Jul 13, 2014
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RSS By: Dairy Today: Know Your Market, Dairy Today

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

Will the New Margin Protection Program Be Part of Your Dairy’s Future?

Jul 10, 2014

A closer look at the farm bill’s MPP, set to launch Sept. 1, and its effect on market liquidity.

Kurzawski photo 2013

By Dave Kurzawski, INTL FC Stone

While the price of U.S. cheese teeters around the $2/lb. level and market participants scan the horizon for some sort of disruption or directional shift in prices, it might just be quiet enough to discuss another evasive topic: the dairy subtitle of the new farm bill.

President Barack Obama signed the Agricultural Act of 2014 in February. A behemoth document that was beaten, battered and caught in the political cross-hairs for two years, the bill emerges with progressive changes for U.S. dairy producers. The dairy section of the bill promises to deliver, among other things, a more sensitive safety net for U.S. dairy farms based on an ‘income over feed’ margin – not milk price alone.

Much has been written about the new Margin Protection Program (MPP), how it operates, and what lose ends will need to be tied up before its launch, slated for Sept. 1. Few, however, have yet discussed the possible consequences of the new dairy farm policy. Among the immediate concerns is the potential influence the MPP could have on derivative market liquidity.

Producers are a very large component of sell-side liquidity at the Chicago Mercantile Exchange’s (CME) dairy markets. By focusing on a "margin threshold" to trigger indemnities to producers, the MPP does a good job of mimicking existing risk management tools used by producers -- such as futures, options and forward contracts to lock in a profit margin. Because of this, the concern is that the new program will cannibalize sell-side liquidity at the CME making it tougher for buyers to hedge. In essence, the more interest there is in the farm bill’s new margin program, the less liquidity there could be in the CME dairy markets.

Currently, several university studies raise this concern, saying that, in general, such a program (if certain levels of participation are realized, etc.) will remove some portion of sell-side liquidity in the existing exchange-traded products and forward contracting programs. Given the structure of the program, producers may, in fact, increase use of MPP during times when the futures market forward curves are already predicting low margins or certainly low milk prices. But the world of commodity risk management decisions has many subtle levels.

Initial discussions with dairy producers tell me they like the flexibility of the MPP but that they will treat it as a safety net for that milk not actively hedged. Those producers who already manage price risk have commented that if they use the new program, it will be in collaboration with current derivative management tools – not in lieu of these tools. The current sentiment is then not very consistent with a significant departure from using present derivatives for hedging purposes. Row-crop producers, who use futures and options as well as crop insurance year in and year out, are a good indication that this mindset could hold up in the dairy markets as well.

Although CME dairy contracts continue to grow yearly, many producers I’ve spoken with who do not actively manage their profit margin today have claimed that there is not enough current information on the MPP to make a call on their future involvement. Final rules and a general lack of understanding today could be the program’s Achilles heel. Still, expect a good showing of MPP participation from producers who do not currently manage price risk because of the, at least perceived, low barriers to entry. That won’t necessarily threaten liquidity of forward contracting programs or liquidity at the exchange.

Sentiment surrounding the MPP is positive, but the current temperature of dairy producers when asked if they will use the program exclusively is lukewarm. While the MPP provides an important safety-net, it seems as though producers won’t enjoy the same type of coverage, flexibility and profit-capture of existing risk management tools. The dairy industry is happy to see a more progressive public policy approach, but with current information available it appears the program is unlikely to result in a material decline in sell-side liquidity for exchange-traded products.

David 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.

U.S. Dairy Herd Increasing, Concerns for Milk Prices Ahead

Jul 03, 2014

These market analysts warn of the historical relationship between increases in the dairy cow herd and subsequent declines in milk prices.

By Will Babler and Luke Strub, Atten Babler Commodities LLC

Record milk prices and attractive margins have enticed producers to decrease their dairy cow culling rates and maximize their potential milk output. The 2013-14 year to date (YTD) dairy cow slaughter is 8.6% lower than last year through May, with recent declines in the slaughter rate accelerating. May 2014’s U.S. dairy cow slaughter of 209,300 head was 15.5% behind the 2012-13 slaughter rate and 11.9% lower than April 2014 on a daily average basis. The May 2014 YOY slaughter decline of 15.5% was the largest monthly decline in nearly four years, and 2013-14 YTD dairy cow slaughter is on pace to be the largest annual YOY decline in nine years.

