It seems that the Class III milk market finally joined the rally and was catching up with every other ag commodity last month, posting substantial gains on the spot market rally in cheese.
This appears to be fundamentally driven on a short supply of cheese (which is not unexpected considering the moderation of cheese output and continued growth in disappearance). Still, compared to lifts in feed prices, margins are not comparable to 2007 levels.
That makes approaching this market different to what may have been effective a year ago. My goal this marketing season is to secure a profitable margin, not necessarily a price.
The milk:corn price spreads still are not approaching levels where you would say hedging on either side is an afterthought. Milk prices have improved enough that you could say historically you are sitting on a long-term high which you cannot ignore. But the brutal reality is that depending on your feed price bookings on 2008 crop, margins may not be all that attractive, particularly through the fall and winter.
So the ageless question for the moment is ‘how much milk:feed to book?' The short answer is not as much as you may like.
It seems Scenario 1 from my last column (May, p. 30) is forming. This scenario called for rising Class III prices with feed markets rising at a comparable pace. If you bought the option spreads, they still play out well given rises on both sides.
What is still missing from the milk market is a sharp lift in powder prices (although butter may be making up for some of the lost time), which is the sharp distinction from this summer to last. More certain is that unless you are fully-booked in feed for new crop, continue to tread lightly in milk. My reasons:
- The corn market is still very uncertain. Fundamentals (regardless of your projection source) call for very tight carry-outs and high use. Considering that at press time, the acreage battle may be over, but there is still a lot of weather risk before harvest (proteins have some chance of a downward movement). Corn in particular has much more upside risk than milk has downside. I maintain my approach in that you book feed before milk for new crop. Right now, I'm targeting 50-75% corn coverage before harvest depending on if and when the market breaks.
- The milk market is beginning to realize there is not enough cheese to go around. However, there is still limited pull from other milk channels, particularly condensed skim and dry milk. Powder and increasingly butter exports are pulling record amounts of milk from the domestic supply and this is reflected in the cheese vat. Depressed fluid sales fill in some of the gap that exports are taking, but it is not enough to meet cheese demand. I continue my analysis that powder is oversold and prices should recover. The ‘if and when' becomes a bit trickier. It is difficult to get excited about selling major milk increments until I know powder price lifts are reflected in market price. The reason: I will either be holding the de-pool bag or worse, selling an uncovered forward contract or futures leg that is under priced. Give that most of my feed price decisions will not be made until later this summer, milk sales decisions will probably follow suit at that time unless scenario 1 prices present favorable and sustainable margins for the business.
So far, Quarter 1 2008 break-even prices compared to Quarter 4 2007 are up from 50-75¢/cwt. That reflects a fair amount of hedged feed. The big awakening will be when new crop pricing/contracts come online and further pressure margins. In the intermediate term, feed prices add a higher hurdle to milk price targets.
Fundamentally the outlook is for higher feed and lagging Class III pricing. I would look very hard at your budgets. If the new crop milk:feed prices give you sufficient margin to meet your needs, there is no reason to shy away from hedging a margin using a covered option strategy for both feed and milk.
There is still a lot of uncertainty on the feed side and more price recovery with milk. Maintaining pricing flexibility and a profitable margin is more important than a price lock at this point. That is not to say I do not buy feed opportunities on breaks. But I am waiting for more favorable milk:feed margins on the longer-term contracts.
Chart of Jul 08 CL III milk:corn price spread
Marv Hoekema is president of Dairy Decisions Consulting LLC. You can contact him at email@example.com.
- June/July 2008