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April 2010 Archive for Know Your Market

RSS By: Dairy Today: Know Your Market, Dairy Today

Dairy trading experts offer strategies and practical perspectives to optimize market performance.

Marketing Decisions Can be More, or Less, Fun

Apr 23, 2010

By Steven Schalla, Stewart-Peterson

“Marketing is more about the strategic decisions you execute, and less about what you know.”

If you’ve been keeping score at home, you’ll recall this line from one of my previous columns about becoming a strategic marketer. This is our simple golden rule of strategic marketing.

If you look closely at this statement, you’ll notice that there are two key points: What you need more of and what you need less of to be an effective marketer. The right combination can make your decision-making process more objective and less emotional. That’s where most dairy producers want to be when it comes to marketing. The constant stress of decision-making amid uncertainties is not fun.

So, let’s first address what you need less of. Within our decision-making process, market analysis makes up about 25% of any final decision. The ability to understand markets does play a role. Unfortunately, many commodity marketers put an undue amount of emphasis in acquiring information about the markets. Most of their time is spent in pursuit of this knowledge with the intent to outguess the market, and that leaves less time for the important strategizing.

To be clear, knowledge does matter, but the pursuit of new information must be properly focused. Knowledge is valuable when it comes to how marketing tools work—deciding which tool to use when. For example, if our analysis suggests that there is more risk for lower prices, a forward contract with the milk plant might be our tool of choice. On the other hand, if our analysis suggests that there is potential for higher prices, a put option might be the solution.

Knowledge about marketing tools gives you more flexibility. The more knowledge you have of the tools in your toolbox and how they work, the better likelihood that you’ll quickly and efficiently get the job done. So, knowledge is important, as long as your time is spent acquiring the most useful kind.

The second component of our golden rule, the strategic part, is what a marketer needs more of, because it accounts for about 75% of our decision-making. We call it Market Scenario Planningsm and it sets the stage for the decision-making process.

Market Scenario Planning is the process of analyzing all the potential market and price scenarios and determining in advance what decisions you’ll execute should those scenarios present themselves. With scenario planning, we are able to compare different potential price outcomes when various marketing strategies are applied. Our goal is to answer two questions:

  • What are the potential results of each specific decision?
  • How well does each decision support our goal to achieve your highest possible weighted average price? 

Here’s a quick example to give this concept some context. Please keep in mind that these are sample strategies for educational purposes. They are oversimplified and not recommendations.

An example of Market Scenario Planning

Let’s say today’s milk futures price is about $15/cwt. Using the Market Scenario Planning  process, what are the different effects of these possible decisions?

  • Forward selling 50% of your total production at $15.00/cwt. (either though your milk plant or using the CME).
  • Purchasing $14 put options at a premium cost of 50¢/cwt. to gain downside coverage on 50% of your total production.

Remember, we can’t always accurately predict what the market will do. So, in this example, I’ve indicated three possible price scenarios and the final weighted average price for each price level. I used potential price moves to $12/cwt., $15/cwt., and $18/cwt. So, if today’s futures price is about $15/cwt., what happens with these two strategies if milk falls $3, stays about the
same, or rallies $3?  The numbers in the table below make our decision-making more clear.

NOTE: These are sample simplified strategies for educational purposes and not recommendations.

As you can see, the weighted average prices vary considerably and result in significant financial implications. If the final price for this time frame is $12, your weighted average price is much better with the forward contract. However if prices make a move to $18, you are closer to achieving the optimal final price with the Put Options strategy. 

Either of these sample strategies could be the “best” way to go when you factor in other considerations. First, the current milk fundamental and technical indicators, and whether they suggest higher or lower prices, will impact which strategy decision we choose.

In addition, an individual’s risk tolerance also must be considered. This could include the farm’s debt situation, comfort with margin calls for a hedging account, or making sure others in the operation are comfortable with potential results. 

Using Market Scenario Planning allows us to evaluate how a specific strategy will perform based on potential final prices. We then can compare different strategies at potential prices to help us find the “best” route to take.

Running this analysis allows us to make objective, unemotional decisions with confidence because we’ve prepared for whatever the market may do. We can be much less concerned with what the market might do (and spend less time trying to figure it out).

Instead, we spend time strategizing what we will execute in any given situation, and we know what the results will be with each applied strategy. Planning ahead for every possible scenario is what strategic marketing is all about, and it’s actually much more fun than trying to guess what uncertain markets will do.

