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Know Your Market

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Dairy trading experts offer strategies and practical perspectives to optimize market performance.

High Milk, Falling Corn Prices Still Call for Bottom-line Protection

Jan 13, 2014

Why you still need to implement a balanced hedging plan that protects your dairy.

Chris RobinsonBy Chris Robinson, Top Third Marketing

Dairy producers have been faced with many marketing challenges in the past few years. Recent volatile price swings in both inputs and the price of your product could have resulted in unforeseen changes to a producer’s bottom line.

Specifically, between 2010 and 2013, we saw the board price from corn rally from the $3.50 per bu. level in the spring of 2010, to record highs during the summer of 2012, peaking out at $8.32 ½ during August at the height of the drought.

Watching your input prices go up by 140% put incredible stress on your bottom line as well as your emotions. If you had not had a hedge to protect against that move, you were at the mercy of the weather as well as the market. Finally, in 2013, we saw the reversal in corn prices. Many producers spent the last 14 months arguing that, for a myriad of reasons, corn would "never go below $5.00." Last Friday’s pre-USDA report low was $4.06 ¼; this represents the lowest price for corn in over 40 months.

Conversely, your output has fluctuated with lows in 2009 near $10.00/lb., up to record highs at the $21.00 level. Between 2011, 2012 and 2013, $21.00 has been a price level that has represented incredible resistance for Class III milk. Indeed, in the past month, milk has been spiking higher, challenging this level once again. The recent rally was sparked by a change in China’s public policy, which now allows citizens with a certain economic status to have a second child. This represents a tremendous move away from its previous policy of one child per family, which had been the rule since approximately 1978. Since the announcement that relaxed this edict, we have seen a high spike in demand for Class I milk as new demand for baby formula is under way.

This is a fortunate convergence of supply and demand for the dairy farmer. Your margins, which had been upside down just 18 months ago, have now gotten very healthy. Given this reality, how can you as a dairy producer use a hedging program to manage your risk in this environment? The answer is by implementing a balanced hedging plan that protects high prices of your milk, as well as protecting against a higher spike in feed costs. It is possible to use a put option as a substitute sale of your milk for a specific length of time, with a defined financial cost. The put is a substitute sale of your milk until you sell your physical milk.

Conversely, you can protect your business against the possibility of a return to $6, $7 or $8 corn with a call option to protect against higher prices in the future. Again, it’s taking your business risk away from the cash market and putting it on paper where your risk is defined.

With over 25 years as a broker, trader and risk manager, I learned long ago that opinions are only useful if they help your bottom line. Only 7% of speculators make money over time consistently. That means 93 out of 100 folks who think they can outguess the market are, over time, relieved of their trading capital. As risk managers, we strive to ignore opinions and predictions of the "gurus" and just take advantage what the market is giving us today.

Our approach to hedging is, first and foremost, risk management while avoiding speculation. The past five years have shown us how volatile the markets can be, whether it is Mother Nature, the financial markets or the population control policies of China. Right now conditions are favorable for your bottom line. There are hedges available that can take advantage of these prices while still allowing you to benefit if the current trends continue. You owe it to yourself to at least investigate a hedging program to see if it’s a good fit for your operation.

This material is conveyed as a solicitation for entering into a derivatives transaction. This material has been prepared by a Top Third broker who provides research market commentary and trade recommendations as part of his or her solicitation for accounts and solicitation for trades. Top Third, its principals, brokers and employees may trade in derivatives for their own accounts or for the accounts of others. Due to various factors (such as risk tolerance, margin requirements, trading objectives, short term vs. long term strategies, technical vs. fundamental market analysis, and other factors), such trading may result in the initiation or liquidation of positions that are different from or contrary to the opinions and recommendations contained therein.

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 crobinson@topthird.com.
 

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