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June 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.

Milk Marketing Is for Everyone

Jun 18, 2010

By Steven Schalla, Stewart-Peterson

 

Most people dairy because it’s what they love to do. Between the countless hours of tending to the cows and young stock, working in the fields, and fixing the latest broken piece of equipment, it’s a lifestyle in its own category, offering its own rewards and fulfillment. 

At the end of the day, however, we all know that the dairy is also a business and needs to produce income to be sustainable. 

 

It’s been well noted that many dairy producers are feeling financial stress, and that risk management tools are imperative to keep many farms going. However, engaging in strategic marketing can be useful to any operation, regardless of your debt situation or financial status.

 

Why do I say that marketing is useful for everyone?

 

One of the common goals of marketing is to reduce the stress of volatile markets. For anyone, stepping away from what we think is going to happen and instead formulating a firm strategy can be very rewarding. You are prepared for whatever comes your way, making life much more comfortable. You are free to focus on other management needs. Naturally, this is a desired position for any farm manager—to be efficient with time and focused on what really matters. 

 

Even from a strictly fiscal standpoint, strategic marketing can be rewarding to any operation. Remember, the goal of good strategic marketing is to focus on the weighted average price of all of your production. By placing emphasis on our weighted average, we ultimately work toward a competitive advantage and have the flexibility to pursue whatever goals the operation desires. 

 

There still are many dairies that currently have a favorable debt situation. These farms may not be highly leveraged but, at the same time, there are concerns about eroding equity, maintaining profitability and maintaining available cash. Good strategic marketing allows them to pursue the goals they desire--maybe expansion, improved genetics, new equipment or even generational transition and retirement. 

 

Even for these mature farms, simply maintaining that comfortable position will continue to be a challenge with the volatility that is expected to continue in both the milk and feed markets. While it may be possible to “ride out” the stretches of poor prices, those who engage and take a proactive approach to marketing will have a dramatically better chance of reaching their personal goals. 

 

And, as we mentioned above, there are also operations that have become very leveraged and therefore it is necessary to carefully maintain profit margins and manage cash flow in order to service debt. Here too, using a strategic approach to marketing is essential to ensure the bills are paid, as well as maintain the flexibility to take advantage of better prices when they present themselves, to dig out of the debt hole. 

 

Whether it is reducing stress of volatile commodity markets or taking a proactive role in your farm’s financial situation, strategic milk marketing is for everyone. More and more lenders are taking this stance and will likely continue to require their customers to address their marketing needs.

 

All in all, it appears that marketing will continue to be an increasing factor that separates the good farms from the best. 

 

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.

Protect Your Input Prices

Jun 07, 2010

By Jon Spainhour, Rice Dairy

 

So far in this column, we have discussed the difference between fixed price contracts, called futures, and flexible priced contracts called options. In last month’s column, we discussed options contracts that are called puts.

 

Puts are essentially insurance contracts that allow for producers to establish a floor on the price of their expected milk production. By purchasing puts, a producer can know today what the minimum price he/she is going to receive for their milk at some point in the future, while still being able to participate in higher prices if the price of milk moves higher.

 

This type of contract is different from a fixed priced contract, which allows producers to establish a guaranteed price for their milk but does not allow them to participate in any of the upside if the price of milk were to move higher. 

 

Another type of option that is used in risk management is the call option. Calls are very similar to puts from the standpoint that they are essentially an insurance contract as well. However, they are insurance against the price of a commodity moving higher. The buyer of the call is establishing a ceiling on prices of a certain commodity, while still allowing themselves to participate in lower prices if the price moves lower. 

 

In the milk world, puts are most commonly used by producers who sell their milk, trying to establish a floor against lower prices. Calls are typically employed by end users like restaurants and food companies, who buy milk, trying to establish a ceiling on their milk price.

 

Producers, however, don’t just have output price risk to worry about. They also have input price risk in the form of feed and energy prices that they need to worry about too. The most common method that dairy producers use to manage that input price risk is by buying futures or options on their feed prices. While not all of their feed prices can be hedged through futures and options, inputs like corn, soymeal, cotton and canola oil can all be hedged through these instruments. 

 

For example, a producer today can establish a ceiling on his corn inputs for December at $4.00/bu. by purchasing $4.00/bu. calls at $0.17/bu. This means that the maximum price that he is going to pay for his corn during the month of December is going to be $4.17/bu. ($4.00 + $0.17 premium). 

 

If come December the spot price of corn is $5.00/bu., the producer will pay his supplier $5.00/bu. However, his options account will have $0.83/bu. worth of profit in it. When you apply those profits to his spot price, you get a net price of $4.17/bu. 

 

If come December, the spot price of corn is $3.00/bu., he will pay his supplier $3.00/bu. His call options that he spent $0.17/bu. on, however, will expire worthless. This means that his net pay price for corn in Dec will be $3.17/bu.

 

In either case, he was able to know today that the maximum price that he would have to pay for his corn in Dec would be $4.17/bu. This same method of hedging corn can be applied to the other exchange traded commodities like soymeal, canola oil and cotton as well. 

 

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.

 

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