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July 2013 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.

Boom-Time Protection: Don’t Wait

Jul 26, 2013

Prospects for dairy’s fourth-quarter margins have never looked stronger. Why you should act now to capture this historically high opportunity.

chip whalen thumbBy Chip Whalen, CIH

As the current row-crop marketing year winds down, dairy producers and other livestock feeders are understandably looking forward to the new-crop season, given the outlook for lower feed costs.

While recent futures price activity would suggest that outlook is quite favorable to margins -- although from a cash-flow standpoint -- profitability remains squeezed by historically high basis levels being paid across the country for spot feed supplies. As of this writing, the corn crop is going through its pollination phase, and the market eagerly anticipates the upcoming USDA WASDE report on August 12 for actual field surveys to confirm expectations of trend-line yields and record production this season.

Likewise, soybeans will also soon be going through their pod fill stage of development, and with favorable weather forecast to continue into August, the outlook for soybean yield and soybean meal supply will soon become clearer as well.

While the forward curve of corn and soybean meal futures prices currently reflects the discount from spot levels, and the market has been declining of late, milk futures contracts have been supported recently by strong exports and declining production tied to the summer heat. The forward curve actually reflects a premium into the October Class III contract, with the Q4 average of October, November and December futures, as a pack, trading at a premium over the spot August contract and only 50 cents lower than September.

While prices are obviously subject to constant change, when one considers the matrix of corn and soybean meal prices relative to milk, Q4 margins look very attractive right now and present a great opportunity for a dairy to protect forward profitability.

Based on a model dairy operation in Idaho with corresponding new-crop basis levels, non-feed costs of $6.95/cwt. and non-milking revenue of $1.00/cwt. projected for the fourth quarter, the current profit margin projection is a positive $2.45/cwt., which exists at the 94th percentile of the past 10 years. This essentially means that the dairy has only been more profitable than $2.45/cwt. in the fourth quarter 6% of the time within the past 10 years. For reference, I included a couple graphs below that chart the current Q4 margin since we began tracking it a year ago (Figure 1) as well as a "stacked" history of the past 10 years of Q4 margins (Figure 2).

In the first graph, you will notice that the margin is currently as high as it has been since we began tracking it, matching a previous high near $2.80/cwt. set back in April.

Whalen chart 7 26 13aThe horizontal blue line represents the 90th percentile of the past 10 years. You will also notice in this graph that last year’s fourth quarter finished quite strong as well when referencing the green line, thanks in part to milk prices over $20.00/cwt. in the fourth quarter despite surging feed costs as a result of the drought. This year’s Q4 projection in red, however, is even stronger than last year’s profit margin.

The second graph in Figure 2 shows each of the past 10 years’ fourth quarter margins stacked on top of one another. While this view presents a somewhat "busy" chart, what it allows you to do is visually put the current margin in perspective relative to where it is for this point in the year and where it has been. I have circled the current margin for 2013 Q4 so you can see it more clearly.

Whalen graph 7 26 13bWhat you will notice is that with the exception of two years (2007 and 2004), fourth quarter margins have never been stronger in the actual fourth quarter than where they are currently being projected.

While margins can certainly strengthen further through a combination of either higher milk prices, and/or lower feed costs, I think it is safe to say that based upon history there is likely more risk for margins to deteriorate from current values than strengthen further.

While any individual dairy operation’s margin will vary based upon its unique input costs and local basis levels, the relative opportunity should still be very strong within a historical context and this should be considered carefully when evaluating your risk management plans for the fall.

As Vice President of Education & Research at CIH, Chip Whalen is responsible for developing and conducting all of CIH’s Margin Management seminars. He is also the editor of CIH’s popular Margin Watch newsletters. Whalen can be reached at (312) 596-7755 or cwhalen@cihedging.com.

Profit Margins with Projected Prices: What’s Your Game Plan?

Jul 19, 2013

Even with a positive dairy outlook, it’s important to maintain risk management strategies to decrease volatility, secure a margin or capture an upside surprise.

Kristen SchulteBy Kristen Schulte, Iowa State University

Currently the Corn Belt has adequate moisture to grow an average to bumper crop while other parts of the U.S. are still waiting for rain to relieve ongoing drought.

This is a different picture from a year ago when a large portion of the U.S. was entering a drought, causing producers to evaluate feed sources and cow inventory.


Weather is just one cause of increased price volatility that dairy producers have experienced over the past years. Export markets for dairy products have been over $3.5 billion dollars since 2011, with this trend continuing in 2013. Product exports are expected to be level or grow in coming years. New Zealand, Australia and the EU-27 are key producing countries to watch; however, China, Southeast Asia, and developing countries are important to watch for demand growth, new opportunities, and internal supply growth, which all may impact the global dairy supply/demand balance.

