Volatility: Managing Your Way Through the Ups and Downs
Oct 24, 2011
Look at a business plan that can reduce your operation’s bottom-side risk. Some forward contracting and other option-type strategies like purchasing CME options or a LGM-Dairy policy can take away some of your volatility.
By Marv Carlson and Ron Mortensen, Dairy Gross Margin LLC
Sometimes volatility creates opportunity. Sometimes volatility just creates risk. That risk can just eat into profits.
With the volatility in the markets today, it is increasingly difficult to hedge all the components of a dairy operation. Just think: You have a concentration of overhead in facilities and the cow herd. In addition, you have feed in the bunker or in the field. Or, if you do not have any feed, you have risk of prices moving higher. Then there is the milk price—up, down, sideways? There are lots of moving parts.
Today, there are many more influences on commodity prices than in the past. In the past, it was exports, feed demand, government programs, weather. Today we have multiple issues including the dollar, the world economy, the Chinese economy, weather around the world, exports and money flow. Yes, money flow. A great number of new investors are making bets on crude oil, corn, soybeans, wheat, gold and other hot commodities. All these factors are capable of helping or hurting your operation.
Greg Squires from Dairy Enterprise Services commented, “Living through the down market to see the next high is becoming increasingly more difficult.” So how do you manage your way through the ups and downs? Look at a business plan that will attempt to reduce your operation’s bottom-side risk. Some forward contracting and other option-type strategies like purchasing CME options or a LGM-Dairy policy can take away some of your volatility.
Look at January 2012 milk. From Sept. 9, 2011 to Oct. 18, 2011, the average daily price swing (from high to low) has been $.25 /cwt. From Jan. 1, 2011 to Oct. 18, 2011, the average monthly price swing (again from high to low) in January milk was $.80 /cwt. LGM–Dairy, with an average amount of corn and meal, covering December through February can be purchased for $.17/cwt for the $1.00 deductible or $.61/cwt for the zero deductible.
So what about corn and other feed? If you have just cut silage or have wet corn in a bunker, you need to feed it. So, an option strategy or the LGM-Dairy can be used with the lowest amount of corn. If you do not have feed purchased, then LGM-Dairy can be adjusted to essentially buy corn for the operation. Remember, the LGM-Dairy feed portion is similar to a call option. So, if feed goes up, you have some protection but if feed goes down, you can buy it cheaper.
Think about this simple approach. Thirty-three percent of your milk is forward-contracted if you can price it above breakeven. Thirty-three percent of your milk is covered with LGM-Dairy or CME options. Thirty-three percent of your milk is left open. What could happen? If the milk market goes down, you have 66% of your milk priced. If the market goes higher, you only have 33% of your milk priced. Obviously, the percentages can be changed to suit your specific financial goals.
Look at the example below of the LGM-Dairy calculator for December 2011 through July 2012. The final prices will be calculated on Oct. 26, 27 and 28. The next LGM-Dairy sales date is Oct. 28, 2011.