm has increased substantially, and farmers have a longer response time to environmental protection policies. The number of sows in breeding inventory has remained basically stable since March 2016, indicating that capacity and supply may already be at a bottoming stage. In addition, large-scale farming has improved pig farming efficiency and can ensure capacity at a lower inventory level. Minor cycle: seasonal factors dominate, and there may be a small rise in the short term. Judging from the situation in past years, the supply-demand relationship tends to tighten during August to October, and pig prices rise seasonally month on month. Coupled with the lagged effects of floods and high temperatures, pig prices may still rise in the short term. But from the perspective of the major cycle, pig prices are already at a high level, and even if there is a short-term rebound, the strength is expected to be very limited.
The driving force of pig prices is gradually weakening, and inflation is worry-free in the short term. Considering the influence of seasonal factors, we assume that pig prices in the coming year will change according to the average trend of past years. The results show that the year-on-year growth rate of pig prices will decline all the way from the high of 33.6% in May, and is expected to reach negative values in the second quarter of next year. Its contribution to the year-on-year CPI will also fall from 0.77 percentage points to negative territory. Although in the fourth quarter, due to low-base factors, the driving force of pig prices on inflation will increase somewhat, the strength may not be comparable to that in the second quarter. Moreover, considering that the long-term downturn may be relatively large, the speed at which pig prices weaken their effect on inflation may also exceed expectations. Overall, because food prices rose relatively sharply month on month in the same period last year, we expect the year-on-year CPI increase in August to still be likely to decline slightly, and CPI in the third quarter is expected to stabilize at around 1.8%, but there is a risk of a slight rebound in the fourth quarter.