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June 2012 Archive for AgDairy Market Update

RSS By: Robin Schmahl, Dairy Today

Robin Schmahl is a commodity broker and owner of AgDairy LLC, a full-service commodity brokerage firm located in Elkhart Lake, Wis. He provides dairy market insight.

Dairy Reports Provide Market Direction, Not Reaction

Jun 25, 2012

The numbers point to slowing milk production and herd growth, suggesting a tightening milk supply. But demand will be key.

A number of USDA dairy reports for the month of May were released last week. The industry and traders look to these reports for market direction even though these reports are released after the fact.

Milk production has already been absorbed into the market in one way or another by being consumed or manufactured into some type of dairy product. Either way, the industry has already done something with the milk, and it is somewhere in the system. The general public will not find out until the cold storage, fluid milk sales, exports and commercial disappearance reports are released for the month of May. These reports will not be through the system until mid-July. Then what is the purpose of these reports and what can they tell us?

The milk production report provides an indication of trend. Yes, the milk is already in the system, but looking at the progression of milk production over consecutive months and comparing cow numbers can indicate market direction.

May milk production increased 2% over the same month last year. This is the slowest percentage growth so far in 2012. This production growth is somewhat similar to 2009. The industry was feeling the effects of high-priced feed, resulting in heavy culling and lower production. However, milk prices were very low, not as a result of that but the result of the economic situation which affected demand. We are still facing high feed costs and the lowest milk/feed ratio on record.

Milk production continues to outpace last year, but the growth is slowing. Growth in cow numbers has been a bit slower this year than last year for the first five months. Cow numbers on a month-to-month basis, however, fell in May for the first time this year. The indications are that production and herd growth are slowing, giving the perception that milk supply could tighten as the year progresses. This has been one of the fears in the market that has turned it from the bearishness seen in April to the bullishness seen today. Milk futures have rallied over $3 per cwt. in some contracts as market sentiment changed.

Dairy cattle slaughter in May increased significantly. Although slaughter numbers were not the highest seen in any one month, 251,000 cows were culled, an increase of 31,000 head over last year. This was an increase of 11,000 head from April.

This trend may continue if milk prices cannot keep pace with a rising feed price. Exceptionally dry weather across the Midwest so far this year is becoming critical. Lower yield potential is being factored in due to declining crop conditions. Buyers are becoming more aggressive, resulting in corn futures increasing nearly 80 cents per bu. in a little more than a week. This means there may not be much change in the milk/feed ratio, and a stronger milk price outlook is being met with higher prices, resulting in just trading dollars for dollars.

American cheese inventory surprisingly declined in May despite strong cheese production. Stocks declined 9.5 million pounds from April to nearly the same level as last year. Other cheese stocks increased 8.3 million pounds. The result was a decline in total cheese inventory of 400,000 lb. from April.

All-in-all, these reports indicate the trend is for declining milk production, given the direction of the milk production reports and dairy cattle slaughter. Cheese inventory seems to have peaked and will decrease as fall and end-of-the-year demand increases. This lends support for better milk prices than previously anticipated. Current Class III futures contracts have a nearly $1 per cwt. premium in them relative the underlying cash, which may be realized if cheese buyers become more aggressive.

Demand will be the key. If demand does not maintain or improve, a declining milk and cheese supply may not allow prices to hold where they are. Milk prices do look better for the year, but profitability may not change much if crop conditions do not improve.

Upcoming reports:

- Commercial disappearance on June 26
- Agricultural prices report on June 28
- June Federal Order price on June 27
- June acreage and quarterly grain stocks report on June 29
- California Class 4a/4b prices on July 2

Robin Schmahl is a commodity broker and owner of AgDairy LLC, a full-service commodity brokerage firm located in Elkhart Lake, Wisconsin. He can be reached at 877-256-3253 or through their website at www.agdairy.com.

The thoughts expressed and the data from which they are drawn are believed to be reliable but cannot be guaranteed. Any opinions expressed are subject to change without notice. There is risk of loss in trading and my not be suitable for everyone. Those acting on this information are responsible for their own actions.