Increasing Dairy Cow Herd

Recent declines in dairy cow slaughter have led to an increase in the U.S. dairy cow herd. Dairy cow numbers have increased each of the past six months, with a total increase of 54,000 head throughout the period. The number of dairy cows on farms increased by 10,000 head in May 2014, to 9,252,000 total head, the highest figure since May 2012. Dairy cow herd and milk per cow figures were not published from Mar 2013–June 2013 due to government sequestration so a YOY analysis is not available; however, milk production increased 1.2% YOY from Mar 2014–May 2014.

The Effect of Herd Expansion on Prices

Previous run-ups in cow numbers, many times a result of high milk prices, have led to significant subsequent corrections in milk prices. From 1998-2013, the top three percent of month-over-month (MOM) increases in U.S. dairy cow numbers corresponded to an average decline in the U.S. all-milk price of 7.3% in the following month and 23.2% at the trough.

Current Production Environment

In the current environment, increases in the dairy cow herd have been crucial in keeping U.S. milk production afloat. Milk-per-cow yield has been hampered by poor forage quality and adverse weather conditions in the first half of the 2013-14 production season, leading to marginal production gains compared to other major exporting regions. The 2013-14 YTD milk-per-cow yield increase of 0.7% is less than half of the previous 10-year average milk-per-cow yield increase of 1.6%.

Milk per cow yield normalized in May 2014, increasing by an estimated 1.6% YOY as Midwestern producers rebounded from the effects of cold and wet weather. Increasing milk per cow yield, coupled with the increase in the domestic dairy herd, is expected to amplify increases in U.S. milk production in the following months. According to the June USDA World Agricultural Supply and Demand Estimate report, 2014 U.S. milk production is projected at 206.1 billion pounds, a 2.4% YOY increase. At the time of publication, 2014 YTD (Jan-Apr) milk production was up 1.0% YOY, implying milk production growth is expected to accelerate to a YOY growth rate of 3.1% for the rest of the year.

Potential Ramifications

With near-record milk prices and attractive margins continuing, producers will look to continue the trend of decreased dairy cow culling in future months, expanding the domestic dairy cow herd. Dairy producers should be wary of the historical relationship between increases in the dairy cow herd and subsequent declines in milk prices, especially as regional milk-per-cow yields normalize and milk output strengthens.

Will Babler is a principal with Atten Babler Commodities LLC. The firm serves producers, processors and end users in the dairy industry by providing education, margin management programs and futures and options brokerage services. You can reach Atten Babler Commodities at 800-884-8290, info@attenbabler.com or www.attenbabler.com.

The information and comments contained herein are provided as general commentary of market conditions and are not and should not be interpreted as trading advice or recommendation. The information and comments contained herein are not and should not be interpreted to be predictive of any future market event or condition. Information contained herein is obtained from sources believed to be reliable, but cannot be guaranteed as to its accuracy or completeness.

Why You Should Consider an LGM-Dairy Policy

Jun 19, 2014

This risk management strategy can be a valuable form of price protection in the volatile world of farming.

ron mortensen photo 11 05   Copy

By Ron Mortensen, Dairy Gross Margin, LLC

Last month, we discussed how Livestock Gross Margin for Dairy (LGM-Dairy) can be part of the conversation with a lender, as one of the different marketing strategies that can be used to reduce the risk in today’s world of volatile feed and milk prices.

First, here’s a review of the basics of purchasing an LGM-Dairy policy:

1. Sales are made one day per month, on the last business Friday of the month. Sales begin in the late afternoon/early evening.

2. The application is relatively easy.

3. The payment for the premium due is made at the end of the policy period.

A policy can be designed in many different ways. First, what months do you want to cover? Buying a policy for at least two months means you get a government premium subsidy. You can cover up to 10 months. Next, you can choose the deductible you want. Of course, the higher the deductible, the lower the premium. Finally, you can choose the amount of feed you wish to cover (you need to have some feed in the policy, but you can adjust it depending on your ration/crop condition, etc.). Use a University of Wisconsin website to help you choose the amount of feed coverage. Go to http://future.aae.wisc.edu/lgm_analyzer/

Consider using LGM-Dairy to insure milk out in the future, say the last three months that can be purchased. This is where the greatest level of uncertainty is regarding both milk and feed prices. So, on June 27, protect 15% of your milk production for March/April/May of 2015.

