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August 2013 Archive for Know Your Market

RSS By: Dairy Today: Know Your Market, Dairy Today

Dairy trading experts offer strategies and practical perspectives to optimize market performance.

Wildcards Are Driving the Milk-Price Outlook

Aug 30, 2013

With compressed dairy margins and continued price volatility, producers must take charge of their marketing decisions to secure profits.

Kristen SchulteBy Kristen Schulte, Iowa State University Extension and Outreach

Variability is a key word this year as dairy producers deal with a wide range of weather conditions. Some have gone from too wet to too dry in the space of six weeks. Several top dairy producing states are experiencing their second year of extreme weather conditions.

For dairymen, continued drought or prevented planting acres have affected the quantity and quality of feed available along with price. All three factors—quantity, quality and price—will continue to be issues for producers this year.

While there are several factors affecting milk prices, the relationship of corn and milk prices is one factor to watch. Since corn prices declined below the psychologically important $5.00 mark during the last part of July, the corn chart and the milk chart have moved in tandem.

Corn prices have come down from historical highs due to larger number of acres planted and expected yield potential. However, the growing season has resulted in variable yield expectations. The resulting price of new crop corn still has potential variability due to several late-season factors. One is timing of the first frost; in areas where crops were planted late, an early frost could impact the final stages of crop development and result in a yield hit. Potential first-frost dates and corn maturity are on a collision course in several parts of the country.

Feed demand is perhaps the biggest wild card in the corn demand situation. Lower prices have the potential to increase feed demand. In addition, feed demand from the poultry sector could especially increase due to higher numbers and improved profitability.

Many dairy producers across the Midwest have seen above-average milk production this summer due to the cooler weather. Milk production has seen increases in most regions except for the western states. With the overall increased milk production, dairy product inventories have also increased—demand has not absorbed the additional supply. Will the hot weather moving across much of the Midwest this week, school being back in session, and suppliers anticipating holiday product sales be enough to put bullish moves on milk prices?

Corn and milk prices have seen large movements in the past year. In 2012, the U.S. All-Milk price varied $5.90 (from a low of $16.20 in June and July to a high of $22.10 in November). On a percentage basis, this is 36.4% and is the second-highest price variance within a calendar year in the past 20 years. The All-Milk price has varied $0.80 so far in 2013.

The national corn price varied $1.56 (from $6.07 to $7.63) in 2012, which is a 25.7% move. Looking at the 2012 corn marketing year (September through August of 2013), the variation is only $0.36. New-crop corn is expected to be in the range of $4.50 to $5.30 per bushel range according to the latest USDA supply/demand report. Remember, expected prices received by producers (paid by dairymen) will vary.

With variability on both sides, where are milk margins or income over feed costs at currently? Prices continue to change; earlier this summer I anticipated the change in feed costs to be larger than the change in milk prices. While the reality in price volatility may vary for producers based on location and basis, margins have further compressed from the softening of milk prices over the past few months.

I challenge producers to ask themselves, "What has our operation done to secure profit margins?" With changing input prices, "Have I recalculated cost of production for my dairy operation?" How often should cost of production be recalculated depends on the variability of input prices the operation endures. The more volatile input prices mean recalculating costs should be done on a monthly to quarterly basis. Current costs of production will assist the producer in making the right marketing decisions.

Finally, with changing market influences and prices, I encourage producers to not let emotions ride with marketing decisions. Calculating one’s cost of production and having a marketing plan can help to make profitable business and marketing decisions. The softening of milk prices can trigger too many emotions and make decision making too difficult. Remember, margins create profits and opportunities.

Kristen Schulte is an Iowa State University Extension and Outreach Farm Business Management Field Specialist. Contact her at kschulte@iastate.edu.

Managing the Friend You Have in Volatility

Aug 26, 2013

Although most dairy producers likely share a negative connotation attached to price volatility, it can actually be more of a friend than an enemy.

chip whalen thumbBy Chip Whalen, CIH

As I write this article, corn futures are currently up almost 30 cents while soybean meal prices are trading around $9.00 to $23.00 per ton above Friday’s close.

