Know Your Market
Will Milk Prices Follow Feed Prices Down?
Aug 05, 2013
While there are many fundamentals that can be tracked, there is usually one major driver for dairy prices. Right now, this is the one.
By Bob Devenport, Stewart-Peterson Inc.
A pretty quiet week fundamentally was highlighted by a seasonally expected drop in cheese production, as reported by USDA late last week. Total U.S. cheese production for the month of June was 914 million lbs. and is 1.4% higher than June 2012, but 3.9% below May 2013. (See Chart A.)
During a quiet week, we could view this fundamental for what it is – a seasonal decrease, or, we could look at this fundamental and use it to support our bias about where we think milk prices might go. For example: "A drop in cheese production is generally supportive of milk prices, and therefore I am going to remain bullish on milk." Be aware, however, that there is usually one key fundamental that drives a market, and at this point in time, it is the corn price.
Given how much corn has sold off since January, if history repeats itself, we can expect milk prices to follow. There is a strong correlation between corn and milk (Chart B). After a short lag, there is a high probability that milk will follow corn down and $16.00 milk is not out of the question.
One piece of advice we are giving producers right now is to caution against "recency bias." This is the tendency to weigh recent data or experience more heavily than earlier data or experience. Many producers are remembering the good and bullish news of the last three years and favoring that over the possibility that milk prices could follow feed prices down. It’s been such a long time since we saw corn in the 4s or milk below $16 that we psychologically believe it is less likely to happen.
Recency bias is talked about in the investment world all the time. The most vivid example is investor behavior after the 2008 financial collapse and the flock to "safe" investments, as described by Fidelity Worldwide’s Nick Armet:
"Prior to the financial crisis, investors had largely underestimated the likelihood of such an event precisely because the last one had been so far in the past (and one they had no personal experience of).
"Now, the opposite appears to be the case; the fact that such a significant crisis happened in recent memory has made investors overestimate the odds of a recurrence. High demand for safe assets has helped to drive the price of government bonds like US Treasuries and German Bunds down to historic lows."
Armet’s point is that our investment decisions are heavily influenced by the most vivid and recent memories. As a result, news or data is often weighted to support that psychological mindset. As a dairy producer, ask yourself if you are giving more weight to certain fundamentals than you are to the one that is actually driving the market.
Combatting recency bias
Armet offers his investors an antidote to recency bias: "One solution lies in the application of systematic rules. Investment professionals have long recognised that a consistent, research-driven investment process is a valuable defence against psychological biases."
Likewise, a dairy operation’s marketing approach should be systematized and disciplined, free from the psychological traps that are typical to any investor or business owner who has skin in the game and therefore, normal emotions.
The news is full of fundamental analysis and opinions. In fact, you can watch a review of all the fundamentals in the Dairy Today Market Week in Review. Just remember that while there are many fundamentals that can be tracked, there is usually one major driver, and right now, it’s feed prices.
Bob Devenport is a dairy market advisor for Stewart-Peterson Inc., a commodity marketing consulting firm based in West Bend, Wis. You may reach Bob at 800-334-9779, or email him at email@example.com.
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