Your Goal: Protecting Price, Not Outguessing the Market
May 17, 2010
By Robin Schmahl, AgDairy LLC
Last week, USDA released its estimates for milk production, supply and demand, milk prices and product prices for this year as well as 2011. This was the initial estimate for 2011, and it showed some good numbers and some not-so-good numbers.
First of all, USDA raised the milk production estimate for this year to 190.2 billion pounds, an increase of 300 million pounds from last month’s estimate. It indicated that stronger production per cow prompted the increased estimate.
USDA’s initial production estimate for 2011 is for 193.0 billion pounds of milk. In a way this is quite surprising given the extended period of low milk prices and the difficulty in obtaining operating loans. In a way, however, this is not surprising since history has shown that a better price outlook results in farmers somehow getting more milk out of the cows.
Now, one thing we need to realize is that these estimates by USDA are not the gospel truth, and are just that – estimates. Generally, USDA changes these estimates on a monthly basis, depending on which direction the dairy product prices or futures prices are moving. So, how do these initial estimates for 2011 stack up to historical estimates and final prices?
Over the past five years, final milk production has exceeded the initial estimate. Previous to that, the estimate was higher than the final production number for four consecutive years. This year is on track for milk production to again exceed USDA’s initial estimate.
Heavier culling has been taking place over the past year from necessity as well as the result of good cull-cow prices. A large inventory of heifers has been available throughout the winter and the spring, which has likely been the result of improved milk production per cow as indicated on the monthly milk production reports.
Improved genetics are increasing production per cow and annual milk production. There have also been areas of the country that have been feeding excellent forage from last year, which has also improved milk production. Much of the corn from last year left much to be desired, but nevertheless milk production is increasing.
Cheese prices are expected to improve next year but not by very much. Price is expected to range from $1.5050-$1.6050, up from the current average estimate for 2010 of $1.5050.
The nonfat dry milk price is estimated to range from $1.21/lb. to $1.28/lb., up from the 2010 average estimate of $1.20, with dry whey only showing a possible slight improvement to $0.3750/lb. to $0.4050/lb. rather than the average of $0.3800 this year.
Surprisingly, the butter price is expected to decline, according to USDA, with the 2011 price ranging from $1.39 to $1.52 versus the current 2010 price range of $1.4450 to $1.5250.This does not give us much hope for a significant change to a cycle of higher prices.
There is a lot of time before these estimates are fulfilled, however, and much can happen from weather as well as forced liquidations and/or improving domestic and world demand.
The estimated 2011 all-milk price should range from $15.70/cwt. to $16.70/cwt, The Class III price is likely to range from $14.25/cwt. to $15.25/cwt., and Class IV from $14.15/cwt. to $15.25/cwt. These estimates are also only slightly higher than the estimates for this year.
The main thing producers need to focus on is not the USDA estimates, which change monthly, but what can be done to protect prices while leaving the upside open to some degree.
Focus needs to be put on both feed inputs and milk production. Rapid planting progress should result in lower grain prices until the calendar moves into the classic weather market of mid-June through July. Call options can be purchased to protect against higher feed prices while at the same time leaving it open to purchase at a lower price if this were to develop.
For milk, put options in closer months and fence strategies in later months will allow either for unlimited upside price potential or a much higher ceiling price than current futures prices are offering. These strategies may be implemented to protect income over feed costs and at least keep matters from getting worse.
The purchasing of a $15.00 put option and the sale of a $17.00 call option for August through December in Class III contracts can be done for an average of 50 cents.
The pattern has been that front-month futures contracts roll down as they converge with cash. For instance, May is basically priced and has rolled down from $14.00 where it was in February and again in April. If prices remain stronger and increase further, you can still take a higher price up to the strike price of the sold call minus the cost of the option spread. The goal should be to protect price and not outguess the market.
- The April milk production report on May 18.
- The April livestock slaughter report on May 21.
- The April cold storage report on May 21.
- Commercial disappearance on May 25.
- The May Agricultural Prices report on May 28.
- Fonterra auction on June 1.
Robin Schmahl is a commodity broker and owner of AgDairy LLC, a full-service commodity brokerage firm located in Elkhart Lake, Wis. He can be reached at 877-256-3253 or through their website at www.agdairy.com.
The thoughts expressed and the data from which they are drawn are believed to be reliable but cannot be guaranteed. Any opinions expressed are subject to change without notice. There is risk of loss in trading and my not be suitable for everyone. Those acting on this information are responsible for their own actions.