Each day across cattle country tens of thousands of cows change hands at livestock markets. The size and the quality of the venues differ, but most facilities contain a holding area to view the animals, a sale ring that the animals enter and exit, and an amplified auctioneer rhythmically chanting the upward march of the market’s asking price.
One common amenity of the markets is a cafe to grab a snack like chips, candy, or a hot dog or a beverage served in a styrofoam cup. Large markets located at historical hubs of the cattle trade such as Forth Worth and Omaha even have high-end steakhouses attached.
Most of the livestock markets I’ve attended are glorified barns with stadium seating. It’s often hot or cold inside. Tobacco use is tolerated and the attire features boots, denim, and baseball hats. Some of the old timers are just there for the show and might be going-out-dancing afterward. They’re wearing their best pair of pressed khakis and freshly carnaubaed footwear.
One of my friends asked what it smells like at the market once? Money! I declared definitively. To quote Louie (Dan Akroyd) in Trading Places, “Well this is it. The last bastion of real pure capitalism on earth.”
The livestock market provides the services of a physical broker hosting buyers and sellers while earning a commission. It supplies hay and water to the animals as well as labor to facilitate the sale.
If there is price distortion from fair value on the bids or there aren’t enough buyers the livestock market itself can step in and buy on their own account. Circumstances, where the market transitions from a broker to a market maker to provide liquidity and price support, helps sellers have some price assurance.
There are seasonal highs and lows for certain weight classes of animals that sellers can arbitrage. Other aspects that impact prices at the local market are weather, feed costs, distance to the feedyard, the relative costs of other sources of protein, and the futures market.
When I was growing up my grandfather would attend the local market every Saturday afternoon to commiserate and gossip with fellow cattlemen and women. I have fond memories of those experiences and have taken my children even when we weren’t participating in a sale. Honestly, they go for the snacks, but maybe they’ll have similar childhood memories from the experience.
The livestock market employs an English auction also known as an open outcry. From Wikipedia:
Unlike sealed-bid auctions, an English auction is “open” or fully transparent, as the identity of all bidders is disclosed to each other during the auction. More generally, an auction mechanism is considered “English” if it involves an iterative process of adjusting the price in a direction that is unfavorable to the bidders (increasing in price if the item is being sold to competing buyers or decreasing in price in a reverse auction with competing sellers).
The auctioneer gives a brief description of the cattle in the ring and begins offering them for sale based upon their weight. When cattle are received at the market they are weighed. As an example, an 800-pound steer might sell for $1.30 a pound grossing $1,040.
Renowned investor Charlie Munger, of Berkshire Hathaway fame, gave a now-famous speech entitled “The Psychology of Human Misjudgment” in 1995 at Harvard Law School. Describing this type of auction he said:
Well, the open-outcry auction is just made to turn the brain into mush: you’ve got social proof, the other guy is bidding, you get reciprocation tendency, you get deprival super-reaction syndrome, the thing is going away. I mean it just absolutely is designed to manipulate people into idiotic behavior.
In the livestock business, the place where Munger’s description is most evident is at bull and seedstock sales.
Once or twice per year, a bull breeder hosts a sale where all of the buyers come to view their breeding stock, eat some barbeque, and maybe drive home with an animal in the back of their trailer. Bulls are evaluated and ranked with metrics called EPDs (expected progeny difference). Bulls that industry cattlemen use to enhance the breed and will be used for artificial insemination programs can go for tens of thousands of dollars and even into the six-figure range.
A large portion of the sales prices is a true reflection of the genetic stamp that producers believe the bull will put on his offspring. Buyers also get the prestige of being listed as the new owner of one of the top five most expensive bulls on that particular day in the sale results report. And then, some of the price is a result of Munger’s description of the auction bidding process turning the brain to mush.
There are some rules of thumb that an average bull should go for between three to four times the value of one of his male offspring. When the cattle market tanked in 2014 bull prices bucked that trend and didn’t decline. Bidders have been known to ignore their reserve price when a bidding war ensues and the only thing that matters is purchasing the bull (“winning”), despite the price.
Warren Buffett described his opinion on auctions even more bluntly than his partner Charlie Munger. Buffett’s advice is don’t go.
Buffett is known as someone who doesn’t negotiate on price. He wants to know the seller’s price and make a decision based upon that information. This strategy can be used when doing an on-farm purchase (aka private treaty) where just the buyer and seller are present and the crowd isn’t driving price action.
Many of the financial open outcry trading pits are a historical outgrowth of livestock markets and are now also a part of Wall Street’s past. Many no longer function. They’ve been replaced by digital trading done on computers and in dark pools. However, strategies such as momentum investing continue to work. Crowd psychology still plays a part in stock prices and volatility.
We’ve seen a 20% decline and nearly a 20% retracement off the lows between December 2018 and February 2019. This partially demonstrates that markets aren’t entirely efficient. As Ramp Capital would say, “Thanks For Playing.” (T4P) Similarly, market prices for many closed-end bond funds showed a drastic decline well below net asset value in December and rebounded in January (H/t Jake).
Today’s most obvious brain-mush inducing systems for investors are elaborate six screen trading platforms. The screens flicker hypnotically like Clark Griswald’s 25,000 imported Italian twinkle lights. Some professional investors need fighter pilot inspired trading platforms, but for the vast majority of investors, these features are just noise that encourages excessing trading activity and speculation.
Some of the strategies for individual investors to avoid the bad behavior that auctions and enhanced trading platforms can encourage are simple in theory, but hard in practice due to a variety of psychological factors.
Financial advisors recommend establishing a risk and goals adjusted investment plan (ie. asset allocation). This recent article by Nick Maggiulli poists that, “asset allocation is by far the easiest retirement [investment] decision you can make.”
A second tool for mitigating poor purchasing decisions is dollar cost averaging (DCA). DCA is a systematic long-term investment activity where funds are invested frequently, often in small increments. If you have a 401k with payroll deduction contributions you are using DCA.
Again, Nick demonstrates this strategy in his article “Even God Couldn’t Beat Dollar-Cost Averaging.” DCA is the preferred investment strategy because of the odds that markets are rising more than declining and the near impossibility of timing the market.
If you’re concerned that our poor farmers have no hope as a buyer competing against the vicissitudes of Mr. Market in an auction please consider someone like the dearly departed Gordon Hazard as an example.
For the most part it’s a major uphill battle, but Doc Hazard used a 1-3 scoring system with a #1 being the best quality animal. Doc bought #1-1/2 graded steers and then upgraded (fattened) them on cheap grass pasture. He also bought at seasonal market lows and sold at seasonal market highs.
He marketed tractor-trailer loads of steers on the farm amongst other systems that reduced risk and increased returns. Instead of being at the whims of an auction market, strategies like those and Doc’s famous thriftiness would even make investment greats Warren Buffett and Charlie Munger smile in approval.