After being out of the office last week, I returned to find that the Pro Farmer annual crop tour pegged projected yields for both the corn and soybean crops below current USDA estimates, which were already low to begin with, relative to market expectations in the August WASDE. With temperatures tomorrow in Chicago expected to approach a record high for this date in August, there is growing concern that the weather is not providing the best finish for either crop as we near harvest later this fall.

The current state of affairs is a sharp departure from fairly recent assumptions that yields well above trend might still have been achievable if only the weather would have cooperated. Such is the fickle nature of commodity markets and price trends – particularly during the volatile summer growing season.

Volatility is, of course, nothing new to those who follow the agricultural markets and is something that has required more skill to navigate and manage with the expanding price ranges we have experienced over the past several years. Most people have negative connotations when it comes to volatility, which is probably because it is often portrayed in that light.

As an example, I don’t believe I have ever the term "volatitlity" mentioned by the news media in the financial markets on days of sharp stock market advances. It is, however, the default label attached to events such as "flash crashes," "Black Mondays" and the like. The fact of the matter is that volatility has nothing to do with price direction. It is more the speed of that direction which determines whether or not a market is volatile. Soybean prices advancing $2.00 a bushel in the past two weeks certainly qualifies as passing the volatility test, and while corn prices have not witnessed the same type of strength, they nonetheless have advanced about 12% in the same span of time.

Although most dairy producers likely share the negative connotation attached to price volatility, it can actually be more of a friend than an enemy. As a margin manager, a dairy will likely make pricing decisions on its milk and feed costs simultaneously as a result of a margin opportunity presenting itself, irrespective of the price levels of the individual commodity prices that make up the input and revenue side of that margin equation.

While the strategies may differ on protecting feed costs versus milk revenues as a result of market bias, the point is that an initial position will result from a margin opportunity showing up – not because I think it’s time to buy feed or price milk independent of one another. As market prices change, subsequent opportunities may present themselves to enhance that margin over time.

As an example, many of the clients we work with shared the negative outlook on feed costs earlier this year with expectations that we would realize record large crops this season. As a result, the strategies they employed were more defensive in nature – protecting against higher prices while allowing for the opportunity to achieve lower prices should the markets decline.

With prices trending lower and margins improving through the month of July, an opportunity presented itself to strengthen those hedges by making adjustments to the initial position structure.

Similarly, there has been a recent sharp decline in milk prices following expectations that increased feed supplies resulting from large crops would eventually work to expand milk production later this fall and over the winter. Initial milk hedges taken earlier in the spring and summer because of the same margin opportunity then allowed dairy producers to add flexibility back to those positions should a price recovery then ensue. This now appears to be taking place, with Class III futures up sharply in the past two sessions.

Some people might view this as speculation, but I see it differently. Speculation is the assumption of risk where a change in price direction will necessarily lead to a gain or a loss in the market. Hedging is the transfer of risk where a position is taken in the market to lock in a price or protect an opportunity (in this case a favorable forward profit margin).

In the above example, the initial position is created because a margin opportunity presented itself that was attractive for a dairy to protect. The subsequent adjustment to that initial position – strengthening a feed hedge or adding flexibility back to a milk hedge – is a function of working with what the market allows you to do. This goes to the heart of what being a margin manager means, namely, managing a position through time and price to improve on the margin opportunity that initially presented itself. It is allowing market volatility help you improve your profitability over time. Is volatility your friend or enemy and how well are you managing it?

As Vice President of Education & Research at CIH, Chip Whalen is responsible for developing and conducting all of CIH’s Margin Management seminars. He is also the editor of CIH’s popular Margin Watch newsletters. Whalen can be reached at (312) 596-7755 or cwhalen@cihedging.com.

There is a risk of loss in futures trading. The information contained in this publication is taken from sources believed to be reliable, but is not guaranteed by Commodity & Ingredient Hedging, LLC, CIH Trading, LLC nor any other affiliates, subsidiary, or employee, collectively referred to as CIH, as to accuracy or completeness, and is intended for purposes of information and education only. Nothing therein should be considered as a trading recommendation by CIH. The rules and regulations of the individual exchanges should be consulted as the authoritative source on all contract specifications and regulations. Past performance is not indicative of future results.

Copyright 2013 Commodity & Ingredient Hedging, LLC. All rights reserved.

