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March 2012 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.

March Madness Sends Ripples through the Milk Market

Mar 26, 2012

Extreme price swings this month kept us all on the edge of our seats. Producers should be filling out their “brackets” – weighing the impact of various strategies on their average feed and milk prices for 2012.

WDE D10106a DoorninkBy Liz Doornink, Stewart-Peterson

Let’s take a look at the play-by-play for the March madness of milk prices, then take a “time out” to discuss a potential game plan for managing the volatility that is still ahead:

Thursday, March 1
The first day of March was truly the calm before the storm as cash cheese was unchanged and milk prices tacked on modest gains. The 2012 Class III average price was sitting comfortably at $16.10 with strong premiums built into the nearby months as the market anticipated optimism in the short-term.
 Class III March 1 2012
 
Friday, March 2
Milk prices were pressured as aggressive selling emerged in the cash cheese market. Blocks were down ¾ of a cent on a total of 13 trades, and barrels were down 2 cents on a total of eight trades. A total of 21 carloads traded hands, solidifying the strong selling interest in the marketplace. Milk prices quickly erased their premiums, with April milk finishing down 61 cents and May milk finishing down 53 cents. The 2012 Class III average softened, moving below the $16.00 price level, and closed at $15.93. Class III March 2 2012
 
Monday, March 5
Losses were extended sharply to start the week as cash cheese traded lower and reached new lows for the year. Blocks were down 2 cents to $1.4600, and barrels were down 2¼ cents to $1.4575. New lows in the cash cheese market, dating back to January 2011, spooked the milk market, with April and May milk trading down the daily limit of 75 cents. The price action suggested the milk market was throwing in the towel and saying, “Look out below.” In two days, April milk lost $1.36, and the 2012 Class III average trimmed 48 cents to $15.62.  Class III March 5 2012
 
 
Tuesday, March 6 to Thursday, March 22
After hitting rock bottom, milk prices made a 180-degree turnaround and trekked higher without looking back. In 12 out of these 13 trading days, April milk has been either unchanged or higher, accounting for $2.07 during the stretch. Cash cheese also posted a strong reversal with the block/barrel average up 17 ¼ cents, from $1.45875 to $1.6300. The 2012 Class III average sat at $16.33, which is 70 cents off the low on March 6 and 23 cents higher for the month of March.
Class III March 22 2012
 
Friday, March 23
The March madness continues. Cash cheese was hit hard as the sellers came off the sidelines and stepped back into the driver seat. The blocks were down 14 cents to $1.4950 and the barrels were down 16 ½ cents to $1.4600, erasing three weeks of gains in only a few minutes. The sharp losses spilled over into the dry whey market and ultimately the Class III milk prices. The April contract traded down the daily limit a handful of times but buying interest kept the second month contract afloat, avoiding a limit down close. May-Jul y were initially pressured lower but managed to recover the bulk of their losses into the close. Click here for the video "week in review."
Class III March 23 2012
 
What’s next?
As the clock runs down on the first quarter, the supply-side of the equation continues to be the “elephant in the room.” February milk production came in at 16.280 billion pounds, or 15.699 billion pounds when Leap Day milk production is excluded from that total. The year-over-year increase in milk production comes to 4.3% with this adjustment. This is the strongest year-over-year increase in February milk production since 2006, when it grew by 5.3%.
 
The recent rally in corn complicates and muddies the long-term picture. Since 2006, we have seen a very strong directional relationship between corn prices and milk prices. Sometimes milk prices can lag behind, but, if corn is trending higher, milk eventually follows and catches up. So, if the rally in corn is real and not a false breakout, and corn works its way up, there is only so long that milk prices will be able to maintain a downward trajectory. 
Total US Milk Production
 
What’s your game plan?
If you’ve been following this column, you know that we encourage producers to have an end-game goal of building the best possible weighted average price over time for milk and also for feed. Doing so requires consistency and constant analysis, so you are ready to act when prices break one way or another.
 
 
Source: Stewart-Peterson Inc.
 
How can you be ready to act? Take a time out from the action and prepare strategies, then analyze the impact of those strategies in multiple price scenarios. This advance work does two things:
• It allows you to choose the strategy that has the most impact on your overall price.
• It allows you to know the impact if the market price goes up, or if the market price goes down.
That way, there are no surprises.
 
For milk, a simplified analysis for May milk might look like this:

Simplified Market Scenario Planning Table for May Milk
 Simplified MSP Table for May Milk
Source: Stewart-Peterson Inc.
Fees and commissions are not calculated for this simplified example.
 
Simplified Market Scenario Planning Table for Corn
 Simplified Market Scenario Planning Table for Corn
Source: Stewart-Peterson Inc.
Fees and commissions are not calculated for this simplified example.
 
