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March 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.

Base Your Margin Protection Program Decision on the Math

Mar 28, 2014

Although it might be nice to sign up for margin protection and forget about it, a sharp pencil is still required.

Patrick PattonBy Patrick Patton, Stewart-Peterson Inc.

In an article here on agweb.com earlier this week, Dairy Today’s Jim Dickrell said, "The devil is in the farm bill details." That is very well-put. There is much rule-writing that needs to happen before Sept. 1 implementation. Nevertheless, everywhere we go, producers are asking us whether they should take the insurance or not.

There seems to be more buzz about this particular farm bill than previous ones, with the addition of the margin protection program. Maybe that’s because the concept of margin management is in vogue right now. Many dairy producers want to lock in a profitable margin and in effect, forget about it.

Although it might be nice to sign up for margin protection and forget about it, a sharp pencil is still required. Our evaluation of whether producers should participate in these programs is rooted in the math and based on a holistic approach to risk and opportunity management.

Here is a basic summary of the math as we see it today:

Up to 4 million pounds of production, take the insurance. The math shows that dairy producers should take the insurance as part of their comprehensive price protection plan, typically at the highest level of protection, up to the 4 million-pound mark. The premiums are so advantageous, plus, there is a 25% discount the first year you enroll (2014-15). So why not take it?

A special note for dairy producers with 4 million pounds or less of production: If you plan to use the insurance as your only risk management tool, remember that payouts are calculated based on national averages, not your own individual farm’s margin. The risks associated with this feature of the program are further explained in the paragraphs ahead.

After 4 million pounds, do the math. The pricing in the tier above 4 million pounds of production is not necessarily advantageous. Producers should evaluate the protection available in the program at that level compared to what is available in the marketplace to provide equivalent levels of protection. For example, you may be able to protect similar margin levels using calls on feed and puts on milk, for less money. Do this evaluation for any milk production beyond 4 million pounds, especially if you are growing or expanding. In addition, if you choose to protect your production beyond 4 million pounds using hedging tools available in the marketplace, why not manage your price risk for your entire production of milk and feed needs? There is no reason why you cannot do both.

If you are growing or expanding, there’s not much here for you. Because of the way the MPP is set up, if you are growing or expanding, you leave much of your production unprotected. That means you will have to seek some sort of protection for milk produced beyond the initial amount you are eligible to insure.

The math shows that you should also continue commodity price risk management for all your feed and milk. This is especially true if you are growing/increasing production: If the insurance is your only form of price risk management, so much of your milk would be left unpriced and open to market volatility.

For all dairy producers, expanding or not, insurance under MPP is really catastrophic in nature. In the middle ground between a catastrophic price drop and today’s prices, producers could benefit from actively pricing their milk and hedging feed.

Remember, payouts are triggered by national averages, not your own individual situation. Unlike crop insurance, which insures your own farm’s production, the MPP protects a producer against industry- wide losses. It does not protect your individual operation or your region. If you are in an area of the country that is impacted by high feed prices and the rest of the country isn’t, you won’t see a dime in terms of a payout. It is still in your best interest, therefore, to capture as much price opportunity as you can beyond the basic insurance.

Participating in the MPP and maintaining a comprehensive price risk management approach on your own will put you in the best possible position to weather price volatility. Consider this: If you are in an area of the country that is better off than the national average, and you’ve actively managed your risk using tools beyond this program, and the national average triggers a payment, you receive the benefit of both your market positions and your insurance payment.

A concrete example of this is our clients’ experience during the 2012 drought. Our clients had corn prices locked in at an average of $5.50 in 2012 and were able to keep a healthy margin during the drought. Had this program been in place, it would have triggered a payment, and our clients would have benefited from both their own price risk management decisions and the government’s MPP.

So, the savvy producer will use the government program up to its financially advantageous point, and then continue to use all available tools to protect prices and create opportunity. The combination of this insurance and actively managing risk and opportunity is very powerful.

We’ve written a summary report that contains these thoughts plus more math to guide you through future decisions. Simply call me or email your questions, and I’ll be happy to talk you through the math, or provide you with the white paper.

Patrick Patton is Director of Client Services for Stewart-Peterson Inc., a commodity marketing consulting firm based in West Bend, Wis. You may reach Patrick at 800-334-9779, or email him at ppatton@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.
 

China’s Dairy Demand Leads the Way

Mar 24, 2014

High prices are said to cure high prices. So why does the dairy’s forecast seem different this time?