There a lot of factors to consider when projecting prices in the coming months. However, futures markets should reflect the most current market data, and that information, alongside historical data, tells where the dairy industry has been and what is expected in the future.

A year ago, I looked at a price index that uses 1980 as the base year. Corn and milk prices trended in the same general direction until 2010, when the corn price index increased up to above 3.0, while the milk price index stayed variable just above 1.50. While both commodities experienced price variances, corn prices increased at a greater rate. While this has been reality of the last few years, what does the future hold? According to the futures market for new crop corn and milk, the spread between corn and milk price narrows down closer to historical trends.

The graph below shows these price indices--the historical Class III Announced Milk price, U.S. Corn Price, and U.S. Alfalfa Hay Price up to June 2014.

Schulte graph 7 19 13The futures market is used to project prices into 2014 and is displayed with dashed lines on the graph at right.

Corn and milk are projected to track more closely over the coming year, similar to the pre-2010 period. However, hay prices are expected to remain high due to stable hay acres, below average first-cutting tonnage, and continued demand. While decreased corn prices may help feed costs, milk prices are expected to remain consistent into 2014 due to increasing production, rising product stocks and global supply and demand levels.

For 2014, USDA projects in its latest supply/demand report that the expected average price for corn is $4.80/bu. (range of $4.40 to $5.20) and for Class III Milk is $17.10/cwt. Using these prices adjusted for basis, in addition to $200/ton for hay, we can estimate projected profitability for an average dairy producer. Typical other revenue, production costs, labor costs, and fixed costs are factored into dairy budgets.

The projected results based on these prices for mid-year 2014 look promising for a dairy producer. At 22,000 RHA, the estimated profitability is above $2 per hundredweight. This projection is representative of a conventional operation in the Midwest. Different production systems and different regions across the U.S. will see different profitability levels based on cost structure and commodity price basis levels.

As producers continue to learn about risk management options and increase their comfort level with marketing concepts and practices, will strategies change with changing margins? Improved profit projections do not mean producers can breathe a sigh of relief and do nothing. Even with these better projections, it is important to maintain risk management strategies to decrease volatility, secure a margin, or capture an upside surprise.

Based on your operation’s risk management plan, future milk margin estimates, and knowledge or comfort level, will you participate in the futures and options markets, forward contract milk or feed, or purchase margin insurance? Each marketing tool has its own advantage. Each tool must fit the producer’s situation and operation. Finally, with changing commodity prices, it is important to recalculate cost of production on a regular basis to evaluate any change in prices and the impact of different marketing options on the profit margin.

Kristen Schulte is Iowa State University Extension and Outreach Farm Business Management Field Specialist. Contact her at kschulte@iastate.edu.

Additional comments from Ron Mortensen, Dairy Gross Margin, LLC:

The comments above highlight the improved potential margins in 2014. The data regarding LGM-Dairy insurance supports this. The projected margins are actually pretty good compared to the last 10 years. If you look at January, February, March and April using 1,560 cwt. of milk, 20.5 tons of corn and 6 tons of meal, the margins rank very high. Margins that can be locked in via LGM-Dairy insurance for January and February are the second best. Only 2008 was better. March margins were better in 2008 and 2011. April margins were better in 2004 and 2007.

Take Matters Into Your Own Hands

Jul 16, 2013

Don’t wait for the government to protect your business. Start your own risk management plan.

Katie Krupa photoBy Katie Krupa, Rice Dairy

As we all know there has been a lot of discussion in recent years about the government’s role in price protection for dairy producers. Recently most of the discussion has boiled down to the current discussion about margin protection and supply management, and by now many producers have a crick in their neck from watching this discussion go back and forth like a Ping-Pong ball.

I’ve never been one to idly sit as others decide my fate, and from what I know of dairy farmers, they aren’t very good at it either. If you are worried about the future of the milk price, the feed prices, and the milk-feed margin, don’t wait for the government to step in and try to protect your business. Take matters into your own hands and protect your business yourself.

Moving further down the road and assuming the margin protection plan is implemented, many producers are concerned that the potential coverage level will not be high enough to earn a sufficient income. While the market doesn’t always offer an opportunity to hedge a profit, you should be prepared to take advantage of the times it does. Here are some outlets to help you get your own risk management plan started.

Work With a Broker.

