Thursday, November 10, 2011

The Derivative of Hogs: the Real McRib Arbitrage

Willy Staley of theawl wrote an article this week title "A Conspiracy of Hogs: The McRib as Arbitrage." He points out the correlation between McDonald's introduction of the McRib and pork prices. According to the Pork Cycle, supply and price of livestock is cyclical as changes in demand cannot easily be met due to gestation and breeding.

Key: 1. November 2005 Farewell Tour; 2. November 2006 Farewell Tour II; 3. Late October 2007 Farewell Tour III; 4. October 2008 Reintroduction; 5. November 2010 Reintroduction.
What Staley fails to consider is that McDonalds has not only introduced the McRib when pork is cheap, but also when beef is relatively expensive. See the graph below where the spread between the spot price of live cattle (beef) and lean hogs (pork) is shown:
Live cattle shown in orange, lean hogs shown in white, and the spread is yellow. The same five events are market as previous key. 

During the five periods mentioned by Staley, a particularly wide spread exists between the two meats. There is a wide spread right now, as the McRib is being served. Thats six for six!

Ostensibly the McRib cannibalizes demand for other purchases. Customers who buy the McRib are often switching from BigMacs. The two are comparable products. Introducing the McRib while pork is cheap and beef is expensive maximizes profit, improving margins.

Watch the spread (not seasonality, or the price of pork!) to see when the McRib is coming back.

I'd rather have a burrito.