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October 2010 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.

Developing a Relationship with Your Broker

Oct 25, 2010

Hedging certainly isn’t rocket science, but it is likely something that you have never done before. Your relationship and communication with your broker can determine how successful your hedging career will be.

 
Spainhour PS jpegBy Jon Spainhour, Rice Dairy
 
During the last 10 months, I have described some of the underlying fundamentals associated with dairy price risk management. We have discussed fixed-price contracts called futures and insurance-like contracts called puts and calls. 
 
We discussed how those contracts can be used to establish minimum output prices and maximum input prices for our dairy and commodity prices. We have discussed the importance of knowing our breakeven prices on the farm and how we can use different strategies to protect those levels.
 
We even discussed the importance of having a well-financed hedge line of credit so that we don’t have to rely on our “cash on hand” to meet margin calls, which can sometimes outpace our cash flow schedules. Finally, we discussed the importance of developing a sound hedging policy and remaining committed to it, as opposed to jumping in and out of the market simply because the market is moving against us. 
 
For many, this litany of points makes common sense and, while unfamiliar with the market particulars, they are still able to grasp the importance of hedging and the underlying mechanics of how a hedging plan would work. However, they are still uncomfortable about how to actually get started. 
 
In an earlier column, we discussed that one of the first steps in this whole process is to locate a broker and establish a relationship with him or her. While the field of brokers dedicated to dairy risk management is not as robust as other markets like the grains, there are several brokerage houses that do dedicate the majority of their time and efforts to dairy futures and options. 
 
My suggestion is to contact each one of them and explain where you are at in your hedging career. Do not be afraid to tell them that you do not know what you are doing. If you do know what you are doing, great! But if you don’t, it is nothing to be embarrassed about. The majority of the brokers you will speak with have no idea how to milk a cow. Don’t be embarrassed that you don’t know how to use their products. 
 
Once you overcome this psychological hurdle, ask the broker to help educate you further. Spend time with him or her on the phone. Ask for educational material. Go to their educational seminars. Don’t be afraid to let him or her know there is something that you don’t understand. Ask questions. Most of all, though, force the broker to understand the economics of your operation. Every farm is different, and every farmer has a different outlook on what his risk profile should be and how he would like to manage it.
 
At the same point in time, it also your responsibility to put in the work on your end to ensure that you understand the material at hand as well. Hedging certainly isn’t rocket science, but it is likely something that you have never done before. Your broker can help educate you and understand your operation, but he can’t force you to put in the front-end work needed to get you started hedging. 
 
Once you’ve interviewed several brokers and found the one you feel the most comfortable with, you will need to open an account and fund it. Once you have proven to yourself and your broker that you feel comfortable with hedging and have sound expectations and an even sounder hedging policy, you then need to decide what kind of relationship you want to have with your broker. 
 
Do you want to be active in the futures market every day and rely on your broker for their market insight? Or do you simply want to find the cheapest, most risk-averse hedging strategy you can find and be done with it?
 
I personally have dairy producer clients whom I speak with every day and others that I speak with once a quarter. The frequency of the communications is based entirely on their hedging strategy and style. There is no reason to speak with your broker every day if you have simply bought puts against your expected breakeven levels, but there is also no reason to put on a very active futures position and not speak with your broker for weeks at a time, especially if you are relying on them for their market insight. 
 
Some clients even go so far as to turn their hedging over completely to their broker and enter into what is called a “Power of Attorney” arrangement. This relationship is not for everyone and should not be entered into lightly. Under this arrangement, once a producer demonstrates he understands hedging and its risks and benefits, he communicates his hedging strategy to his broker and allows his broker to take care of the details. 
 
In any case, your relationship and communication with your broker is likely what is going to determine how successful your hedging career will be. Each relationship will be different, but make sure you develop that relationship and stick with it. Like all good relationships, they can be hard, but it will be worth it in end. 
 
Jon Spainhour is a broker/trader 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 Spainhour at jcs@ricedairy.com.Visit www.ricedairy.com.

Capturing Milk Prices Into 2011: Where Should Your Focus Be?

Oct 11, 2010

Focus on preparing and implementing strategies to protect your prices now. You may be anxious to get started with 2011 pricing, but don’t overlook the immediate months.

