A decline may be imminent, but here’s why you shouldn’t second-guess yourself if you used the right reasons to hedge your milk price below current highs.
Strong cheese prices are a welcomed sight to dairy producers. Cheese prices have achieved new record highs, and February Class III milk is also poised to set a record high. February’s price may still be affected for another two weeks, but it is unlikely cheese prices could fall enough to keep it from establishing a record high. Grain prices have been fairly steady, leading to an improved milk/feed ratio. The ratio for January climbed to 2.44, the best since January 2008.
Traders are cautious at current high prices as a price decline is imminent, although no one knows when. A few more loads of blocks and barrels are beginning to come to the spot market, but buyers are ready to pick up what is offered and yet are looking for more. Cheese prices could dropped 20-30 cents and still remain at unusually high prices. Right now buyers are willing to stand in and purchase at $2.30 and higher.
There is reluctance from retail buyers to purchase any more product than is absolutely necessary at current prices, reducing their orders. Both food service outlets and retail outlets are slowing orders to keep purchases in line with demand. Some food service outlets are looking at changing menus to reduce, or in some cases, eliminate dairy from certain dishes. Manufacturers are attempting to hold production in line with demand to keep from building inventory, which could keep stocks lower than usual for this time of year. As long as cheese prices remain high, this may be the pattern. Extra milk is moving to other channels. Dryers have been the recipients as more loads of nonfat dry milk are available to the spot market as well as the international market.
Exceptionally strong dairy prices and increasing milk futures prices have most producers who hedged milk earlier now second-guessing themselves, and some even liquidated their hedges. Yes, hindsight is always 20/20 and it can be very frustrating when you continue to receive margin calls.
You do have to remember why you hedged your milk in the first place. It was to protect against the price falling below cost of production. Some producers used fence strategies, resulting in the sale of $18.00-$18.50 call options. Now that prices are quite a bit higher, this does not look very smart. But consider this: A strategy was implemented to protect against a lower price, and most producers hedged about 50% of production.
Most of these fence strategies consisted of the purchase of a $16.50 or $17.00 put. If prices were to fall, a floor was protected that provided cash flow. Overall milk prices could have been below the cost of production, depending on how far the price fell, since only 50% was hedged. At current price levels, with 50% of production hedged, you have put yourself in a very good position with the whole of your milk worth about $20.50–$21.00 announced price, or a mailbox price of $22.00-$23.00 per cwt., depending on location, components and premiums paid.
Of course, some states outside of the Federal Order are paid on a different scale, which may result in lower prices. So, you have to ask yourself whether it was a good business decision to protect the downside and give up some upside while enjoying better-than-expected milk prices. Or is it better to gamble and hope prices remain high and do nothing? Or worse yet, blow out of positions, risking a lower price than before if cheese prices decline, since you have already paid the margin and will not get it back. Dairy producers should not attempt to implement strategies to beat the market but to protect the farm. It is a business.
- Global Dairy Trade auction on February 4
- Federal Order class prices on February 5
- December Dairy exports on February 6
- World Agricultural Supply and Demand report on February 10
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.
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