Curran FCStoneBy Brenden Curran, INTL FC Stone

The bull market that erupted in the fourth quarter of 2013 continues to have legs in the dairy complex, leaving many to question the long-term sustainability of high prices into 2014 and beyond.
Before that question can be answered, it’s imperative to grasp the origins responsible for the strength in the first place. At some point, high prices have to cure high prices, and a certain amount of demand destruction should play itself out in the market.

So, why does it seem like "it’s different this time"?

The dynamics with the Chinese and their seemingly insatiable appetite for dairy products have their roots in the structural changes being made to their domestic infrastructure, their long-term goals of self-sustainability, a growing middle class and a fear of food insecurity. In an effort to replicate the United States’ dairy industry, the Chinese have made the commitment to fewer farms while increasing the capacity of larger operations. This endeavor is ambitious to say the least and also a major contributing factor as to why the world suddenly finds itself exporting in bulk to them.

China Dairy Exports 3 24 14 jpg

Without the necessary infrastructure in place to accommodate such a radical shift, the Chinese dairy industry has found itself in the conundrum of smaller dairy operations being forced out of business and subsequently culling their herds in an effort to take advantage of high beef prices. Another factor contributing to lower milk production has been the foot-and-mouth disease that has been rampant across their herds. Coupled with water quality, forage and technological issues, their productivity has been hampered, declining over 6% compared to last year.

The burden of the Chinese shortfall has been placed on both the world market and the U.S. domestic market, with exports up across the board in New Zealand, Europe and the U.S. Another aspect to this bull market is the fact that many buyers in competition with Chinese purchasing eventually found themselves priced out of the market and have been waiting for a pullback in prices that has yet to materialize. This pent-up demand has yet to be satisfied, which will prove to be supportive to the market in the long term.

An argument could be made that prices will ease a bit with increasing production from Europe and an anticipated spring flush domestically, but this has yet to materialize and translate into lower prices. Upticks in production out West have largely been muted out by a stalled Midwestern flush, as winter has been reluctant to relinquish her grip.

Notwithstanding a "black swan event" from a macro perspective, such as continued negative economic reports out of China, or to a certain extent, a downturn in our own economic climate, the fundamentals driving this market will likely remain intact.

Class IV products lead the way to the upside, putting the squeeze on Class III and if prices do abate, look for Class IV to lead to the downside. This will be the first signal that the winds of change are blowing. However, look for any price weakness to be met with the previously discussed pent-up demand, which is why the trend higher could continue well into 2014. Sound risk management strategies should be implemented in order to navigate the extreme volatility that is likely to persist for the foreseeable future.

Brendan Curran 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 him at 312-456-3613. 

Beyond the Fundamentals: Know Your Marketing Tools

Mar 20, 2014

NCAA basketball teams plan and execute their March Madness strategies. So too should dairy producers prepare for when the high-price bubble will burst.

ken harzell   CopyBy Ken Hartzell, Dairy Gross Margin, LLC

It is March Madness time in NCAA basketball, that time of year when favorites prevail, Cinderellas appear, bubbles are burst, and teams fight to play another day. In the dairy industry, the "favorite" is high milk prices, and the big question is when will the high price "bubble" burst?

In the big picture, the dairy market has strong demand supporting it—high cheese prices, strong demand from China and others for Whole Milk Powder and Skim Milk Powder, and an improving economy. There are several areas of the world, however, also increasing production at the same rate (or greater) than the U.S. Remember the old market saying, "The cure for high prices is high prices"?

With this supply/demand situation, according to futures prices, the cash price for milk should decline during the year. Futures prices are determined by buyers and sellers, using today’s information. They are predictions just like the ones ESPN analysts come up with when predicting winners and losers for each game and region.

In the early days of basketball, teams would work on fundamentals of shooting, passing, dribbling and teamwork, but teams would show up and play each other, taking what the other team did and making adjustments as the game went on. But as the game grew, the risks of being unprepared were bigger and coaches adapted. First came scouting the other team in advance so there was better preparation. Then came films, videos and computers to track what opponents were doing. Teams became much better prepared to weather the storm if the opponent started to press full court, or trap, or set ball screens.

The dairy industry has similar features. For years, we have worked on the fundamentals of getting more milk. Then we’d show up at the market and take the price the market gave us. That is still the way 80% of milk is marketed. But, as the investments in the cost of production continue to grow, how do we become better prepared? Is it enough to just work on the fundamentals of producing more milk?

The last five years since the start of Livestock Gross Margin-Dairy (LGM-Dairy), we’ve seen the increased usage of futures and options, increased usage of forward contracting, and we’ve seen some milk plants work on creative ways to help their producers protect prices. In late 2014, producers will have the option of utilizing the Farm Bill’s newest alphabet soup--MPP or Margin Price Protection. At this point, rules have not been written.