Know Yourself

Aug 16, 2013

Dairy producers may fall into one of four categories when it comes to marketing behavior.

Carl BablerBy Carl Babler, Atten Babler Commodities, Principal

As this column’s title indicates, dairymen are encouraged to "Know Your Market." Working to improve one’s understanding of milk, feed and energy market fundamentals and price behavior implications is a worthy endeavor. Increased market and marketing understanding can be directly associated with improved pricing and hedging success and reduced frustration. It is also observed that market knowledge alone does not ensure price and hedge action is taken. Marketing requires a person to execute the action.

Dairy producers may fall into one of four categories when it comes to marketing behavior.

1. Disinterested. This producer:
• embraces hard work, productivity, self-sufficiency and equity position as a means of managing cash flow volatility. He or she has a "so far, so good" attitude;
• believes that price will average out over the long haul and is not interested in contracting milk or feed needs or missing out on better prices;
• has heard bad things about the futures and options market and is cynical regarding market information and price forecasts;
• gathers financials as required by lender and tax accountant.

2. Outside Looking In. This producer:
• embraces hard work, productivity, self-sufficiency, and equity position as a means of managing cash flow volatility;
• is very interested in exploring means to improve financial aspects of the dairy operation;
• knows his or her dairy’s financial condition and cost of production;
• follows commodity markets fundamentals and prices closely;
• has attended many commodity marketing meetings and workshops but has not contracted milk with his or her milk plant and has not opened a commodity brokerage account;
• expects to take pricing action with milk and feed at some point but not now.

3. Involved. This producer:
• willingly aligns with outside resources to provide specific expertise, i.e., lender, business consultant, nutritionist, commodity advisor;
• has regularly scheduled meetings of the ownership-management team and outside-expertise providers to establish managerial direction of the dairy;
• has come along a commodity marketing learning curve through workshops, classes, self-study and discussions with cash and futures market contacts;
• follows commodity markets closely and has a commodity brokerage account. Takes cash and futures market positions in response to market price behavior;
• does not have a formal written commodity risk management policy;
• wishes to be flexible and, as a result, is willing to shoulder responsibility of marketing decisions, good or bad;
• commonly makes individual commodity price decisions not focusing on a net margin outcome.

4. Margin Manager. This producer:
• believes that the financial condition of his or her operation is the highest priority, or equal in priority with production, and as full time Chief Financial Officer is part of management team or, as manager, assumes the role of CFO. He or she has the ability to know and monitor net margin current and forward and that this is a must;
• has engaged other outside resources to provide specific expertise to enterprise, including a Commodity Risk Manager;
• has a comprehensive, written, ownership-approved Commodity Risk Management Policy that directs all commodity price management activity with a focus on net margin;
• is or has a Commodity Risk Manager who provides internal education, advice and management of the net margin model for executing contracts and hedging;
• fully acknowledges commodity price exposure and its impact on the financial well-being of the dairy;
• has a comprehensive, written, ownership-approved, Commodity Risk Management Policy that directs all commodity price management activity with a focus on Net Margin Management;
• has secured a dedicated line of credit for executing futures and options strategies approved by policy;
• is fully engaged in contracting milk and feed in both the cash and futures and options market simultaneously to manage a margin for the dairy;
• understands that to remove a portion of financial risk in operating a dairy enterprise may come with a cost of hedging line on his or her financials.

This commentary is not to define dairies by size, region or type, nor is it to say a given behavior makes one person a better individual than another. Rather, this discussion highlights differences that exist from dairy to dairy regarding managerial style and varying levels of focus on financials and marketing.

In a dairy environment of volatile prices and margins, it is paramount for dairy producers to be honest with themselves in regard to their behavior across the full spectrum of managerial and marketing issues. Dairies fall in all four categories relative to managing commodity price and margin. Whether you’re disinterested, outside looking in, involved, or a margin manager, "Know yourself."

Risk in purchasing options is the option premium paid plus transaction. Selling futures and/or options leaves you vulnerable to unlimited risk. Atten Babler Commodities LLC uses sources that they believe to be reliable, but they cannot warrant the accuracy of any of the data included in this report. Past performance is not indicative of future results. Contact Atten Babler at cbabler@attenbabler.com.

