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July 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.

Hedging: Would I Be Better Off Doing Nothing?

Jul 28, 2014

If doing nothing means achieving an average price return over the long run, a good question to ask may be, "Do I strive to be average?"

chip whalen thumbBy Chip Whalen, CIH

In discussing margin management and proactively hedging forward opportunities, some questions that get asked a lot are: "Is there really any long-term advantage to doing this?" and "Wouldn’t I be better off doing nothing at all?"

Perhaps some of this stems from concern that hedges may lose money, result in margin calls, and the effort and capital necessary to devote to the process just aren’t worth it in the long run. Moreover, there are many stories out there about bad experiences using the futures market, and this likely scares people into thinking they are actually taking on more risk to their operation by trying to hedge forward margins.

While an introduction to hedging with the futures market and an overview of proper hedging mechanics are probably best left for a different article, the main question is pretty straightforward to address.

Below is a graph showing historical profit margins for the dairy industry. It examines a rolling average of four calendar quarters worth of profit margins at a given time within a long-term historical context. Given that we are currently in Q3 of 2014, the last observation would be averaging the profit margin in spot Q3 with the margins of Q4 as well as Q1 and Q2 of 2015. This allows us to see where a group of margins average out looking forward a year in time at any given point, and compare that value against a long-term historical average.

Two things should be immediately clear when analyzing the graph. First, current margins are well above the long-term historical average when considering the opportunity looking out over the next year. Second, with the exception of only a few years within this history, the four-quarter rolling margin was above the long-term average at some point in almost every year.

Whalen graph 7 29 14

Getting back to the original question, what if you actually did nothing over time? If I am a dairy producer, this essentially means buying my feed on a hand-to-mouth basis as I need it and getting a milk check from my co-op as I ship product in the cash market.

In doing so, I basically will realize an average margin over a long-term time horizon. There will be periods such as the current year where I will make a lot of money, but there will also be times such as in 2009 when I will be losing a great deal of money. I will ultimately catch every high as well as every low, and thus achieve an average return over the long run. Many producers can likely identify with this and are familiar with the ebbs and flows of profitability in this cyclical industry. Some might even be wise in realizing they should save and build equity from the strong returns they are currently realizing to help cushion the eventual drawdown they will endure when the cycle turns the other way.

In addition to the average margin on the graph, you will notice that there are a few other lines drawn in as well. These depict the 70th, 80th, and 90th percentiles of where those profit margins have been over that range of history. While there are only a few years within the history in which dairy margins reached or exceeded the 90th percentile of profitability, the occurrences of margins above the 80th and especially above the 70th percentiles are much more common.

As an example, dairy margins attained the 70th percentile in eight out of the past 10 years. If I am trying to achieve better results than doing nothing, and doing nothing means receiving an average margin over a long-term time horizon, it doesn’t appear very difficult, based on looking at this chart to beat an average return over a long period of time.

While in any given year (such as the current one) I might be better off staying open to the market, my results will average out over a long period of time. Just as you wouldn’t judge a ball player or sports team based upon a single game or series but rather over an entire season, the same thing holds true with judging the merits of hedging and proactive margin management.

While it may be true that in the current year a dairy producer can argue they would have been better off doing nothing, it may be more difficult to make this claim when considering that strategy over a longer time horizon. A question one might ask at this juncture is, "How can I manage margins successfully so that I would in fact be better off than doing nothing?" This is where a carefully crafted plan comes into play.

Knowing that forward margins typically achieve above-average historical percentiles in almost every single year, implementing a plan that spells out how to capture those margins when they are achieved can put you in an advantageous position to be better than average. While hedging a 70th, 80th or 90th percentile historical margin is, of course, no guarantee that the margin won’t continue to strengthen, it does help assure you won’t sustain extreme financial hardship should margins subsequently drop to very unprofitable levels.

Just as a batter is much more likely to reach base by only swinging at pitches in the strike zone, by implementing hedges when returns are historically attractive, a producer is much more likely to achieve stable, attractive returns over the long run. Because some years may be more challenging, a plan should also spell out contingencies for potentially protecting breakeven levels should margins never achieve targets in which hedges would be implemented. This can help protect against losses that could be more significant without protection in place.

In the end, if doing nothing means achieving an average return over the long run, a good question to ask may be, "Do I strive to be average?" Most producers look to excel in their production practices, incorporating improvements in technology, genetics and other factors to constantly improve upon what they are doing. Should their approach to managing the risk associated with forward profit margins be any different?

