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End of an Era: R.I.P. Pork Belly Futures

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Structural changes in the hog industry lead to the demise of history's most recognizable commodity contract.

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On Friday, July 15, 2011, the beloved pork belly future passed away at the age of 50.

"The glamour market was the pork bellies. There was a mystique about it, maybe it was the name," trader Harvey Paffenroth told the Chicago Tribune.

"In the early 1970s, there were people that used pork bellies as an inflation hedge," John Lothian, president of the electronic trading division at brokers Price Futures Group in Chicago, told the Financial Times.

No longer.

In a statement the CME Group, parent of the Chicago Mercantile Exchange, wrote, "Because of a prolonged lack of trading volume and after significant discussion with industry participants, CME will be delisting Frozen Pork Bellies Futures and Options effective Monday, July 18, 2011."

"We continue to work with our meat-sector customers and other market participants to identify new products to address their risk-management needs," said a CME spokesman.

The pork belly contract -- each one comprising 20 short tons, or 40,000 lbs. of frozen, trimmed bellies from which bacon is made -- was introduced in 1961 to provide, as explained by Doug Cameron of the Dow Jones Newswire, "a way for meat packers and food companies to manage their price risk of bacon."

"Pork bellies were frozen and stored away in the winter, and then thawed out in the summer to accommodate the annual summer increase in demand for bacon as the nation munched through millions of bacon-lettuce-and-tomato sandwiches," he points out. "The seasonal pattern gave rise to the need for producers to hedge against price fluctuations."



However, according to Price Futures' Lothian, increased sales from today's year-round bacon consumption has created "less need to hedge the frozen meat for sale in summertime."

"People don't put bellies into storage the way that they did. It's all fresh bellies these days," he said.

Beyond the simple increase in consumption, structural shifts in the industry played a part in the death of the pork belly future, as well.

"Major consolidation in the industry led to extremely thin trading volume," Gary Truitt, president of Hoosier Ag Today, tells Minyanville.

"We've seen this happen with a few other commodity contracts, like oats," Truitt says. "That market is dominated by a small handful of big players like Quaker (PEP). With the bacon business so strong, and the way the packing industry has shifted to fixed contract pricing, there's really not much need for hedging in the belly market anymore."

Money manager Shawn Hackett, founder and CEO of Hackett Financial Advisors, a Florida firm with a special focus on agricultural commodities, is not surprised. He traces the beginning of the end of the pork belly future back to the 1980's when pork prices crashed and major producers like Smithfield (SFD) and ConAgra (CAG) began "buying up smaller assets very, very cheaply."

"There used to be a ton of mom-and-pop hog operations," Hackett says. "When they all got bought up, it made the remaining small producers even less competitive -- sort of how Home Depot (HD) will go in somewhere and put small hardware stores out of business. When the industry started to consolidate, the major companies wanted to streamline operations, manage risk more simply, so they went to fixed pricing. Now, that long-term contract may be above current prices, but at least the buyer knows exactly what he's getting and how much it'll cost."

(The phenomenon is not entirely dissimilar from the massive consolidation seen in the beef industry. In his 2002 book, Fast Food Nation, Eric Schlosser wrote: "In 1970 the top four meatpacking firms slaughtered only 21 percent of the nation's cattle. A decade later, the Reagan administration allowed these firms to merge and combine without fear of antitrust enforcement. The Justice Department and the P&SA's successor, the Grain Inspection, Packers and Stockyards Administration, stood aside as the large meatpackers gained control of one local cattle market after another. Today the top four meatpacking firms-ConAgra, IBP, Excel, and National Beef-slaughter about 84 percent of the nation's cattle. Market concentration in the beef industry is now at the highest level since record-keeping began in the early twentieth century.")

Aside from the Maillard Reaction's influence on bacon consumption, the McDonalds (MCD) and Burger Kings (BKC) of the world have also contributed heavily to the parabolic rise in bacon's enduring popularity.

"Every time bacon is put on a fast-food sandwich, it is incremental growth in sales," Ron Plain, an agricultural economist at the University of Missouri, told Agriculture.com back in April. And with a 60% rise in restaurant menu items that include bacon over the past ten years, the sales cycle seems poised to continue.

Shawn Hackett says the end of the pork belly future "will have very little, if any, material effect on the market," though he can see some feeling "sort of nostalgic for [pork belly futures], it's sort of the end of an era."

For traders themselves, it's probably just as well the pork belly pit has gone the way of the diplodocus.

"The pork belly traders were a little fraternity that seemed just a little bit different than everyone else," notes Gary Truitt. "Every now and then, you'd get a newcomer that would kind of wander into the pork belly pit and they would absolutely clean his clock. Those guys were always an interesting group."

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