If you’re in business and haven’t utilized hedges to protect profit levels, you’re speculating.
By Chris Robinson, Top Third Marketing
Over the past 2½ years, dairy producers have watched the value of your out put on a very slow, determined rally. Glancing at a weekly price chart, the trend has definitely been in favor of the producers.
Class II milk on the August price board is bumping up against the $22.00 level. Back in November 2011, the price struggled at the $14.00 level. All of the experts and price gurus have had opinions over the last 2½ years as to when the trend will end.
At the end of the day, you need to ask yourself, as a producer and a business person, if you’re comfortable speculating on the direction of prices over the long term. You have to ask yourself if you would be either psychologically or financially stressed if, for some unforeseen reason, milk prices were to begin sliding back towards those 2011 levels.
If you are not hedging some or all of your price risk, you are speculating. As a producer, you are in effect making the same decision that an "investor" might be making by deciding to buy milk and hold it looking for higher prices. Make no mistake about it: If you are in business and you have not utilized hedges to protect profit levels, you are speculating.
Many hedgers resist adding a marketing budget to their business bottom line simply because there is a cost associated with any hedging program. If you are using futures markets to hedge, you are opening yourself up to margin calls, and you might need to be on a first-name basis with your banker to have them:
1) Understand, and
2) Be willing to finance a hedge for your milk.
The grain and livestock commodities were the original derivatives market. In 1851 the first "forward contracts" ever were created and began trading in Chicago. Farmers were given a way to protect themselves against uncertain price moves. That means for over 160 years, farmers and producers have had a method to hedge their business risk.
As we head into the second half of 2014, the farmer is faced with a lot of business risk. Record hog and beef prices are being enjoyed by producers. Milk is also sitting at contract highs. Domestic and worldwide demand for beef and pork as well as dairy has held up well. One can only hope that this demand continues strong. There is an old saying, however, among hedgers and producers: "Hope is not a marketing plan."
Is there a price associated with hedging? Absolutely. However, with prices near record highs, one could argue that there is an even greater level of risk. The higher the prices, the value of your product increases. As a producer, you have downside price risk up until the day you contract your milk. Prudent risk management would suggest having downside protection of some sort in place until that physical sale is booked. In essence, the hedge, either a futures contract or an options contract on the futures price, is a substitute sale. Your risk is on paper, as opposed to being completely unprotected in the cash market.
So what is a producer to do?
First, educate yourself about hedging. Secondly, find an advisor or group of advisors whom you trust to help you make hedging decisions. Finally, make sure you include a line item in your business budget for marketing. You have line items for your inputs, electricity, etc. You owe it to yourself to budget for your marketing. With prices at or near record levels, you have a lot riding on that marketing plan.
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 firstname.lastname@example.org.
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