Remember, knowing your weighted average price for feed and milk is important. This is not the figure you see on your milk check, which represents only a portion of your yearly average price. Calculate your weighted average price for the year, then stay focused on incrementally bringing that weighted average price for milk up (or down for feed purchases). Then you will have a true measure of your marketing effectiveness.
 

Liz Doornink is in Dairy Business Development for Stewart-Peterson, Inc. Liz can be reached by calling 800.334.9779 or at ldoornink@stewart-peterson.com.

Market Scenario Planning is a service of Stewart-Peterson Inc.

The data contained herein is believed to be drawn from reliable sources but cannot be guaranteed. Neither the information presented, nor any opinions expressed constitute a solicitation of the purchase or sale of any commodity. Those individuals acting on this information are responsible for their own actions. 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. Any reproduction, republication or other use of the information and thoughts expressed herein, without the express written permission of Stewart-Peterson Inc., is strictly prohibited. Copyright 2012 Stewart-Peterson Inc. All rights reserved.

Strategies that Make Sense

Mar 19, 2012

Sometimes it makes sense to use forward contracts or futures, like buying put options and selling calls on milk.

 
ron mortensen photo 11 05   CopyBy Ron Mortensen, Dairy Gross Margin LLC
 
Back to basics. Protect the stakeholders. Pay the bills. Get to next year. Just get to next month. Marketing plan. Business plan. Cash flow statement. Defend and protect. Guarantee cash flow. Keep the marketing plan simple.
 
We all have had these types of discussions with ourselves. We may have even these discussions with our spouse, our children, our employees and even a few of these with our lenders. Sometimes in the business cycle, we should look at using different types of strategies. Sometimes it makes sense to defend cash flow. Sometimes it makes sense to do nothing. Sometimes it makes sense to use forward contracts or futures.  
 
Think about how to defend cash flow and defend net worth. Option strategies can be used to add to previous sales. They can be used to protect cash flow and net worth. Option strategies can be used to get closer to 30%, 50%, 75% or 90% total coverage without creating a lot of risk. Options, used in combination with a forward contract or futures, tend to reduce risk if prices go lower and also reduce risk of selling too much if prices go higher. 
 
Strategy I
 
Buying put options on milk can be the tool to give you a floor price but not put a cap on profits. Your risk is the premium you pay for the put option. You will not lose any additional money except for the premium.
 
When do you use this strategy? When you cannot lock in profits of if costs are above the futures prices. If you sell, you will be locking in losses. What do you cheer for? Prices to go higher. The put option may turn out to be worthless, but if milk prices rally, your cash flow will be better.
 
If you review an August Class III milk chart, you will see two important areas--$16.00 and $16.70. Look at buying puts with strike prices at one of these support areas.      
 
August Milk Put  
Futures Price     $16.78/cwt (as of March 16, 2012)
Put Strike price $16.75  
Premium              - $.97
Floor Price           $15.78
 
Second choice with the lower strike price:
Futures Price     $16.78/cwt (as of March 16, 2012)
Put Strike price $16.00  
Premium              - $.63
Floor Price           $15.37
 
Strategy II
 
Buying put options and selling calls on milk can be the tool to give you a floor price and a ceiling price. The ideal time to use this strategy is if the put price is near your break-even. In addition, the call option you sell would allow you to sell milk at a profitable level that meets your financial goals.   
 
This strategy will be a little cheaper than just buying a put option. However, it will be marginable. In other words, if you put this trade in your account, you will be subject to putting in additional margin money. If the market moves higher, you will need to fund your account. What do you want to cheer for? Prices to go higher and settle just below the call option you sold. In this case, below a settlement price of $18.49 would be optimal. You may have had a few margin calls, but prices rallied and you sold your milk at a higher price.    
 
August Milk Put/Call Spread
Futures Price     $16.78/cwt (as of March 16, 2012)
Put Strike price $16.75  
Put Premium      - $.97
Call premium     + $.40
Floor Price           $16.18
 
Call strike price $18.50
Put Premium     - $.97
Call premium     + $.40
Ceiling Price        $17.93
Net cost              $ .57
 
Feed Insights
 
USDA once again released information regarding U.S. and world supply/demand. It was a yawner for the US data. The world data showed smaller soybean crops for Brazil and Argentina.
 
The big surprises will be coming on March 30 when the USDA releases the Grain Stocks report. Especially important is the corn stocks number. USDA has had a tough time with this number in the past. Look for lots of volatility in the days after this number. The second report that day is Prospective Plantings. Private firms have now estimated as high as 95.5 million acres to be planted to corn. This would be a big crop if there are trend-type yields. On the other hand, it looks like the U.S. may need to plant an additional 1 or 2 million acres of soybeans to offset the reduced production in South America.
 