Remember how much flexibility is built into LGM-Dairy. A producer can "layer" or "stack" coverage. So, as the months go by, continue to purchase the last three months of coverage available. At the end of July, buy 15% for April/May/June of 2015. At the end of August, buy 15% for May/June/July of 2015. Eventually you will be covering 45% of your milk, and you will have a bundle of policies protecting your dairy’s financial position.

If LGM-Dairy becomes part of a risk management plan, what are some of the practical questions and considerations?

First may be the whole question of "do you really want to receive a check from the insurance company for a loss?" Receiving a payment on your LGM policy means margins (highly influenced by the price of milk) have collapsed. Yes, you have made money on your LGM policy, but your overall dairy operation is probably suffering.

An LGM policy is a form of insurance, and it is probably best if it does not pay off. No check from the insurance company means that margins are wider than what you insured and, as a result, your dairy is probably more profitable. Having said that, the LGM policy can be a valuable form of protection in the volatile world of farming nowadays.

One of the hardest wrinkles of this program to grasp is how to calculate gains and losses to come up with a net indemnity (a net payment on the policy). A gain or loss is calculated each month, but for policies that last multiple months (as most do), the gains and losses are added together to determine any potential payment. In a 10-month period, there could be five loss months and five gain months. These gains and losses offset, and there might not be a payment on the policy. The University of Wisconsin website (mentioned above - http://future.aae.wisc.edu/lgm_analyzer/) can help with these calculations.

If there is an insurance indemnity, what do you do? Provide your insurance agent with proof of production from your processor or cooperative for the amount of milk insured.

Ron Mortensen is principal of Dairy Gross Margin, LLC, an agency that specializes in LGM-Dairy products. Mortensen also is owner of Advantage Agricultural Strategies, Ltd., a commodity trading advisor. Reach him at ron@dairygrossmargin.com or visit www.dairygrossmargin.com.

 

Protein Prices Up, Milk Prices Mixed

Jun 05, 2014

Protein prices and milk volatility could equal a "summer squeeze" for dairy producers.

Devenport, Bob

By Bob Devenport, Stewart-Peterson Inc.

Since January, the price of the July soybean meal futures contract has climbed from a low of about $390 per ton to $509 per ton as of this writing. That’s about $47 per ton less than the 2012 high, when prices peaked due to drought conditions. (See Chart 1.)

For the second year in a row, inventories are tight for old crop soybeans, and that is keeping protein prices high. Inventories are tight largely due to world demand for U.S. soybean meal. For the 2013-14 marketing year, U.S. soybean meal export commitments are running about 4.8 percent ahead of 2012-13’s pace as of week 31 of the marketing year (the week ending May 1). While 4.8 percent may not sound like a huge increase, it follows a year where soybean meal export commitments were up 27.3 percent from the 2011-12 pace at this same time of year.
As of this writing, total export commitments for soybean meal stand at 9,129,659 metric tons. At this point in the marketing year, total export commitments have never been this high. (See Chart 2.)

The strong demand for soybean meal is giving plenty of support to prices now. In view of soybean planted acres for this year’s crop, the market is anticipating replenishing supplies. The October and November contracts for soybean meal are looking more attractive, priced at about $100 per ton less than these nearby months of July and August. So there should be better buying opportunities in the fall. The key is to manage through these expensive months.

Summer squeeze?

When I say "manage through," what do I mean? Let’s turn to the milk side of the equation. It’s important to stay defensive on milk in these nearby months where your cost of protein is significantly more expensive. Looking out to fourth quarter milk prices, we are still expecting attractive prices: Those contracts are in the $19-$20 range right now. Also, by that time, protein should be at least $100 per ton cheaper. So if prices were to weaken in milk in the fourth quarter, there is not as much of a margin squeeze.

This summer, however, could be a different story. Milk prices are such a mixed picture right now, and that is producing the volatility we’re seeing lately. When volatility picks up and trade gets choppy, the market has the potential to move sharply in either direction, and that increases price risk through the July and August timeframe.

One area of concern is that global dairy prices come down steadily over the last couple of months. For the eighth auction in a row (reported this week), the Global Dairy Trade (GDT) Price Index lost ground, losing another 4.2%. If dairy prices globally continue to fall, U.S. prices could track with them to remain competitive.

