Good, Bad or Ugly: Exploring Dairy’s Price Scenarios for 2012
Oct 15, 2011
We’ve developed an opinion about next year’s prices. However, we’re not as focused on where prices are going as we are on getting you prepared for whatever prices do.
By Steven Schalla, Stewart-Peterson
Events like World Dairy Expo are a welcomed chance for many producers and industry people to recharge the batteries and get excited about the coming year for the dairy industry. In our discussions with producers at Expo, there seemed to be a more cautious feeling about 2012. As we looked at the Class III futures for next year, the reaction from each producer was strikingly similar: “Those prices are not very exciting.”
The second most popular phrase we heard was in the form of a question: “Are 2012 prices going to be good, bad or ugly?”
Some Expo goers were a bit taken aback by our answer: “We’re not as focused on where prices are going as we are on getting you prepared for whatever prices do.”
That’s the outcome of great marketing: having a plan in place that flexes with the markets and puts you in a position to avoid the major downtrends while remaining close to the highs.
“What? You don’t have an opinion on prices?”
Sure we do. We’ve analyzed all the available information, and our team developed an opinion about next year’s prices. After the uptrend of 2011, historical price patterns suggest that 2012 could be down as much as 20-30%, meaning that as 2011 prices close the year at an average of $18.00, next year’s average price could be in the range of $14.40 to $12.60 as a base Class III price.
That’s our opinion. However, there are so many moving parts that will impact what milk prices will be and determine whether they are good, bad, or ugly. In each potential scenario, there are many things that will have to fall into place in order for that scenario to play itself out.
Here are some of the key developments on our radar that could push prices towards a specific result:
Good price scenario
· International demand continues to expand and exports provide strong demand pull.
· Milk per cow struggles and limits production growth as feed costs and feed quality plague many dairy regions.
· The Federal Reserve continues easy money policy through stimulus and drives commodities higher as a whole.
Bad price scenario
· U.S. consumers continue to tighten their belts in a stagnate economy and dairy demand softens.
· International milk production is plentiful as Oceania achieves its aggressive growth goals, leading to international prices declining.
· Feed prices maintain lower levels relative to the summer highs, encouraging some production growth with better margins.
Ugly price scenario
· Global debt challenges boil over and cause a double-dip recession, taking financial markets, including commodities and milk, sharply lower.
· The U.S. dollar rallies as it is still perceived to be the safest currency, pressuring export opportunities.
· U.S. production jumps as producers follow through from strong prices in the second half of 2011.
Of course, the definition of whether prices are good, bad, or ugly is subjective. The definition of great marketing is less subjective to us, and that’s why we focus there. Great marketing is maximizing the difference between your price and the “bad” or “ugly” prices, while staying as close to the higher “good” prices as we can.
If you have a solid understanding of all the marketing tools available, it is possible to evaluate how various positions, often in used in combination, can achieve this goal of “great marketing.” In fact, we can “pressure test” potential strategies against price swings, and in the process build confidence that we are prepared for whatever the market brings—good, bad or ugly. We call this Market Scenario Planning.
The table below illustrates an example of this process with current 2012 prices, although please remember it is simplified and designed as an educational example.
In the table, we assess different marketing positions and how they will impact the base Class III price received. For the purposes of evaluating results, let’s say that:
· A base Class III price of $16.00 or higher is a “good” price, meaning that after adding milk plant premiums we are over breakeven costs and in profitable territory. These prices will be in green.
· “Bad” prices are in yellow and are less than $16.00, but higher than $15.00, representing breakeven to manageable losses for the year.
· Finally, the red boxes show “ugly” prices, where devastating losses will be sustained as prices move below $15.00.
· The goal of our marketing is to increase the green area and reduce as much red and yellow area as possible.
In the Market Scenario Planning Table, the prices below each column heading represent the effective prices received when each strategy is implemented. With this table, it is easy to see how a given position will perform if different actual prices materialize.
For example, in line one where no action is taken, the effective prices will be the same as the actual prices. However, by implementing a combination of small forward contracts and purchasing Put Options in line two, it is possible to start separating from the lower prices, eliminating a red box and assuring the breakeven level is achieved at the $14.00 level.
Moreover, in line three, by being a bit more aggressive with forward contracts and using fence positions, it is possible to assure the breakeven level is hit regardless how much the market declines. Naturally, some upside potential is lost by obtaining this coverage, which needs to be acknowledged.
Like many others in the dairy industry, we have studied the spectrum of milk price indicators and have offered our best opinion on prices for 2012. However, we believe that taking your marketing to the next level means going beyond opinions, beyond attempting to outguess the market. It means knowing in advance what your revenue stream is going to be, because you planned for multiple price scenarios. Using Market Scenario Planning, great marketers can transform 2012 from uncertain to predictable, and in doing so turn concern into confidence.
© 2011, Stewart-Peterson, Inc.
The data contained herein is believed to be drawn from reliable sources but cannot be guaranteed. Neither the information presented, nor any opinions expressed constitute a solicitation of the purchase or sale of any commodity. Those individuals acting on this information are responsible for their own actions. 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. Any reproduction, republication or other use of the information and thoughts expressed herein, without the express written permission of Stewart-Peterson Inc., is strictly prohibited. Copyright 2011 Stewart-Peterson Inc. All rights reserved.