Steven Schalla is a Market Advisor for Stewart-Peterson, Inc. He can be reached at (800) 334-9779 or sschalla@stewart-peterson.com.

The data contained herein is believed to be drawn from reliable sources but cannot be guaranteed. Neither the information presented, nor any opinions expressed constitute a solicitation of the purchase or sale of any commodity. Those individuals acting on this information are responsible for their own actions. Commodity trading may not be suitable for all recipients of this report.  Futures trading involves risk of loss and should be carefully considered before investing.  Past performance may not be indicative of future results. Any reproduction, republication or other use of the information and thoughts expressed herein, without the express written permission of Stewart-Peterson Inc., is strictly prohibited. Copyright 2010 Stewart-Peterson Inc. All rights reserved.

The Fixed-Price Contract Can Foretell Your Milk Price

Apr 12, 2010

By Jon Spainhour, Rice Dairy

 

Many dairy producers have begun to change their attitude toward risk management tools like futures and options.

While they once viewed these tools as a form of gambling, producers are changing their minds. Many now see them as a sound business practice that will help them survive the ever-increasing volatility in the price of dairy products. 

 

One such tool is the fixed-priced contract, more commonly referred to as a “futures” contract. This is nothing more than an agreement to buy or sell something at a specific price, at a specific time, in the future. 

 

In the dairy complex at the Chicago Mercantile Exchange, we predominately trade Class III milk. The contract size is 200,000 pounds. There is a contract on every month for 24 months in the future.

This means that as dairy producer, I can agree to contract my milk today at a specific price, for as little as one month in the future and as many as 24 months in the future, in 200,000-pound increments. The price that I choose to contract that milk at is a price that is decided on the open market. 

 

Let’s assume, for example, that a dairy producer creates an average of 1 million pounds of milk every month, or an equivalent of five Class III contracts (1 million pounds/ 200,000 pounds). He would like hedge his expected production today, for only the July 2010 time period. The futures contracts for July are trading at $14.25/cwt.

He agrees to sell his five contracts worth of milk at those levels. This means that during the middle of April, he knows that the price that he will receive for his 1 million pounds of milk in July will be $14.25/cwt., regardless of what happens to the spot price of milk between now and July.

 

Let’s use two scenarios. In the first, the price of milk is below $14.25/cwt. We’ll assume that the Class III price for July was $12.00/cwt. For the second scenario, the price is below $14.25/cwt. at the end of July.

 

First scenario: While the mailbox check that he will receive will only be $12.00, his futures account will have contracts in it that he sold at $14.25. This means that his futures account will have $2.25/cwt. worth of profit of in it for each of his five contracts that can apply toward his low milk check. Between his $12.00 mailbox check and his $2.25/cwt. futures profit, his net milk check is $14.25/cwt.

 

Second scenario: The flip side of this discussion is the case where the mailbox check comes in higher than the Class III contracts that were sold at $14.25/cwt.

If the price of milk in July were to come in at $17.00/cwt, the dairyman would receive a mailbox check of $17.00/cwt. Because he agreed to sell his milk at $14.25 on the futures market, however, he will have $2.75/cwt. worth of losses in his futures account. When he applies those losses to his milk check, his net price is $14.25/cwt.

 

In either case, his net price for his milk production in July was $14.25/cwt. This means that in the middle of April, this dairyman knew the price he was going to receive for his milk in July would be $14.25, regardless of what happened to the spot price of milk. 

 

That is the nature of a fixed-price, or futures, contract.

 

Look for “Know Your Market” in the May 11 issue of Dairy Today eUpdate, when I will discuss contracts that act more like insurance, guaranteeing a minimum milk price while leaving the potential for much higher prices. Those contracts are called “options,” and I hope you will join me for that discussion. 

 

Jon Spainhour is a broker/trader with Chicago-based Rice Dairy, a boutique brokerage firm offering guidance, analysis, and execution services on futures, options, spot, and forward markets. You can reach Spainhour at jcs@ricedairy.com. Visit www.ricedairy.com.

 

 

This column is part of the Dairy Today eUpdate newsletter, which is delivered free to your inbox every Tuesday morning. Dairy Today eUpdate provides the latest in dairy markets, policy, management and production, and news. Click here to sign up.

 

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