Ron Mortensen is one of the founders of Dairy Gross Margin, LLC, which was formed in 2006 to sell Livestock Gross Margin Insurance to dairy producers. Mortensen’s firm is now licensed in 23 states. He is also president of Advantage Agricultural Strategies, Ltd., which he founded in 1985, to provide individual risk management advice for farmers and agribusiness using futures, options and cash trading strategies. Contact him at 515-570-5265 or ron@advantageag.com.

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.

Using Options to Manage Dairy Financial Opportunity

Mar 05, 2012

Taking a fixed position is a bold action and requires conviction and courage. Options are a remedy for greed and fear. They are available and do work, but they have a premium cost and limitations. 

Carl BablerBy Carl Babler, First Capitol Ag

As we have candid and honest discussions with dairymen nationwide, we learn that one reason marketing decisions are not taken is fear.  

The fear of missing out on a better price opportunity after contracting to sell milk or buy corn is real. Fixed price commodity positions are just that -- fixed, set, final and unchangeable commitments to a given price, revenue and margin. When a dairy producer contracts for a fixed price, knowing he or she will not receive a worse price, that usually does not offset his or her fear of not getting a better price. Thus, the decision to do nothing is taken.  

Greed, or the desire for more, is common to all mankind. Dairy marketers do have commodity options that can effectively help satisfy their desire for a better opportunity. Options, when used to hedge a fixed commodity position, can provide extra opportunity if price moves against a fixed position.

How does this strategy work?

  • A dairy sells milk for a fixed price with its processor and simultaneously buys Class III call options equal to volume and term of its plant contract. If the milk price during the term of the fixed price contract moves to higher levels, the call option position can capture a part of the higher price opportunity. 

  • A dairy buys corn on a forward contract and simultaneously buys corn put options. The use of put options following a contract to purchase corn is also functional if the corn price would drop after the corn purchase price is fixed by contract. 

Dairy margin example - In June 2008, the price of corn for 2009 was at $7 futures, and the 2009 price of Class III milk averaged over $20. To manage the margin, it required a dairy to sell milk and simultaneously buy corn. Many people close to these commodities advised dairies to buy $7 corn because they believed the corn market was going higher, and not to sell milk because they felt the milk price had to go higher as well. As a result, many dairymen, in fear of missing out on a better margin, accepted the risk of doing nothing.

Let us look at how options could have fit in:

  • Buy the $7.00 corn to lock in the corn price, and buy corn put options to cover the bushels contracted for the forward period involved. The corn puts would gain equity if the corn price would fall to lower prices after contracting at $7.

  • Sell the $20 milk, and buy milk call options to cover the pounds contracted for the forward period involved. The call options would gain equity if the milk price continued to move higher after being fixed at $20.  

The above actions protected a margin, with the options providing opportunity for additional profitability if corn dropped and the milk price increased. These options have a premium consummate with the price levels protected. Options used to open the door of improved financial opportunity have a cost that must be budgeted and deemed affordable. However, they are available, they do work and they can be a practical remedy to greed and fear.

Dairymen who had acquired an understanding and proper expectation of options did in fact use this strategy when corn was $7 and milk was $20. They then were in a position to capture an improved margin opportunity when, in July 2009, milk futures prices dropped to $10.90/cwt. and corn fell to $3.50/bu. 

Looking backward at what would or could have been may be helpful, but the real question is what can be done now?

Options can be used to manage margin risk and allow a dairy to be open to improved margin opportunity if the corn price drops and the milk price improves. With current feed prices and Class III milk averaging $16.25 for July through December 2012, margins are currently at or below breakeven in the West and moderate in the Midwest. Buying call options to cover the risk of a higher corn price while buying milk puts to manage the risk of a lower milk price for the period July 2012 through Dec 2012 is possible. The options manage margins against a decline while allowing room for upside participation. You are not locked into a corn or milk price; you only have taken an option position.  

In conclusion, taking a fixed position is a bold action and requires conviction and courage. Options are a remedy for greed and fear. Options are available and do work, but they have a premium cost and limitations. Dairy producers have come to an improved understanding of the usefulness of dairy options and are using these tools to open themselves to improved price and margin opportunities. An 800-word discussion cannot cover this topic in its entirety, but if your interest has been stirred as to how to manage opportunity after a contract position is established, we invite your inquiry. 

Carl B. Babler is a consultant and senior hedge specialist with First Capitol Ag in Galena, Ill. He has been involved in the futures industry as a broker, educator and hedger since 1975. Babler holds master’s degree from the University of Wisconsin-Platteville and completed agribusiness course work at Harvard University. You can reach him at 1-800-884-8290 or cbabler@firstcapitolag.com.

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