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

A Rising Tide Lifts All Boats – Until It Collapses

Jul 24, 2014

Dairy prices, exports and the stock market have surged, but a ‘Black Swan’ event could change all that. Have you developed a way to protect your milk price from a sudden downturn?

Katie Krupa photo

By Katie Krupa, Rice Dairy

The old saying goes, ‘A rising tide lifts all boats,’ and in many ways this statement can be applied to the recent surge in the dairy market.

In recent years, the strength of the dairy market has been heavily reliant on the world economy with a significant amount of our domestic dairy production meeting the demands of the international market. While this rising tide is helping push domestic dairy prices higher, a growing world economy is not a guarantee for higher prices.

The first chart (below) shows the USDA announced the Class III milk price and the Dow Jones Industrial Average. Prior to 2008, there doesn’t seem to be much correlation between the Class III milk price and the Dow Jones average, but that changes in 2008. The rise in both the milk price and the Dow Jones in 2008 followed by the crash in 2009 start a trend of prices moving closer together. Starting in 2010, the trend is the same for both Class III milk and the Dow Jones Industrial Average, but the statistical correlation is not very high – it is around 0.70 (the closer to 1.0 the higher the correlation).

You can look at various charts for different economic indicators compared to the Class III milk price, and you will find the same pattern for many of those charts. The economic crisis of 2008 had a noticeable impact on many industries and the dairy industry was certainly one of those industries.

The underlying issue for much of the dairy industry’s troubles in 2008 and strength in recent years has been the strength of the export market. The second chart shows the annual dairy exports. As you can see, the exports drastically decreased in 2009 and then have been at historic high levels in recent years. The export market chart and the Dow Jones Industrial Average charts both have the same trend – decreased in 2008 and then increasing since 2009.

While both of these charts show the same trend, these charts are not a guarantee of the future weakness or strength of the dairy industry. Unfortunately, our dairy industry is dependent on various factors that are both domestic and international issues. And worst off, there are many issues that can occur that have nothing to do with milk production, cows or the feed situation, but still have an impact on your milk price.

For example, several things that can turn the industry around are a geopolitical issue (here or abroad), a significant weather or world event, such as an earthquake or tsunami, or continued economic growth in developing countries. These are what I call Black Swan events, and there are many more that could potentially occur. The trouble with these Black Swan events is that you can in no way predict them. Unlike a change in the milk supply due to cold weather, poor feed quality or a change in cow numbers, a Black Swan event happens fast and the impact is nearly immediate. While there are many benefits of being in the international market, there are also some negatives. It is important to remember that although the stock market may be strong, that is no guarantee that the dairy industry will be strong.

As dairy producers, you have many Black Swan events that can happen on a daily basis in your business. These on-farm events you can personally manage, and you probably have developed ways to work around these more frequent issues. The international Black Swan events may be harder to work around, but luckily there are multiple risk management strategies available to help you protect your milk price for the future months. Just as you have developed ways to manage around on-farm weather issues, cow death or employee issues, you can also develop a way to protect your farm milk price from changes in the world that would negatively impact the milk price.

Katie Krupa is a broker 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 Katie at There is risk of loss trading commodity futures and options. Past results are not indicative of future results.

Time to Take Care of Business with Corn, Protein Purchases

Jul 14, 2014

Mathematically, it’s far more advantageous to protect corn prices incrementally now than to wait for the perceived home run that might not materialize.

MikeRusch   Copy

By Mike Rusch, Stewart-Peterson Inc.

Articles about how producers’ emotions intertwine with pricing decisions seem to strike a chord. Several readers emailed me after my last column about "Why Active Management Beats "Set It and Forget It." The comments I heard were along the lines of, "That’s me. That’s how I think, and I know I need to do something about it."

So, I thought I’d offer a sequel. I could use this space to write about what we think the feed and milk markets are going to do; however, we get very few reactions from prediction columns. Opinions are a dime a dozen. Rather, we hear from readers when we talk about the psychology of pricing decisions. Today, let’s talk about making mathematical decisions about today’s corn and protein markets.

No one wants to talk about corn right now because it is at a multi-year low. In 2013, when corn hit $8.44, that was "exciting." Our phones were ringing and producers were seeking out help. Then the corn price began its cyclical bear trend. This month marks the 24th month that corn has been in its current bear trend.

