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January 2014 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.

Prudent Choices to Consider with High Milk Prices

Jan 25, 2014

Suggested strategies for dairy producers who choose to use the Livestock Gross Margin for Dairy program.

ron mortensen photo 11 05   CopyBy Ron Mortensen, Dairy Gross Margin

How high will milk go? When will it end? Can the margins get better? How long will they last?

It is hard to look forward and so easy to look back. However, looking back can serve as a wake-up call, encouraging action and guiding your decisions in the future. It can be a big help with perspective and attitude, especially with high milk prices. What is the past saying about the big opportunity presented right now?

Think of the chart below as a monthly price chart with a twist. It is a monthly chart of historical actual margins (the blue line is actual and the pink line on the right is anticipated margins). The circled areas indicate the best margins since 1998. Margins were strong for only two to three months in 2004, 2011 and 2012. However in 2007, margins remained strong for nine months.

Mortensen chart a 1 28 14In this discussion, you also need to consider market structure in your decision-making process. What is market structure? Notice that nearby futures prices are higher than farther out prices. February Class III is about $22.00/cwt., May is about $19.00 and December is $17.60. As a futures contract approaches expiration, it could rally sharply. While the immediate reaction may be to do nothing (because the market always rallies), the more prudent choice may be a minimum price strategy. You will benefit from any rally in the last month or so before the milk futures contract expires. It is a more flexible strategy than using futures contracts.

Again, the blue line represents the historical values of Livestock Gross Margin for Dairy (LGM-Dairy). The pink line represents the future insurable margins based on 1,560 cwt. of milk, 20.5 tons of corn and 6 tons of soybean meal. This chart also reflects the current market structure as discussed in the paragraph above. Milk prices are higher in the front months so the margins look the best in the first few months.

Suggested strategies:

1. Lock in minimum cash flow. A very simple plan would be to buy LGM-Dairy or options that are above your break even. This is an easy one to do. It provides guaranteed cash flow if milk prices go lower and allows you to capture better margins if milk prices move higher. Cover a significant amount of milk with this program. Remember to factor in your basis level when evaluating the sort of minimum cash flow for your operation.

2. Lock in minimum profits. If break-evens are low enough to buy LGM-Dairy or options and lock in a minimum profit, it is even better. Be willing to spend more money by reducing the deductible on LGM-Dairy or use a higher option strike price. Once again, if milk goes higher you will get the higher prices.

3. Improve your position. If you have already done LGM-Dairy or options, it may now be possible to lock in a higher level of cash flow or profits. Essentially, you would forget the old LGM and options and start over. Do this to improve your position. Keep move up your coverage as the market moves higher.

The chart below called "Quick Looks" shows potential margins that you could establish at the end of January. 

Mortensen chart b 1 28 14

The risk of loss in trading commodities can be substantial. You should therefore carefully consider whether such trading is suitable for you in light of your financial situation.

Ron Mortensen is principal of Dairy Gross Margin, LLC, an agency that specializes in LGM-Dairy products, and owner of Advantage Agricultural Strategies, Ltd., a commodity trading advisor. Contact him at ron@dairygrossmargin.com or through www.dairygrossmargin.com.

Tilted Market Psychology on Corn Carries Risk for Feed Purchasers

Jan 17, 2014

The risk-reward ratio is 4:1 against feed purchasers right now. This should alert dairy producers to take action on feed.

MikeRusch   CopyBy Mike Rusch, Stewart-Peterson Inc.

Going into the USDA’s January Crop Report, the market psychology for corn was bearish, and corn prices made a new low prior to the report’s release, down 52% from the 2012 high. With USDA’s cut in yield numbers, corn made a 20-cent rally, its biggest one-day rally in several months. Still, prices are at extremely attractive levels for feed buyers. It is important to examine your feed needs without delay. More than likely, the consequences of inaction will impact your 2014 margins.

The seasonal pattern going forward is pointing to more upside risk for corn than downside risk. Now that we’re through January, the supply side of the equation is firmed up. There will be no more changes to yield, and no changes to acreage for the 2013/2014 crop. What corn does heading into spring will depend on the demand side (which is supported by low prices) and spring weather. We’ll also be keeping an eye on the planting intentions report at the end of March, since we’ve already heard numbers trickling in that corn seed purchases are down relative to beans. All of these uncertain factors support the premise that the amount of additional downside opportunity for corn is greatly outweighed by the potential upside risk.

So, as a dairy producer, if you are thinking that corn may go 20 cents lower and you are waiting to try to grab that, remember that there is a greater risk that corn could go 70 or 80 cents higher. The risk-to-reward ratio is 4:1 slanted against the feed purchaser right now.

Many of the headlines here on agweb.com and elsewhere have talked about "$3.00 corn," and many are asking, "How low can it go?" We’ve even heard of suppliers telling producers they think feed will go down in price, and recommending that producers hold off on purchases. From a risk perspective, feed purchasers should not be sucked into this hype. Everybody and their dog right now is bearish on corn. The psychology of the market is so tilted … to the point where everyone is prepared for lower prices and no one is prepared for prices going higher. And that’s just another reason why this market has more risk to the upside than down, because that is what nobody is prepared for.

The probability of corn going back to $5.00 by June is high. We are not guaranteeing that corn will go back to $5.00. We are simply saying that producers need to consider the possibilities, weigh the risks, and act to protect what you work so hard to earn. Calculate the risk for yourself – the difference between corn going down 20 more cents or up, say, 50 or 80 cents. And think about what you can do to secure these good prices now.

