Hedging decisions aren’t easy when greater milk per cow and tight heifer supplies play out against wavering cheese prices and strong dairy demand.
USDA was optimistic on the latest World Agricultural Supply and Demand report, and rightly so.
High milk prices will increase the desire to improve milk production as much as possible. USDA’s current estimate of 206.1 billion pounds is 3.9 billion pounds over last year and 9.9 billion pounds over 2011. There has been an increase in cow numbers of around 15,000 head since 2011 nationwide, but current inventory is running below last year.
We can clearly see that milk production per cow has made a significant improvement. In fact, production per cow per day is about 1.3 pounds more this year in comparison with 2011. Per-cow milk production has increased 15.1% over the past 10 years. Now, with record high milk prices and the outlook for a good year ahead, according to USDA, one can expect that milk production may improve at a more rapid pace. Of course, there are many things that will be a factor in milk production growth, but, under average circumstances, production could exceed the current USDA estimate.
There is increasing demand for replacement heifers, which are currently in tight supply. Prices have raised the desire to fill barns, causing buyers to scour the countryside for anything available. There was a period of time when cull prices were higher than live prices, so some heifers were showing up for slaughter due to better returns. This has left a bit of a void in the market at the present time.
Despite the recent decline in cheese prices, with blocks moving to the lowest level since Feb. 21, they’re not expected to continue to drop. Buyers will step back up to the plate to pick up supply for later demand. Inventory has been unable to increase for the first two months of this year, and indications are that March inventory did not improve either. Increasing cheese production from greater milk volume as the calendar moves through spring flush may swing the pendulum, but the inability to increase supply will keep support in the market. Dry whey price is also providing good support. Weekly Agricultural Market Service (AMS) prices indicate dry whey is currently just over 67 cents per pound and the highest level since Jan. 2012.
Class III futures traders anticipate cheese and whey prices to decline as the year progresses. Futures months carry a discount with December holding a discount of around $5.50 from April. This has made it difficult making hedging decisions. Typically, the futures carry a premium in the later summer-early fall months due to that being the time of greatest demand as buyers prepare for school and holiday demand. The market seems to feel that greater milk supply will be forthcoming and sufficient supply of milk and dairy products will be available when late-year demand is present.
My recommendation is to purchase a put option spread for the last half of the year. Purchase put options close to the current underlying futures price and then sell put options $1.25-$1.50 lower to help pay for it. This will give limited downside protection to the level at which the put option was sold, but will leave unlimited upside potential. There is no margin money required with this position.
- GDT auction on April 15
- March Milk Production report on April 21
- March Cold Storage report on April 22
- March Livestock Slaughter report on April 23
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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