Morgan Stanley challenged interpretations that shrinkage in the US cattle herd to its smallest in 61 years is bullish for prices, cautioning over a relatively strong supply of animals for fattening.

The investment bank said that it was "less constructive on prices than the market on a full-year basis", citing the spillover effect of a drop in placements of feeder cattle on feedlots in the second half of 2012.

This decline included a 0.5% drop in the feedlot intake in December, well short of market expectations of a rise of more than 4.1% in placements.

And it suggests "there is room for expansion in feedlot inventories in the coming months", with a negative impact for prices of feeder cattle, and ultimately fattened, or so-called "live", cattle too.

Surplus of feeder cattle

"The weakness in placement demand from feedlots in the past three months has left the available supply of feeder cattle for the first half of 2013 up year on year for the first time in three years," Morgan Stanley said.

"Over the course of the spring, these supplies will find their way to market, pressuring feeder cattle prices and deferred live cattle prices."

Furthermore, details of the US Department of Agriculture's cattle survey, published on Friday, showed that while the overall domestic herd shrank 1.6% last year to 89.3m head, its lowest since 1952, the beef industry had already positioned itself for expansion.

"The lowest heifer slaughter rates, as a % of total slaughter, in over 10 years has left beef replacement heifer inventories - the longer-term breeding herd - up 2% year on year, leaving operators free to start expanding again over the course of the next year," assuming market and weather conditions allow.

'Moderately bullish'

The comments contrast with a more positive take on the data from commentators including Paragon Economics and Steiner Consulting, which deemed the cattle report as "moderately bullish" overall.

The USDA estimate of the US calf crop falling 2.9% last year, to 300,000 head short of market expectations, "implies a net reduction in the number of cattle that will come to market in late 2013 and 2014 – hence this report being construed as bullish for deferred live cattle and feeder cattle contracts this year".

Beef supplies, expected by the USDA to fall this year 3.9%, will also be constrained by a reluctance among farmers to send further cows for slaughter, and by the feed through onto future live cattle supplies of the recent reduction in cattle placements on feedlots.

Record prices ahead?

At Purdue University, agribusiness economist Chris Hurt said that "finished cattle prices should strengthen in the spring as beef supplies drop" thanks to the lower feedlot placements.

This 12% year on year decline, in the July-to-November period, "will create a period of reduced marketings from feedlots in the late winter through mid-summer," at a time when a potential revival in the US economy may be spurring demand.

"Recent futures price declines, which are suggesting late winter and spring prices in the low-to-mid $130s per hundredweight, may have been excessive," he said, forecasting finished cattle prices recovering to "mid-to-higher $130s this spring and early summer".

Prices, after easing back to the "higher $120s" per hundredweight in the summer will "then strengthen in the fall to the low-to-mid $130s".

And values could set a "new record high" in 2014, if US drought eases, encouraging ranches to restock, and promoting competition between farmers and feedlots for animals.