Successful basketball coaches are continually learning and improving, and dairy producers need to do the same. Not every coach uses a zone press or a 1-3-1 defense or motion offense in every game, but they are aware of them. They do have some type of offense and defense in place. The point is, they make decisions and then do "something" beyond the basic fundamentals. It is not always right, they don’t always win, but it keeps them disciplined and not losing by as much as they could have.

By 2015, dairy producers will have more tools and more alternatives to help protect milk prices than ever before. Do they have to use all the tools? No. Do they have to use only one? No. Can they combine these tools? In some cases, they can. But the No. 1 thing is to get educated on what’s available, what the marketing tools will do and won’t do, and then do "something." Just like the basketball coach, it may not always be right, and you won’t always "win" (sell at the top), but "something" could make you money and/or protect your operation from a downturn.

Ken Hartzell is an agent with Dairy Gross Margin, LLC, an agency that specializes in LGM-Dairy products. Reach him at ken@dairygrossmargin.com or visit www.dairygrossmargin.com.

World Milk Production Responds to Record Prices, Improving Weather

Mar 10, 2014

A closer look at the output numbers in New Zealand, the European Union and the U.S.

By Will Babler and Luke Strub, Atten Babler Commodities LLC

Announced Class III and Class IV prices have increased throughout the second half of 2013 to at or near all-time record highs, providing producers with an incentive to increase output. Coupled with improving weather, record high prices and profitability have expectedly increased production across major milk-producing countries.

Babler graph 3 10 14 world

New Zealand Milk Production

New Zealand, the largest dairy exporter in the world, experienced a severe drought in early 2013, resulting in a 12.0% year-over-year (YOY) decrease in the first half of the 2013 calendar year. As favorable weather returned, New Zealand increased production by 5.5% in the second half of 2013. Monthly New Zealand milk production declines seasonally until lows are reached in the summer months. YOY production increases, however, are expected to continue, assuming favorable weather and strong margins continue.

Babler graph 3 10 14a

EU-28 Milk Production

EU-28 milk production finished the 2013 calendar year up 1.0% YOY after a strong second half of the year. Production was down 1.4% in the first half of the year, due to high feed prices and wet and cold weather in major milk-producing countries. Production, however, increased 3.5% YOY in the second half of the year as weather conditions and margins improved. December 2013 EU-28 milk production continued the recent trend of production growth, increasing 4.4% YOY. For 2013-14 year to date (Apr 2013 – Dec 2013), EU-28 milk production is up 1.8% YOY, with additional increases in production expected as producers prepare for the expiration of the EU quota system in April 2015. Monthly EU-28 milk production will continue to increase seasonally until the summer months, after reaching a seasonal low in November.

Babler graph 3 10 14b

U.S. Milk Production

U.S. milk production increased 0.5% YOY through the first third of the 2013-14 production year, trailing production increases in other major milk-producing countries. U.S. milk production has been hampered by cold and wet weather in the Midwest, which has reduced output. Excluding major Midwest milk producing states -- including Wisconsin, Minnesota, Iowa, Illinois, and Missouri -- U.S. milk production improved 1.3% YOY in December and January and 1.0% YOY through the first third of the 2013-14 production year. Additional output is expected as weather conditions improve in the Midwest.

Babler graph 3 10 14c

Major Regions Combined Production

For the 2013 calendar year, combined milk production for New Zealand, EU-28, and the United States increased 0.7%. Production in the second half of the year was up 2.8% YOY, with production increasing 3.2% YOY from August – October, prior to adverse weather affecting U.S. production. As shown highlighted in the chart below, production for the most recent data point (December 2013) increased 2.8% YOY.

New Zealand and EU-28 have rebounded from poor weather conditions to significantly improve milk production as record high milk prices have been reached and strong margins continue. As weather in the Midwest improves, it is reasonable to expect the U.S. to follow suit and increase overall production.

Babler graph 3 10 14d

Will Babler is a principal with Atten Babler Commodities LLC. The firm serves producers, processors and end users in the dairy industry by providing education, margin management programs and futures and options brokerage services. You can reach Atten Babler Commodities at 800-884-8290, info@attenbabler.com or www.attenbabler.com.

The information and comments contained herein are provided as general commentary of market conditions and are not and should not be interpreted as trading advice or recommendation. The information and comments contained herein are not and should not be interpreted to be predictive of any future market event or condition. Information contained herein is obtained from sources believed to be reliable, but cannot be guaranteed as to its accuracy or completeness.

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