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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.

Strike While the Iron Is Hot

Aug 25, 2012

Rare opportunities for producers to protect milk prices at historically high prices mean it’s time to take a serious look at risk management strategies for the rest of 2012 and 2013.

Katie Krupa photoBy Katie Krupa, Rice Dairy

This summer has been a time of uncertainty for many producers across the country. Between the drought devastating crops, the heat hampering milk production, and lower milk prices this spring, many producers had to tighten their belts and become even more innovative.

One silver lining is that milk prices for the end of 2012 and 2013 are currently providing producers with some notable hedging opportunities.

Firstly, your financial situation for the upcoming 12 months will most likely be driven by your feed availability and weather this summer. For example, those in the Midwest who did not receive nearly enough moisture this summer will be needing to buy more feed and subsequently paying more for that feed, while those in the Northeast who had a good growing year will be in somewhat better shape (although purchased feeds will still be higher, regardless of location). In short, now more than ever you want to make sure you are looking at your unique operation and cost structure to determine what price is “good” for your farm business.

Having said that, currently there are some hedging opportunities that are near historical high prices, and I urge any of you interested in risk management to review the strategies currently available. I will compare what is currently available for the end of 2012 through 2013, to what was available in the summer of 2008 for the end of 2008 and the 2009 year.

Currently Class III futures prices trading on the Chicago Mercantile Exchange for October-December 2012 average $19.85. This compares to the October-December 2008 average Class III futures price of $19.85 that was trading on July 15, 2008 (if you recall dairy prices peaked in 2008 toward the end of July). Currently, a producer can purchase an $18.00 put option (protects against prices declining, but does not limit the upside) for October-December 2012 for around 20 cents per cwt. Back on July 15, 2008, the $18.00 put option for October-December 2008 was 40 cents. The current opportunity offers tremendous price protection for dairy producers. Although each producer’s cost structure is unique, to protect an $18.00 Class III price for only 20 cents per cwt. is a rare opportunity.

Looking out to 2013, the Class III futures average for January-June is around $19.15. Producers can purchase a $17.00 put option for roughly 45 cents per cwt. Although the premium is more expensive and the coverage level is a little lower than what is available for the last quarter of 2012, this is still good price protection for many producers. This price is comparable to what was available in 2008 for the first half of 2009. On July 15, 2008, the Class III futures average for January-June 2013 was $19.35, and the $17.00 put option could have been purchased for 52 cents per cwt.

Where the current market differs most from the opportunities of 2008 is for the back half of the upcoming year. On July 15, 2008, the July-December 2009 Class III futures were trading just over $20.07, while today the Class III futures for July-December 2013 are around $18.25 – nearly a $2.00 difference. In 2008, the $16.00 put option for July-December 2009 could have been purchased for around 40 cents per cwt. Today, the $16.00 put option for the back half of 2013 is nearly 70 cents per cwt.

I bring up this comparison to 2008 because that is the last time we saw prices this high for the upcoming year. This year differs greatly from 2008, most notable to me because 2008 was a bubble inflated by higher world fuel prices and what was perceived to be a growing economy and growing demand. Today we are driven by lower milk production numbers and higher feed prices due to a lack of supply rather than a seeming growth in demand.

History is not guaranteed to repeat itself, but it could -- and if it did, wouldn’t you like to be prepared? There are currently opportunities for producers to protect their milk prices at historically high prices, and, although every operation has a different cost structure, I encourage interested producers to take a serious look at current risk management strategies for the remainder of 2012 and 2013.

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. 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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