It’s important to note that during times of high price volatility it can be difficult to get positions in place. We’ve seen several limit moves for Class III milk recently. If you do not have some milk price protection as this volatility kicks in, you may not be able to get the positions you want, and you will have to weather some ups and downs in the coming months.

This potential summer volatility is the reason why we are such strong advocates for a consistent approach to commodity price management, all year long, so that when we go through these volatile periods, your position is safe and you’re not left scrambling. Sometimes we forget how fast milk prices can fall, and a $1.50 per cwt. drop, especially with high protein prices, can be a significant margin change.

So, if you are hesitant to act – and many producers are during times of relatively high milk prices – think about the impact that protecting $1.50/cwt. would have for you this summer. Dairy producers often pride themselves (and rightly so) in doing the "little things" well. Proactively managing through a $1.50 price swing over the summer months can be a "little thing" that adds to the 2014 bottom line, along with all the other "little things" you do well this year.

If you’d like a better picture of price volatility and what is behind the recent milk price swings, view the Dairy Today Market Week in Review, posted each weekend. Click here for this week’s video.

 


Chart 1: July 2014 Soybean Meal Futures Daily (in $ per ton)
Chart 1: Since January, the price of the July soybean meal futures contract has climbed to levels approaching the 2012 high. Source: Stewart-Peterson Inc. and ProphetX.


 


Chart 2: Total Export Commitments of U.S. Soybean Meal (in metric tons)
Chart 2: Total export commitments for U.S. soybean meal have never been as high as they are this year. Source: Stewart-Peterson Inc. and USDA FAS.

 

Bob Devenport is a dairy markets advisor with Stewart-Peterson Inc., a price management 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 2014 Stewart-Peterson Inc. All rights reserved.

A Time to Reap, a Time to Hedge

May 29, 2014

Understanding seasonal tendencies can help refine strategies to protect both feed costs and milk revenues.

chip whalen thumb

By Chip Whalen, CIH

Many producers know that there are certain times of the year which are more profitable than others.

After all, agricultural commodities follow seasonal trends that can either pressure or support prices of the goods they use and produce. For example, crop producers often find that the value of their crops can be depressed at harvest time as an abundance of supply hits the cash market all at once. Likewise, dairy producers may find that milk prices tend to be depressed during the "spring flush" season, which pressures margins in the early part of the year.

Understanding seasonal tendencies can play an important role in how a producer may want to approach managing forward profit margins.

For example, if you are heading into a period where margins tend to be under pressure, it probably is a good idea to have a fair amount of coverage in place to protect those margins – even if the margin itself may not be historically strong. Moreover, if you understand the reason why the margin tends to be depressed, this may help guide you in the strategy selection process.

As a dairy operation exposed to increasing feed costs, you know that the greatest period of uncertainty surrounding crop production is upon us. From how many acres will be planted to what the weather will be like during germination and reproduction to how many bushels will ultimately be harvested, this uncertainty can lead to increased volatility in crop prices over the summer.

Understanding this, you may want to retain flexibility in the strategies you use to protect your feed costs. On the one hand, if there is a drought like we experienced a few years ago, you want to make sure you’re protected against significantly higher prices. On the other, should we harvest a large crop later this year, you want to participate in the lower prices that could minimize your feed expense and improve your dairy’s bottom line.

While seasonality can certainly play a role in the decision-making process, it is important to remember that the market does not always behave according to seasonal tendencies. In any given year, the fundamental backdrop unique to that period may trump any seasonal pattern. Moreover, historical patterns are based on past price movements, so seasonality itself is changing every year as new price activity gets added to the ongoing history.

The profit margin itself should be the main driver of any strategic decision to manage forward profitability. Understanding seasonal tendencies can help refine strategies to protect both feed costs and milk revenues, though seasonality itself should not be the main decision making consideration.

Understanding the seasonality of price movements or of overall profit margins can certainly assist in tactical strategy selection and position management over time. This may include decisions to include more or less flexibility at certain times of the year, taking on more cost in option positions, or even increasing coverage levels. A strong understanding of how seasonality affects prices and profit margins can help you make better decisions and give you more control over your dairy’s profitability.

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.

 

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