As a broker I work with herd sizes from 60 – 10,000 cows, and outside of the herds with less than 50 cows, brokers can provide risk management strategies and advice for what is typically referred to as a ‘smaller’ farm. When working with a broker, your risk management opportunities vary, and are flexible when it comes to adjusting the strategy or exiting a strategy. From fixing your price to simply protecting against a drastic price decline, there are numerous options from which a producer can choose. Because of contract sizes for corn and soybean meal it does get harder for herds with less than 100 cows to hedge feed on the exchange. But still opportunities may exist off the exchange and your broker may be able to guide you to the right sources.

When working with a broker you have many strategies to utilize and can hedge your milk and your feed on the exchange. A broker should be able to guide you through the tedious analysis and tough decisions that go along with risk management implementation. I find many producers enjoy getting the broker’s opinions and advice. It often helps them make the tough decisions that are necessary for the financial security of the business.

Work With Your Cooperative or Milk Plant.

Typically cooperatives or milk plants will have fewer options than working with a broker, but usually the contract size is more flexible. Additionally, the contracts require no cash up front; rather any monetary difference from the contract will be applied directly to the producers milk check for the month of the contract. That makes the contract very easy for producers to implement.

Typically cooperatives and milk plants do not offer advice, but you have the option to work with a broker on a consulting basis for the advice and still implement your hedges through your cooperative. When creating and implementing a risk management strategy you should be reviewing and utilizing all your resources available.

Work With Your Lender.

While your lender does not offer a traditional risk management strategy, you should always be working with your lender so that they can understand your breakeven and your full financial situation. If milk prices should decline, your lender will be aware of the financial strength of your business and be better suited to help you manage through the low milk price cycle. Also your lender can establish a hedge line of credit which can be used to fund your brokerage margin requirements. Currently many lenders are requiring a marketing plan and a hedge line of credit that can be used to help implement the required marketing plan.

Katie Krupa is the Director of Producer Services with Chicago-based Rice Dairy, a boutique brokerage firm offering guidance, analysis, and execution services on futures, options, spot and forward markets. If you are interested in learning more, Katie offers monthly webinars on the basics of risk management. You can reach Katie at klk@ricedairy.com.Visit www.ricedairy.com.

Why the U.S. Dollar and Foreign Exchange Rates Matter to Your Dairy

Jul 08, 2013

With more than 10% of U.S. milk production headed overseas, it’s more important than ever to understand the variables that drive exports.

By Atten Babler Risk Management, Commercial Risk Management Division

In past articles, we have discussed the increasing influence of the export market on U.S. dairy prices. With more than 10% of U.S. milk production now destined for the export market, it is now more important than ever to understand the variables that drive exports. One key variable is currency exchange rates.

The strengthening U.S. dollar has recently put exchange rates in the news. A number of factors, both realized and expected, have contributed to the strengthening of the U.S. dollar. Indications from the Federal Reserve, signaling an end to quantitative easing, have driven up interest rates and consequently the U.S. dollar. Additionally, signals of improving economic conditions, improving labor markets and rallying equity markets have increased the desirability of U.S. dollar-denominated assets.

U.S. dairy customers losing buying power

As the U.S. dollar strengthens, it reduces the purchasing power that our trading partners have when buying our goods. Commodities, including dairy products, are generally priced in U.S. dollars in the world markets. When the dollar strengthens, it becomes more expensive in foreign counties to purchase the same good from the U.S. Consequently, a stronger dollar acts to either ration foreign demand and/or reduce the price received by U.S. producers. This serves to limit the desirability of the product and consequently may also reduce its price in order to keep trade constant.

Figure 1 below shows the top five U.S. dairy export destinations, which include Mexico, Canada, China, the Philippines and Japan. Collectively, these countries make up over half of all U.S. export demand.

Atten graph a 7 8 13

Figure 1 – Major U.S. Dairy Export Destinations (source U.S.DA FAS)

All of our top five dairy trading partners, with the exception of China, have seen their currency depreciate versus the U.S. dollar.

Figure 2 below shows the recent upward trend of the strengthening U.S. dollar. (This can also be viewed as a weakening of the foreign currency.)

Attenc chart b 7 8 13Figure 2: U.S. Dairy Export Destination Exchange Rates (source OANDA)

Exchange rates and U.S. export competitors

When assessing the U.S. competitive position, it is also important to look at the currency trends unfolding for other major exporters. Major dairy exporters include New Zealand, the EU-27, Australia and Argentina, as shown in Figure 3 below.

Atten CHart c 7 8 13
Figure 3: Major World Dairy Exporters (source: U.S.DA FAS)

An analysis of exchange rates for competing exporters also signals potential headwinds for U.S. exports. The U.S. dollar has strengthened considerably versus the New Zealand Dollar, Australian Dollar and Argentine Peso. As these exporters’ currencies weaken they continue to sell their dairy products in the world market in U.S. dollars.