 
Copy of S Schulla Bio PictureBy Steven Schalla, Stewart-Peterson
 
It was my pleasure to once again attend World Dairy Expo and meet people from all parts of the dairy industry and the world. It is easy to see that the overall mood, especially of producers, is much better than this time a year ago. Naturally, higher milk prices have gone a long way to help that cause.
 
Still, there remains a level of tension and nervousness among producers, particularly looking into 2011. 
 
Producers are telling us that the break-even prices seen so far this year are better than the losses of 2009, but little progress has been made to recover, and any sustained dip in milk prices would be devastating. In addition, the recent run higher by grain prices has those who buy the majority of their feed on edge. While things have improved, the emotion and stress around the milk and grain markets continues to run high.   
 
So let’s examine what has taken place, as well as how we need to be prepared for in the months ahead. 
 
Milk market patterns
In conversations about the milk market, I have heard folks say, “All the milk fundamentals are bearish (call for lower prices), so I don’t know why milk prices keep going up.”
 
While it’s correct and important to note that cow numbers and milk production have increased, it is also important to note that cheese inventory growth has slowed dramatically, to 4% to 5% over the last three months. This has caused spot cheese prices to rally and remain strong above $1.70/lb. level, thus rallying nearby Class III prices.
 
There’s a pattern at work here that helps explain why milk prices are rallying. Remember that nasty pattern from earlier this year of milk prices slipping as contracts neared expiration?  Cheese prices were a bit weaker and milk futures prices were at a premium, so, as that month got closer, the futures price had to fall to close the gap. Producers would get frustrated and say, “Why are these strong milk prices just dropping off as that month comes due?”
 
The good news is that pattern has now reversed. Cheese prices are stronger, therefore our milk prices are rallying into expiration, despite the increase in cow numbers and milk production. The tables have turned, and it’s working in our favor.
 
At the same time, there’s still underlying nervousness around the strength of cheese. For example, there have been a few particular days that a trading session opens with offers to sell cheese. Traders recognize that when the cheese price starts to slip, milk can go down quickly. The market interpretation of that is, “Oh no, there’s cheese to sell. Milk is going down.” So when we’ve seen moments of weakness, milk sellers rush in.
 
As a result, this pattern suggests that our focus is best spent preparing and implementing strategies to protect your prices now. While many folks are anxious to get started with 2011 pricing, don’t overlook the immediate months. Position yourself to preserve the current strong prices and avoid a possible dip in cheese prices and the resulting milk selling pressure.
 
It is likely that time is on our side to price 2011 milk.  Both five- and 10-year seasonal patterns call for stronger prices for the first half of the following year being offered in the November and December time frame. While the existence of a pattern does not mean that this will certainly be the case this year, further patience could have positive results, even with a short-term set back in cheese prices.
 
In addition, strong grain prices are also supportive to 2011 prices, as demonstrated by the double-digit gains on Friday’s report day. In other words, if you have some flexibility and your financial situation does not dictate locking in now, be patient for 2011 pricing.
 
In any situation, when considering taking market positions for a long length of time, it is critical to maintain flexibility to higher prices, which can be accomplished in a number of different ways. Utilizing a tool we call “Market Scenario Planning” can be very helpful to really understand how these decisions would perform in various market price scenarios.
 
(I’ve talked about this tool in previous columns. It involves charting out the impact of various strategies if the market goes up a little, up a lot, down a little or down a lot. Knowing the impact of decisions in advance helps reduce stress when markets are moving fast and pressure mounts.)
 
Another feed squeeze?
Grain prices have been equally volatile to milk prices, with corn breaking over $5.00/bu. and meal $300/ton. Friday’s USDA report cutting U.S. average yield to 155.8 bu./acre, along with struggling production in Europe and Russia, has caused corn prices to break out of a two-year trading pattern. 
 
With this development, it is important to recognize that higher corn prices are a strong possibility heading into next planting season. Therefore, this harvest season may provide the right purchasing opportunities to make sure those needs are secured until the crop is off to a good start next spring. 
 
In short, it appears there will continue to be plenty of action in the coming months for both milk and grain prices. This means both risk and opportunity, and now is the time to assess your marketing goals, start to review different price scenarios, and determine how different strategies will reduce your risk and stress levels. 
 
 
 
 
--Steven Schalla is a Market Advisor for Stewart-Peterson Inc. He can be reached at 800.334.9779 or sschalla@stewart-peterson.com.
 
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 2010 Stewart-Peterson Inc. All rights reserved.
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