While feed prices are relatively low, producers may find it more exciting to talk about other discoveries and other efficiencies: new technologies that trim costs or increase milk production over time. You may spend hours of time and significant investment to create a 2%-5% increase in efficiency that can translate into increased revenues over the course of the next few years. There is a sense of excitement when, over time, you measure your investment and see results.

Those things are all good. We simply want to caution you to take care of business when it comes to your No. 1 expense: feed. While everyone is excited about higher milk prices and the exciting opportunities they bring, it’s the perfect time to be quietly and methodically putting your game plan in place to protect these opportune prices. If you get complacent on your feed price management, you may negate all the effort you put into gaining production efficiencies through new technologies or products.

The corn market is getting to levels that are long-term attractive, and it is impossible to know where the bottom will be. For perspective, consider that the 2009 low was $3.02 per bushel and the 2012 high was $8.44 per bushel. We are at $3.85 as of this writing. At this time last year, corn demand surged back when the price fell below $5.00.

Chart Source: Stewart-Peterson Inc. and ProphetX


Mathematically, it is far more advantageous to be protecting corn prices incrementally now than to wait for the perceived home run that might not materialize. Singles and doubles add up over time and are less risky than swinging for the fences.

The protein market, while providing opportunity now, may still provide more opportunity. Soymeal historically tracks with or lags slightly behind corn (see chart). Soymeal has now begun falling to track more closely with corn. Now is a good time to be thinking about the price points you want to protect. Run the numbers at different price points, and determine the impact of decisions you might make in the future as the market changes. Doing this now helps you anticipate results, and avoid having to make decisions during the heat of a surprise market move. When you rehearse the decisions you plan to make ahead of a market move, and you understand the impact of each decision on your feed price, those decisions are easier to execute as things play out.

Now might not be the most exciting time to talk about feed; however, the market is offering opportunities to make decisions that will pay off over time. The payoffs can come in the form of cost savings, less hassle to find substitutions, and less scrambling when markets take unexpected jumps.

Create your own excitement with a consistent approach to feed price management that can be measured and celebrated in time.

Mike Rusch is an Ag Business Specialist for Stewart-Peterson Inc., a commodity price management firm based in West Bend, Wis. You may reach Mike at 800-334-9779, or email him at

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.


Will the New Margin Protection Program Be Part of Your Dairy’s Future?

Jul 10, 2014

A closer look at the farm bill’s MPP, set to launch Sept. 1, and its effect on market liquidity.

Kurzawski photo 2013

By Dave Kurzawski, INTL FC Stone

While the price of U.S. cheese teeters around the $2/lb. level and market participants scan the horizon for some sort of disruption or directional shift in prices, it might just be quiet enough to discuss another evasive topic: the dairy subtitle of the new farm bill.

President Barack Obama signed the Agricultural Act of 2014 in February. A behemoth document that was beaten, battered and caught in the political cross-hairs for two years, the bill emerges with progressive changes for U.S. dairy producers. The dairy section of the bill promises to deliver, among other things, a more sensitive safety net for U.S. dairy farms based on an ‘income over feed’ margin – not milk price alone.

Much has been written about the new Margin Protection Program (MPP), how it operates, and what lose ends will need to be tied up before its launch, slated for Sept. 1. Few, however, have yet discussed the possible consequences of the new dairy farm policy. Among the immediate concerns is the potential influence the MPP could have on derivative market liquidity.

Producers are a very large component of sell-side liquidity at the Chicago Mercantile Exchange’s (CME) dairy markets. By focusing on a "margin threshold" to trigger indemnities to producers, the MPP does a good job of mimicking existing risk management tools used by producers -- such as futures, options and forward contracts to lock in a profit margin. Because of this, the concern is that the new program will cannibalize sell-side liquidity at the CME making it tougher for buyers to hedge. In essence, the more interest there is in the farm bill’s new margin program, the less liquidity there could be in the CME dairy markets.

Currently, several university studies raise this concern, saying that, in general, such a program (if certain levels of participation are realized, etc.) will remove some portion of sell-side liquidity in the existing exchange-traded products and forward contracting programs. Given the structure of the program, producers may, in fact, increase use of MPP during times when the futures market forward curves are already predicting low margins or certainly low milk prices. But the world of commodity risk management decisions has many subtle levels.