These U.S. dollars are increasingly able to be exchanged for more of the exporting countries currency. This serves to extend the in-country value of the U.S. dollar-denominated export sales. Even if dairy prices drop, these countries may be able to generate the same in-country revenue as long as the U.S. dollar strengthens proportionally. This helps maintain profitability and the appeal of exports for U.S. competitors.

Atten chart d 7 8 13
Figure 4: U.S. Dairy Export Competitor Exchange Rates (source OANDA)

Conclusion

Currency prices are no less volatile than dairy prices or the weather. While it isn’t clear if we are seeing the beginning of a major trend, or a just a temporary appreciation of the dollar, it is worth noting that strength in the U.S. dollar has already impacted U.S. dairy exports. Dairy producers are encouraged to consider the risks posed by any loss of exports, whether caused by currency fluctuations or other factors, and pursue hedging strategies that secure a margin and limit downside risk in milk prices.

Futures and options trading involve significant risk of loss and may not be suitable for everyone. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition. Contact Atten Babler at cbabler@attenbabler.com.

China’s Explosive Dairy Demand Signals Potential U.S. Market Boon

Jul 01, 2013

Chinese consumer spending on dairy products has increased in double-digit numbers and is expected to grow by nearly 120%.

Ryan Cox Photo   CopyBy Ryan Cox, INTL FC Stone

Like the phoenix rising from its ashes, China’s ascension from poverty-stricken nation to economic power house has changed the world order. To think, it was only 40 years ago that most of the country was immersed in poverty. It’s mind boggling.

So, how has this rapid shift occurred? Chinese domestic policy? U.S. consumerism? Regardless of the reason(s), China’s GDP is now second only to the United States, surpassing Japan in 2010. Today, China is the largest market for automobiles, the world’s largest exporter, as well as one of the largest importers of U.S. grains.

China is an economic force, a burgeoning political force and a boon for U.S. dairy products should farmers and multinationals position themselves appropriately. Food security is a top priority for the Chinese with water resources and arable land continuing to present a challenge for domestic production. As a result, self-sufficiency is something that the Chinese have yet to master, as you can see below.

INTL FC Stone graph 7 1 13

(Source: OECD)

The statistics are staggering. It is estimated that within the last decade some nearly 200 million people have moved into urban areas within China. 200 million! That is over half of the current U.S. population. This shift does not seem to be waning either, with some estimates pointing toward 65-70% of the Chinese population in urban areas by 2030. Urban dwellers are now the majority, and this demographic shift is essential in unlocking China’s potential.

But why? With this rapid urbanization come shifts in cultural norms. Chinese diets are changing. This rapid urbanization has led to a rising middle class and demand for higher protein diets. Milk consumption alone has tripled in the last decade, and it is estimated that urban dwellers consume nearly five times more dairy than their rural counterparts. Since China does have a domestic production issue in both dairy and grains, import dependence has roughly doubled. From 2001-2012, import dependence increased from 6 % to roughly 13% for all agricultural trade, resulting in a trade deficit of 31 billion dollars in 2012, according to the United Nations FAO.

On the dairy front, Chinese consumer spending has increased in double-digit numbers, with U.S dairy exports exceeding $440 million in the last year. Although this is impressive, the dairy market in China is potentially in its infancy. As demand contracts in the developed world, it will be the consumers of the emerging markets that will offer opportunity for dairy exports as well as other agricultural products. As Oceania suppliers rush to fill Chinese demand, their U.S. counterparts should be concentrating on the void left in China and elsewhere in emerging markets. Dairy consumption is expected to grow by nearly 120%, and China has neither the tools nor resources to support this explosion in demand.

U.S. operations are a model for the Chinese. The Chinese understand this, and one could expect further acquisitions in food-related industries outside of the recent Smithfield bid. As we know, the Chinese are the world’s largest pork consumers, and the Smithfield acquisition is probably the first of many. Although the Chinese may, in fact, want more access to U.S. markets through acquisitions, it is the knowledge (of genetics, operations, etc.) that Chinese seek in order to further their food security agenda.

And while some fear a rising China, said fear is a pessimist’s view. As Winston Churchill said, "A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty."

Ryan Cox is a Risk Management Consultant with the Chicago office of INTL FCStone. INTL FCStone offers comprehensive risk-management and margin hedging programs and services to dairy producers, processors, traders and end-users. You can reach Cox at 312-456-3613. 

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