This objective view may make some uncomfortable. There is comfort in following a herd.

As John F. Kennedy once said, and it applies here, "There are risks and costs to action. But they are far less than the long range risks of comfortable inaction."

A good advisor will paint an objective picture and help you use the tools available to you, even if that is outside your comfort zone. Consistent action when opportunities present themselves can help you achieve your long-range business goals.

Mike Rusch is a business development consultant with Stewart-Peterson Inc., a commodity marketing consulting firm based in West Bend, Wis. You may reach Mike at 800-334-9779, or email him at mrusch@stewart-peterson.com.

The data contained herein is believed to be drawn from reliable sources but cannot be guaranteed. This material has been prepared by a sales or trading employee or agent of Stewart-Peterson and is, or is in the nature of, promoting the use of marketing tools, including futures and options. Any decisions you may make to buy, sell or hold a futures or options position on such research are entirely your own and not in any way deemed to be endorsed by or attributed to Stewart-Peterson. 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. Copyright 2014 Stewart-Peterson Inc. All rights reserved.

High Milk, Falling Corn Prices Still Call for Bottom-line Protection

Jan 13, 2014

Why you still need to implement a balanced hedging plan that protects your dairy.

Chris RobinsonBy Chris Robinson, Top Third Marketing

Dairy producers have been faced with many marketing challenges in the past few years. Recent volatile price swings in both inputs and the price of your product could have resulted in unforeseen changes to a producer’s bottom line.

Specifically, between 2010 and 2013, we saw the board price from corn rally from the $3.50 per bu. level in the spring of 2010, to record highs during the summer of 2012, peaking out at $8.32 ½ during August at the height of the drought.

Watching your input prices go up by 140% put incredible stress on your bottom line as well as your emotions. If you had not had a hedge to protect against that move, you were at the mercy of the weather as well as the market. Finally, in 2013, we saw the reversal in corn prices. Many producers spent the last 14 months arguing that, for a myriad of reasons, corn would "never go below $5.00." Last Friday’s pre-USDA report low was $4.06 ¼; this represents the lowest price for corn in over 40 months.

Conversely, your output has fluctuated with lows in 2009 near $10.00/lb., up to record highs at the $21.00 level. Between 2011, 2012 and 2013, $21.00 has been a price level that has represented incredible resistance for Class III milk. Indeed, in the past month, milk has been spiking higher, challenging this level once again. The recent rally was sparked by a change in China’s public policy, which now allows citizens with a certain economic status to have a second child. This represents a tremendous move away from its previous policy of one child per family, which had been the rule since approximately 1978. Since the announcement that relaxed this edict, we have seen a high spike in demand for Class I milk as new demand for baby formula is under way.

This is a fortunate convergence of supply and demand for the dairy farmer. Your margins, which had been upside down just 18 months ago, have now gotten very healthy. Given this reality, how can you as a dairy producer use a hedging program to manage your risk in this environment? The answer is by implementing a balanced hedging plan that protects high prices of your milk, as well as protecting against a higher spike in feed costs. It is possible to use a put option as a substitute sale of your milk for a specific length of time, with a defined financial cost. The put is a substitute sale of your milk until you sell your physical milk.

Conversely, you can protect your business against the possibility of a return to $6, $7 or $8 corn with a call option to protect against higher prices in the future. Again, it’s taking your business risk away from the cash market and putting it on paper where your risk is defined.

With over 25 years as a broker, trader and risk manager, I learned long ago that opinions are only useful if they help your bottom line. Only 7% of speculators make money over time consistently. That means 93 out of 100 folks who think they can outguess the market are, over time, relieved of their trading capital. As risk managers, we strive to ignore opinions and predictions of the "gurus" and just take advantage what the market is giving us today.

Our approach to hedging is, first and foremost, risk management while avoiding speculation. The past five years have shown us how volatile the markets can be, whether it is Mother Nature, the financial markets or the population control policies of China. Right now conditions are favorable for your bottom line. There are hedges available that can take advantage of these prices while still allowing you to benefit if the current trends continue. You owe it to yourself to at least investigate a hedging program to see if it’s a good fit for your operation.

This material is conveyed as a solicitation for entering into a derivatives transaction. This material has been prepared by a Top Third broker who provides research market commentary and trade recommendations as part of his or her solicitation for accounts and solicitation for trades. Top Third, its principals, brokers and employees may trade in derivatives for their own accounts or for the accounts of others. Due to various factors (such as risk tolerance, margin requirements, trading objectives, short term vs. long term strategies, technical vs. fundamental market analysis, and other factors), such trading may result in the initiation or liquidation of positions that are different from or contrary to the opinions and recommendations contained therein.

Chris brings over 23 years of experience to his Top Third clients. He began his career as a broker and analyst in 1991 with a Chicago firm which specialized in cash grain trading and hedging. In 1992, Chris became a member of the CBOT. He joined Top Third in January 2010, capping an 18 year career as a floor trader and broker. Today, in addition to his Top Third duties, Chris is a featured grain and livestock analyst for the CME. He is also featured on weekly video summaries with RFDTV. In January of 2013, Chris became the lead broker for the Pit bull division of Top Third. This is a separate branch of the company that is involved with traditional speculative trading and is separate from the hedging arm of Top Third. Chris is a 1988 graduate of Colgate University with a degree in Political Science and Economics. Contact him at crobinson@topthird.com.
 

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