Initial discussions with dairy producers tell me they like the flexibility of the MPP but that they will treat it as a safety net for that milk not actively hedged. Those producers who already manage price risk have commented that if they use the new program, it will be in collaboration with current derivative management tools – not in lieu of these tools. The current sentiment is then not very consistent with a significant departure from using present derivatives for hedging purposes. Row-crop producers, who use futures and options as well as crop insurance year in and year out, are a good indication that this mindset could hold up in the dairy markets as well.

Although CME dairy contracts continue to grow yearly, many producers I’ve spoken with who do not actively manage their profit margin today have claimed that there is not enough current information on the MPP to make a call on their future involvement. Final rules and a general lack of understanding today could be the program’s Achilles heel. Still, expect a good showing of MPP participation from producers who do not currently manage price risk because of the, at least perceived, low barriers to entry. That won’t necessarily threaten liquidity of forward contracting programs or liquidity at the exchange.

Sentiment surrounding the MPP is positive, but the current temperature of dairy producers when asked if they will use the program exclusively is lukewarm. While the MPP provides an important safety-net, it seems as though producers won’t enjoy the same type of coverage, flexibility and profit-capture of existing risk management tools. The dairy industry is happy to see a more progressive public policy approach, but with current information available it appears the program is unlikely to result in a material decline in sell-side liquidity for exchange-traded products.

David Kurzawski 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 Kurzawski at 312-456-3611.

U.S. Dairy Herd Increasing, Concerns for Milk Prices Ahead

Jul 03, 2014

These market analysts warn of the historical relationship between increases in the dairy cow herd and subsequent declines in milk prices.

By Will Babler and Luke Strub, Atten Babler Commodities LLC

Record milk prices and attractive margins have enticed producers to decrease their dairy cow culling rates and maximize their potential milk output. The 2013-14 year to date (YTD) dairy cow slaughter is 8.6% lower than last year through May, with recent declines in the slaughter rate accelerating. May 2014’s U.S. dairy cow slaughter of 209,300 head was 15.5% behind the 2012-13 slaughter rate and 11.9% lower than April 2014 on a daily average basis. The May 2014 YOY slaughter decline of 15.5% was the largest monthly decline in nearly four years, and 2013-14 YTD dairy cow slaughter is on pace to be the largest annual YOY decline in nine years.

Increasing Dairy Cow Herd

Recent declines in dairy cow slaughter have led to an increase in the U.S. dairy cow herd. Dairy cow numbers have increased each of the past six months, with a total increase of 54,000 head throughout the period. The number of dairy cows on farms increased by 10,000 head in May 2014, to 9,252,000 total head, the highest figure since May 2012. Dairy cow herd and milk per cow figures were not published from Mar 2013–June 2013 due to government sequestration so a YOY analysis is not available; however, milk production increased 1.2% YOY from Mar 2014–May 2014.

The Effect of Herd Expansion on Prices

Previous run-ups in cow numbers, many times a result of high milk prices, have led to significant subsequent corrections in milk prices. From 1998-2013, the top three percent of month-over-month (MOM) increases in U.S. dairy cow numbers corresponded to an average decline in the U.S. all-milk price of 7.3% in the following month and 23.2% at the trough.

Current Production Environment

In the current environment, increases in the dairy cow herd have been crucial in keeping U.S. milk production afloat. Milk-per-cow yield has been hampered by poor forage quality and adverse weather conditions in the first half of the 2013-14 production season, leading to marginal production gains compared to other major exporting regions. The 2013-14 YTD milk-per-cow yield increase of 0.7% is less than half of the previous 10-year average milk-per-cow yield increase of 1.6%.

Milk per cow yield normalized in May 2014, increasing by an estimated 1.6% YOY as Midwestern producers rebounded from the effects of cold and wet weather. Increasing milk per cow yield, coupled with the increase in the domestic dairy herd, is expected to amplify increases in U.S. milk production in the following months. According to the June USDA World Agricultural Supply and Demand Estimate report, 2014 U.S. milk production is projected at 206.1 billion pounds, a 2.4% YOY increase. At the time of publication, 2014 YTD (Jan-Apr) milk production was up 1.0% YOY, implying milk production growth is expected to accelerate to a YOY growth rate of 3.1% for the rest of the year.

Potential Ramifications

With near-record milk prices and attractive margins continuing, producers will look to continue the trend of decreased dairy cow culling in future months, expanding the domestic dairy cow herd. Dairy producers should be wary of the historical relationship between increases in the dairy cow herd and subsequent declines in milk prices, especially as regional milk-per-cow yields normalize and milk output strengthens.

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, or

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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