Know Your Market
The Best Broad-Based Milk Marketing Strategy
Jan 08, 2012
Yes, there is one, Babler says. It involves studying USDA’s announced price for milk over a long continuum and using option-based minimum price strategies.
By Carl Babler, First Capitol Ag
An often asked question of a dairy broker is, “What is the best strategy for managing milk price?”
Those inquiring minds are hoping to get a jump forward on their progression along the marketing experience curve by simply skipping all of the “not so good” methods and approaches to minimizing milk price risk. They hope to avoid strategies that cost too much, are ineffective, may result in excessive margin obligation and, in some way, limit their opportunity for higher milk prices.
Are they asking for too much? No. Are they in dreamland hoping for the impossible? No. Is there a broad-based best strategy for managing milk price? Yes!
To define a “best fit strategy” for marketing milk, we must first examine the milk market and determine if there is a unique consistent market character observed. Analyzing the milk market can be an overwhelming task if you focus on all fundamental factors impacting milk price and price change. Such a study, if continued long enough, can result in “analysis paralysis,” meaning after an exhaustive study one may be unable to derive a true, single, consistent driving force that one could track that would drive one’s best milk marketing strategy.
Instead, I have found it more prudent to shift away from all the factors that move price for one reason or another and look more closely at milk price itself. To simplify further, it is best to just study the USDA announced price for milk over a long continuum. Viewing USDA’s announced milk price for pattern and character may help us determine which marketing strategy is not a good fit.
I present the chart below showing the price distribution for all announced Class III milk prices since 1980.
We can observe the frequency that certain prices have been announced. When applying a curve to the data, the character of the price distribution is revealed. The curve is not a normal bell-shaped curve, but rather a curve with a “long tail to the right,” “skewed to the right” or “skewed to higher prices.” The apparent quick take-away is that price is below $14.30 nearly 80% of the time, with the balance of announced prices (20%) spread over many price levels all the way up to $21.67.
Practical: It is the character of the milk market to make exaggerated moves to higher prices when abnormality comes to the market. It has been common for producers to oppose the curve and lock in or fix a price to mitigate downward price risk and then miss out on a higher price opportunity as the market is set off by some surprise.
Bottom-line: This price distribution curve for milk is to the producer’s advantage, if dairymen apply a minimum price strategy. The use of straight put options, buying calls to cover sold futures or fixed price cash contracts or using min/max strategies are all the best fit for milk’s price distribution profile. With this in mind, one must always consider strategies that allow for higher prices if they come as they chose pricing and hedge strategies. Thus, the best broad-based strategy is to use option-based minimum price strategies that manage the risk of lower prices yet allow dairy producers an opportunity for higher prices if they are presented.
Carl B. Babler is a consultant and senior hedge specialist with First Capitol Ag in Galena, Ill. He has been involved in the futures industry as a broker, educator and hedger since 1975. Babler holds master’s degree from the University of Wisconsin-Platteville and completed agribusiness course work at Harvard University. You can reach him at 1-800-884-8290 or email@example.com.