Confront Your Risk-Hedging Fears

Aug 12, 2013

Whether or not to hedge risk continues to baffle many dairy producers. Remember that you’re establishing profit and removing volatility—not trying to beat the market.

Kurzawski photo 2013By Dave Kurzawski, INTL FCStone

The dairy markets are no stranger to price volatility. Since as far back as the late 1980s, when the U.S. government lowered price supports on milk, dairy producers have dealt with mushrooming price uncertainty. Over the past five years in particular, producers are getting a crash course in that sometimes fleeting fundamental issue of their business: producing milk for a profit.

Although making the move from "price taker" to "price maker" seems simple enough, the issue of whether or not to hedge risk continues to baffle many dairy producers. Many are not familiar enough with the various tools and strategies at their disposal, which breeds confusion and inaction. But let’s dial in a little deeper here. At the heart of the issue, dairy producers really have many misconceptions about risk, concerns about the cost of hedging, and fears of loss on hedging transactions.

You have to first ask yourself: What is it that I’m trying to accomplish? An effective hedging program does not attempt to eliminate all risk—it attempts to transform unacceptable risks into acceptable form. What is unacceptable to you? And what is acceptable? The challenge for you is to decide the business risks you are willing to bear and the ones you wish to reduce or remove by hedging.

I find it helpful to breakdown your business into two risk categories: operational and financial. Operational risks are all those directly associated with the daily production of clean, fresh milk. While problems from a failed refrigeration compressor to a sick cow are serious—they’re fairly straightforward. The financial risks are more evasive but just as serious.

To understand financial risks is to first accept that you have them. The shifting sands for dairy producers over the past several years is enough evidence that profitability on their dairy is more than luck or money made in real estate. Be willing to recognize that the producer who does not take responsibility for his or her financial risks is really betting that the markets will either remain static or move in their favor. Ironically, speculation is another main hurdle to hedging.

When it comes to markets, speculation is a dirty word. Many producers do not hedge precisely because they automatically believe they’re speculating on the price of milk. They believe that using futures or options introduces additional risk. In reality, the opposite is true. A properly constructed hedge lowers risk. Betting that the prices will arrive at profitable levels for you month-in and month-out is really the gamble.

Those who understand and are comfortable with hedging as the opposite of speculating may still struggle with the costs associated with hedging. Admittedly, some hedging strategies do cost money. But consider the alternative. To accurately evaluate the costs of hedging your production, you have to consider them against the costs of not hedging. The cost of not hedging is the potential loss your dairy can suffer if market factors move against your interests.

Next to costs, the failure to evaluate the performance of a hedge by the appropriate benchmark is a real problem. Many producers would rather not hedge—not protect profitability on a portion of their milk—than report a hedge loss. Read that line again. This fear is due to widespread confusion over expectations. The key to properly evaluating the performance of all futures or forward-contracting transactions lies in establishing appropriate goals at the outset.

If you produce 40% Class III milk and you hedge 100% of that milk at an 80¢ per cwt. profit (after considering adjustments for basis), then we need to be comfortable with those figures at the beginning and at the end (there are ways to make the hedge more flexible and profitable but for the sake of this article, we have to be comfortable with the concept of making a profit). You need to be OK with the idea that you’re establishing profit and removing volatility—not trying to beat the market. Market view is important, but it doesn’t necessarily make you profitable.

Market opinion, of course, is not a bad thing. In fact, as a dairy risk consultant, I spend a lot of time talking to producers about short- and long-term price direction based on supply and demand assumptions. Although it’s valuable to get a sense of market tenor, many dairy producers fall into a trap of trying to construct hedges on the basis of their market outlook. The best hedging decisions are made when the producer acknowledges that market movements are unpredictable. A hedge should always seek to minimize risk first. It should not represent a gamble on the direction of market prices.

A well-designed hedge—one that considers the central aspects discussed above—reduces both risks and costs to your dairy operation. Hedging stabilizes earnings, frees up resources, and allows you to focus on basic competitive advantages of quality and quantity of milk production. No one will ever force you into making a profit, and no one will ever say you have to hedge 100% of your milk production. But take some time to review what risks you are comfortable with and which ones make you uncomfortable. Make a plan. And reduce the number of truckloads that you’ll take whatever the market gives you at the end of the month. That is real speculation.

