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Know Your Market

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

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

How to Survive Market Volatility

Mar 09, 2012

If current market volatility has you feeling like you should invest in antacids rather than dairy cows, take control of your milk price and start hedging.

Katie Krupa photoBy Katie Krupa, Rice Dairy

This is not the first article on market volatility, but given the recent movement in the Class III futures market, I feel it is an important topic to once again visit. I have talked with numerous dairy producers across the country and, although the margins for California dairymen are different than those in New York, the stress and anxiety exist across the country, especially for those without risk management plans.

On March 1, the April Class III futures price settled at $15.50 per cwt. Things didn’t look good, but at least this was a survivable price for many dairymen. Within the next two trading days, the April price had dropped $1.36, to $14.24 per cwt., and as the milk price dropped, so did the mood of all of us involved in the dairy industry. But, in the subsequent three trading days, the market rallied $1.00 for the April contract, and folks were breathing a little easier.
So what’s next? The true answer to this question is no one knows. We all just have our best educated guesses. Because of this, the real question you should ask is, what should I do to protect the farm?
While the hedging opportunities currently available are far from the best the market has offered, there are strategies that can help you protect your price. Unfortunately, once the prices start to decline, many dairymen have to decide what level of loss they want to protect rather than what level of profit. This typically results in dairymen walking away and burying their head in the sand.
Before you stop reading and bury your head in the sand, keep in mind that by the time you pick your head back up, the price could easily drop another dollar or two. My advice is to take some time, pick up the phone, call your broker, cooperative or milk plant and see what hedging opportunities are currently available. Then, keep hedging. When the price returns to profitable levels, take advantage and protect your business.
I had many conversations last week. Most were enjoyable (dairymen are resilient, and are even happy in spite of low milk prices), but one conversation stands out. A dairyman I work with is nearly 100 percent hedged for the upcoming months, so he is relatively insulated from drastic price declines. His strategy was to primarily buy put options, which protects the price on the downside without limiting the upside. Although a higher Class III price would mean more money in his milk check, he knew that the worst case scenario would still result in the farm paying all its bills and maintaining its equity. It was incredible to hear the peace of mind that this farmer had because of his risk management plan. And to give the full historic perspective, he was hedged in 2011 and missed out on some higher prices, but in 2011 the farm still made money, paid down debt, and strengthened its equity position.
If current market volatility has you feeling like you should invest in antacids rather than dairy cows, take control of your milk price and start hedging. No one knows what the future will bring, but you have the opportunity to take control of your milk price and, at the least, protect the price from future declines.
It is important to note that there are many different risk management strategies, and if you have the equity, and the guts, to ride out the cycles, that may be your risk management strategy. If you don’t have the equity or personality to ride the rollercoaster of prices, you don’t have to. So put down the Tums, call a professional, and start giving yourself and your business some piece of mind.
Katie Krupa is the Director of Producer Services with Chicago-based Rice Dairy, a boutique brokerage firm offering guidance, analysis, and execution services on futures, options, spot and forward markets. If you are interested in learning more, Katie offers monthly webinars on the basics of risk management. You can reach Katie at klk@ricedairy.com. Visit www.ricedairy.com. There is risk of loss trading commodity futures and options. Past results are not indicative of future results.
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