 

Identifying Pricing Opportunities as Volatility Approaches

Jun 11, 2012

Perceptions of growing tightness in both milk and grain supplies point to an explosive and volatile market ahead.

Dairy futures have been impressive over the past few weeks. Class III futures continue to rebound from the lows established at the beginning of May.
 
Technical traders have turned more bullish as futures prices reach for new highs since setting a bottom. In my opinion, technical trading in milk futures is very inaccurate due to the lack of liquidity in this market. Technical trading works well in a market that has significant activity because many traders follow the same or similar technical studies. The more traders following a technical study, the more buying or selling will take place at certain prices. The main ingredient in a market that follows these indicators is the large fund traders that buy and sell a large amount of contracts. Dairy futures do not have this. Although technicals can be watched, it is generally not something that one should spend much time with.
 
Dairy futures are not a price discovery mechanism as many of the other futures contracts are. The price discovery mechanism is the cash markets, which set the weekly AMS prices. Compilations of these prices set the announced prices for the Federal Orders broken down by class. These class prices set the base for our milk checks. The futures market is an anticipation of what the underlying cash prices will be for each month.
 
Nevertheless, dairy futures have been trending higher. Fundamentally, not much has changed. Perceptions have changed and that is all that is needed to set market direction. Once spring flush ran its course and production began decreasing, manufacturing plants began seeking milk as they now had excess capacity. The days of having plentiful supply and the ability to purchase extra milk at a discount ceased. The perception changed from one of “plenty” to one of “tightness.” There is potential for increased tightness if the forecasts for above-normal temperatures this summer continue.
 
Couple that with the potential of reduced grain yields if dry weather persists. With an already tight grain supply, we have all the makings for an explosive and volatile market.
 
We need to realize that this year has been, and is, no different than previous years. The market is always filled with the unknowns. It is always filled with could haves, should haves, would haves and wish I wouldn’t haves. These feeling are always in hind sight. We will never figure the market out or be able to hit either the top or bottom. The main goal of each farm is to protect prices that work, prices that will pay the bills and, hopefully, build equity. Yes, sometimes that that can be difficult when looking at current prices. That is why it is important to always think ahead.
 
Let’s look at the June Class III contract as an example. It is almost fully priced now that we are near the middle of the month. The current price is near $15.50 and certainly a better price than it had been at the beginning of June. However, looking back in time, we can see that that contract traded at over $17.50 for about a week early in the year. I do not propose that we all could have sold the top, but it did trade above $17.00 for nearly two months. All of the other Class III contracts through December spent some time above $17.00 during January. Of course, the jury is still out on where prices will end the rest of this year. If hedges were placed in January and prices through the rest of the year average $17.00, you would be no worse for the wear. The benefit would have been peace of mind that you were hedged at a price that would keep you in business. 
 
Now that milk futures have moved back up to mid-$16.00, look at fence strategies consisting of purchasing at-the-money puts and selling call option $1.00 or so higher. Late last year into the beginning of this year the spreads could be done at a $2.00 spread, but the time value has eroded, making the calls less valuable. However, fence strategies continue to be very viable for price protection while allowing for some upside price potential.
 
Upcoming reports:
- World Agricultural Supply and Demand report on June 12
- May Milk Production report on June 18
- Fonterra auction on June 19
- July Federal Order Class I price on June 22
- May Cold Storage report on June 22
- May Livestock Slaughter report on June 22
 
Robin Schmahl is a commodity broker and owner of AgDairy LLC, a full-service commodity brokerage firm located in Elkhart Lake, Wisconsin. He can be reached at 877-256-3253 or through their website at www.agdairy.com.
 
The thoughts expressed and the data from which they are drawn are believed to be reliable but cannot be guaranteed. Any opinions expressed are subject to change without notice. There is risk of loss in trading and my not be suitable for everyone. Those acting on this information are responsible for their own actions.
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