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When to Hedge 2012 Milk and Avoid the “Three-Year Cycle”

Mar 28, 2011

The next few months may provide the right opportunity to examine 2012 prices, start setting goals for your marketing, and then start protecting your milk price.

Copy of S Schulla Bio PictureBy Steven Schalla, Stewart-Peterson
Two weeks ago, both milk and cheese prices saw a sharp decline that brought shivers down the spine of milk producers everywhere. Questions of “Is it over already?” or “Are prices going back to $10?” flooded our office. Even producers that I know to have the thickest of skin were on edge with flashbacks 2009. 
The good news in the short run: It appears that cheese and milk prices have found some stability around the $1.65 price level for cheese and $16.50 level for milk. Friendly milk production and cold storage reports, along with firm international prices, have helped milk minimize the damage and keep many long-term indicators pointing higher. 
But the recent drop has been a cold reminder about how quickly things change, sparking further talk about the “three-year milk price cycle” and risk of low prices in 2012. Since the start of the milk futures in 1996, and the first major low point in 1997, there has been a general pattern of reaching a low point every three years. The timeframe from low-point to low-point has ranged from 30-40 months, with not much consistency as to when the major high happens within that cycle. 
The last major low was either January 2009 or June 2009, depending on which signal you choose to use as your bottom. This means that March 2011 is month 21 or 26 within this cycle. Not to worry though. As I hinted above, milk doesn’t look over quite yet, and deferred prices have actually strengthened over the past two weeks.
Looking ahead, the next few months between now and summer may provide the right opportunity to examine 2012 prices, start setting goals for your marketing, and then start protecting your own milk price. Currently these prices range from $15.60-$15.85.
International influence will be a key determinant of how long this cycle can last. Both dairy product supplies as well as milk production in key exporting regions will be critical to our milk prices.
In addition, grain prices will have an influence on milk marketing decisions as overall profitability continues to be a concern. Grain prices over the past months have been equally volatile as milk prices, and it is well known that any major weather disruptions this growing season could bring sharply higher grain prices. On the other hand, a smooth growing season could bring sharply lower prices by harvest as stocks-to-usage ratios ease. 
Hedging milk, or any farm commodity, beyond nine or 12 months away is going to present a few extra challenges for which to be prepared. Here are three key considerations as you look at hedging for 2012:
·                     Consider volume. Like most commodities, milk has most of its volume take place in the closest few contract months. Therefore, you may need to work your futures or forward contracts prices over the course of a few days to get them done, or be prepared to compromise between your asking price and the best bid price to get it done quickly. 
·                     Consider costs. Be aware that option prices will be very expensive, with a ton of time between now and then. This can actually work to your advantage if you consider some of the advanced option strategies such as a fence (min/max) or a put option spread. While these strategies do have their limitations, they will get you in a practical, cost-effective position.
·                     Consider your emotions. When considering establishing hedges on milk a year or more away, be mentally and emotionally ready to ride out market swings. It’s almost certain that at some point your hedges will look really good while at another point they may not. What’s key to remember is your ultimate goal with each position and not get emotionally up or down on yourself for the decision you’ve made.
With goals set in advance and the right strategy prepared now, you will find it easier to execute and manage the risk to your farm when prices do head south once again.   
Steven Schalla is a Market Advisor for Stewart-Peterson, Inc. He can be reached at 800.334.9779 or sschalla@stewart-peterson.com.
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.
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