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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.

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