The Return of $17.00 Milk: Here Today, Gone Tomorrow?
Jun 15, 2012
Consider the underlying fundamentals behind the recent run-up, as well as marketing strategies to reward the rally.
By Rocky Gingg, Stewart-Peterson
Class III milk futures have recently surpassed the $17.00 price level, a psychological boost for many, leaving sub-$16.00 milk in the rearview mirror. Many have raised the question of whether the lows are in for the year, or if the market is setting up for a double-dip.
It has been nearly five months since we have last seen $17.00 milk, and the only month to settle above the key price level this year was January at $17.05. Let’s take a look at the underlying fundamentals behind the recent run-up, as well as marketing strategies to reward the rally while maximizing opportunity and minimizing risk.
CHART NOTE: As of June 13, 2012, the purple line in this chart represents the Class III Milk settlement prices so far this year January-May, and the black line represents current futures prices for June through December.
All eyes have been watching the USDA Milk Production Report, released Monday, June 18. Year to date, dairy producers have added 51,000 head to the U.S. herd, the strongest pace since 2008. The average has been 12,750 head added each month this year. Milk production is up 3.9%, which is the third fastest rate of growth for January-April since 4.7% in 2006 and 4.8% in 2000. Given the recent price action in milk prices, there is much anticipation for a slower growth rate for herd growth and milk production in May.
Demand Fundamentals Remain Supportive
The demand side of the equation has remained strong throughout the year, showing few signs of weakness. Total cheese commercial disappearance has been on a supportive pace this year, with January through March posting record-breaking monthly numbers. The latest dairy export figures for the month of April showed a 12.1% year-over-year gain for total dairy exports. April marked the third largest monthly export total ever at 158,370.10 metric tons. Year-to-date exports have equated to 13% of total milk solids.
Prices rose sharply in the latest bi-weekly Global Dairy Trade auction. The overall index rose 13.5% compared to the previous auction, which is the highest percentage gain since September of 2010. Cheddar prices were up 9.4%, which equates to a 15-cent gain from an average price of $1.30 per pound to $1.45 per pound. Oceania cheddar prices were steady in the latest report at an average price of $1.63 per pound. With CME cheddar climbing to the $1.60 level, the CME/Oceania spread is at the narrowest level it has been since November of 2011. International prices will be closely watched from two perspectives: rising international prices give more room for U.S. prices to move higher, but if U.S. prices move to a premium, exports are at risk of a pull back.
You can watch Dairy Today’s video version of the market week in review by clicking here
What to Do? Comparing Marketing Strategies
Stewart-Peterson advises its clients to build a solid weighted average price over time, much like building a career batting average. To do that, it’s important to know the impact of various strategies on that weighted average price. The table below helps evaluate various strategies at this time.
The sample strategies on the left of the table represent what producers might use to hedge milk at this time. As you can see, each strategy has pros and cons indicated by the color scaling.
• The first strategy, hedging 50% with futures at 16.50, provides the most downside coverage below $17.00, but has the least upside flexibility above $17.00.
• The second strategy, hedging 50% with a 15.00 put at 25 cents, is essentially the inverse, providing the most upside flexibility above $18.00 but the least amount of downside protection below $17.00.
• The third strategy, hedging 50% with 16.25/18.00 fence at 25 cents, is the middle of the road strategy. It provides better downside protection than strategy #2 and better upside flexibility than strategy #1.
Calculating these strategy choices in advance helps address the indecision that can come with the lower to middle-of-the-range prices that we are seeing right now.
Producers should analyze strategies with their risk tolerance in mind, because each operation’s financial situation is different. Keep your management team informed of the possibilities. That way, the entire management team is prepared for whatever price scenario unfolds.
Stewart-Peterson Inc. Market Scenario PlanningSM Table
Rocky Gingg is a Market360® Advisor for Stewart-Peterson Inc. He can be reached by calling 800.334.9779 or at firstname.lastname@example.org.
Market Scenario Planning is a service mark of Stewart-Peterson Inc.
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