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What’s the Biggest Mistake First-Time Hedgers Make?

Jan 13, 2012

Frustration might set in when you miss out on higher milk prices. Don’t forget why you were hedging in the first place.

Katie Krupa photoBy Katie Krupa, Rice Dairy
The saying goes, "Those who cannot remember the past are condemned to repeat it," and unfortunately that statement rings true for many. The dairy industry has experienced its fair share of turbulence over the last several years. I am often asked, if the will volatility continue. While I don’t know what the future will bring, I advise that dairymen plan for continued volatility.
For many dairymen, 2011 was the first year they utilized risk management strategies. And most of these newcomers ended up leaving some money on the table because the milk price climbed higher than their hedged price. While milk prices moving higher is a good thing, many dairymen end up frustrated when the milk price moves higher than their hedged price. Unfortunately, their frustration often causes them to stop using risk management on their operation.
Sadly, I have seen this pattern occur several times in the past. Dairymen begin hedging, milk prices move higher, they stop hedging, and the milk price moves lower. In 2004, many dairymen started hedging their milk for the first time because the milk price was at an all-time high, and they were locking in profits. But many of those dairymen ended up unsatisfied with their decision because the milk price continued to climb. So ultimately they missed out on some upside opportunity.
Krupa Class III price 1 12
Their dissatisfaction with hedging resulted in the discontinuation of risk management for their business. This meant they were not hedged when the milk price moved lower in subsequent years. So, for those who hedged in 2004, they were not hedged in 2005. For those who hedged in 2008, they were not hedged in 2009. So will this pattern repeat itself? 
Just this week I was talking to a dairyman who hedged a portion of his milk for 2011 and missed out on some of the higher prices. While this gentleman was not upset with his decision (he protected profits), his business partner was not happy and vowed never to hedge again. When I hear those types of statements, I cringe for several reasons.
Firstly, I know the dairyman wasn’t fully aware of why they were hedging in the first place. Dairymen should be hedging to protect their profits, not beat the market. Secondly, I am worried that if the price does significantly decline, this dairy, like so many others, will not be hedged and may not survive the next downturn.
Many dairymen and industry leaders believe the milk price will significantly decline in the near future. I don’t know what the future will bring, and truly no one does. Don’t get caught up in price projections, because price projections are not guarantees. Historically, the most significant changes experienced in the milk price have not been predicted -- most notably the crash of 2009. In the summer of 2008 many economists were actually saying the milk price would move higher and approach or even exceed $25 per hundredweight. Unfortunately that projection did not come to fruition.
It is important to understand the past, evaluate decisions (both the good and bad ones), learn and move forward. It is always best to evaluate your past experiences in a rational state of mind, which is often easier said than done, especially when we are dealing with money. By evaluating the past you are better able to manage your future decisions.
Risk management is a difficult and stressful topic for most dairymen. As always, I suggest working with a team that includes both farm managers and industry professionals to help aide you in the decision making process. Make your decisions based on what is best for the financials of your farm, try to avoid fear and greed, and remind yourself that if your business is making money, that is a good thing!  
Katie Krupa is the Director of Producer Services with Chicago-based Rice Dairy, a boutique brokerage firm offering guidance, analysis, and execution services on futures, options, spot and forward markets. If you are interested in learning more, Katie offers monthly webinars on the basics of risk management. You can reach Katie at klk@ricedairy.com.Visitwww.ricedairy.com.
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