Dave Kurzawski is a Risk Management Consultant with the Chicago office of INTL FCStone. INTL FCStone offers comprehensive risk-management and margin hedging programs and services to dairy producers, processors, traders and end-users. You can reach Kurzawski at 312-456-3611 or Dave.Kurzawski@intlfcstone.com

Will Milk Prices Follow Feed Prices Down?

Aug 05, 2013

While there are many fundamentals that can be tracked, there is usually one major driver for dairy prices. Right now, this is the one.

Devenport, BobBy Bob Devenport, Stewart-Peterson Inc.

A pretty quiet week fundamentally was highlighted by a seasonally expected drop in cheese production, as reported by USDA late last week. Total U.S. cheese production for the month of June was 914 million lbs. and is 1.4% higher than June 2012, but 3.9% below May 2013. (See Chart A.)

During a quiet week, we could view this fundamental for what it is – a seasonal decrease, or, we could look at this fundamental and use it to support our bias about where we think milk prices might go. For example: "A drop in cheese production is generally supportive of milk prices, and therefore I am going to remain bullish on milk." Be aware, however, that there is usually one key fundamental that drives a market, and at this point in time, it is the corn price.

S P chart 8 5 13a

Given how much corn has sold off since January, if history repeats itself, we can expect milk prices to follow. There is a strong correlation between corn and milk (Chart B). After a short lag, there is a high probability that milk will follow corn down and $16.00 milk is not out of the question.

One piece of advice we are giving producers right now is to caution against "recency bias." This is the tendency to weigh recent data or experience more heavily than earlier data or experience. Many producers are remembering the good and bullish news of the last three years and favoring that over the possibility that milk prices could follow feed prices down. It’s been such a long time since we saw corn in the 4s or milk below $16 that we psychologically believe it is less likely to happen.

S P chart 8 5 13Recency bias is talked about in the investment world all the time. The most vivid example is investor behavior after the 2008 financial collapse and the flock to "safe" investments, as described by Fidelity Worldwide’s Nick Armet:

"Prior to the financial crisis, investors had largely underestimated the likelihood of such an event precisely because the last one had been so far in the past (and one they had no personal experience of).

"Now, the opposite appears to be the case; the fact that such a significant crisis happened in recent memory has made investors overestimate the odds of a recurrence. High demand for safe assets has helped to drive the price of government bonds like US Treasuries and German Bunds down to historic lows."

Armet’s point is that our investment decisions are heavily influenced by the most vivid and recent memories. As a result, news or data is often weighted to support that psychological mindset. As a dairy producer, ask yourself if you are giving more weight to certain fundamentals than you are to the one that is actually driving the market.

Combatting recency bias

Armet offers his investors an antidote to recency bias: "One solution lies in the application of systematic rules. Investment professionals have long recognised that a consistent, research-driven investment process is a valuable defence against psychological biases."

Likewise, a dairy operation’s marketing approach should be systematized and disciplined, free from the psychological traps that are typical to any investor or business owner who has skin in the game and therefore, normal emotions.

The news is full of fundamental analysis and opinions. In fact, you can watch a review of all the fundamentals in the Dairy Today Market Week in Review. Just remember that while there are many fundamentals that can be tracked, there is usually one major driver, and right now, it’s feed prices.

Bob Devenport is a dairy market advisor for Stewart-Peterson Inc., a commodity marketing consulting firm based in West Bend, Wis. You may reach Bob at 800-334-9779, or email him at bdevenport@stewart-peterson.com.

The data contained herein is believed to be drawn from reliable sources but cannot be guaranteed. This material has been prepared by a sales or trading employee or agent of Stewart-Peterson and is, or is in the nature of, promoting the use of marketing tools, including futures and options. Any decisions you may make to buy, sell or hold a futures or options position on such research are entirely your own and not in any way deemed to be endorsed by or attributed to Stewart-Peterson. Commodity trading may not be suitable for all recipients of this report. Futures trading involves risk of loss and should be carefully considered before investing. Past performance may not be indicative of future results. Copyright 2013 Stewart-Peterson Inc. All rights reserved.

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