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October 2011 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.

Make Market Volatility Work for You

Oct 31, 2011

Although market volatility can be stressful, financial planning, proactive trading and patience can help ensure a proper risk management strategy is executed for the financial health of your dairy business.  

Katie Krupa photoBy Katie Krupa, Rice Dairy
Traveling around the country, I talk with many dairymen who are discouraged from hedging their milk on the Chicago Mercantile Exchange (CME) because of the market volatility and the role of speculators in the market.
My response to this concern: Yes, there is volatility, and yes, there are speculators in the dairy complex, but that is a good thing for your hedge strategy. The market volatility can enable your financially sound hedge strategy to be executed during upswings in the market. Typically, the most difficult aspects of hedging in a volatile market are to be proactive and patient.
Since the beginning of October, the October-December Class III futures price has fluctuated within a range of about $1.30. Early in the month, the October-December Class III average was around $16.50. Then it moved up to $17.70, then back down to $17.00, and most recently it traded as high as $17.83. While this trading volatility can certainly cause heartburn for those watching the market, it also provides opportunity for those actively hedging their milk price.

Krupa to Join Risk Management Panel at Las Vegas Conference

Register now to hear Katie Krupa speak Nov. 8 at Dairy Today's Elite Producer Business Conference in Las Vegas. 

So how do dairymen use market volatility to hedge their milk? Again, the first step is to create a hedge strategy that is financially sound for your dairy business. The next step is to work with your broker or cooperative to place an order that will trade for multiple days – orders can be active until a certain date, or active until cancel. That means an order will continue to trade daily until the order is filled on the market, the specified date in reached, or the order is cancelled.
For example, a dairyman placed an order on Oct. 3, 2011, to sell his milk at $17.50 for October-December 2011, and he set the order up to trade until Oct. 12, 2011 (good until date Oct. 12, 2011). Although the price was only trading around $16.50 when the order was placed on Oct. 3, the price moved up over $1.00 in less than a week. Because the trade was set up to trade until Oct. 12, 2011, the order would have been filled on Oct. 7 when the price traded through $17.50.
By creating a strategy that first meets the financial needs of the farm, and then placing the order and allowing the order to trade for several days on the market, the hedge strategy would have been executed. Please keep in mind that an order placed $1.00 above the current market price will not always be executed because the market may not reach those high levels. But in a volatile market where the market frequently moves 20-50 cents per day, placing an order and allowing it to work for multiple days will enable a hedge strategy to be executed if the market moves higher.
Each day, the Class III futures price can change up to 75 cents per month (the market is limited to a 75-cent change per day). On some days, the market will first trade higher and then move lower. In theory, the market could move 75 cents higher, then change direction, and move down $1.50 (down 75 cents from the opening trade price).
Frequently, dairy producers will check the trading prices once a day at the end of the day. If you are not interested in watching the market throughout the day, you can place your order and allow it to trade for multiple days. If the price reaches your desired hedge price, your order is already working and your hedge strategy will be executed.
There are several things to keep in mind when placing an order that will remain active for a period of time. First, and most importantly, your hedge strategy should be established based on your farm’s financial situation. Secondly, any order that is working for a period of time should be re-evaluated on a regular basis. I suggest that all working orders be reviewed on a weekly basis. It is good to touch base with your broker or cooperative to ensure that your order is still working. From a broker’s perspective, I connect weekly with producers to ensure they are aware the trade is still working.
Although market volatility can be stressful, financial planning, proactive trading and patience can help ensure a proper risk management strategy is executed for the financial health of your dairy business.  
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


Volatility: Managing Your Way Through the Ups and Downs

Oct 24, 2011

Look at a business plan that can reduce your operation’s bottom-side risk. Some forward contracting and other option-type strategies like purchasing CME options or a LGM-Dairy policy can take away some of your volatility.

Marv Portrait 2
By Marv Carlson and Ron Mortensen, Dairy Gross Margin LLC
Sometimes volatility creates opportunity. Sometimes volatility just creates risk. That risk can just eat into profits.  
With the volatility in the markets today, it is increasingly difficult to hedge all the components of a dairy operation. Just think: You have a concentration of overhead in facilities and the cow herd. In addition, you have feed in the bunker or in the field. Or, if you do not have any feed, you have risk of prices moving higher. Then there is the milk price—up, down, sideways? There are lots of moving parts.
Today, there are many more influences on commodity prices than in the past. In the past, it was exports, feed demand, government programs, weather. Today we have multiple issues including the dollar, the world economy, the Chinese economy, weather around the world, exports and money flow. Yes, money flow.  A great number of new investors are making bets on crude oil, corn, soybeans, wheat, gold and other hot commodities. All these factors are capable of helping or hurting your operation.
Greg Squires from Dairy Enterprise Services commented, “Living through the down market to see the next high is becoming increasingly more difficult.” So how do you manage your way through the ups and downs? Look at a business plan that will attempt to reduce your operation’s bottom-side risk. Some forward contracting and other option-type strategies like purchasing CME options or a LGM-Dairy policy can take away some of your volatility.
Look at January 2012 milk. From Sept. 9, 2011 to Oct. 18, 2011, the average daily price swing (from high to low) has been $.25 /cwt. From Jan. 1, 2011 to Oct. 18, 2011, the average monthly price swing (again from high to low) in January milk was $.80 /cwt. LGM–Dairy, with an average amount of corn and meal, covering December through February can be purchased for $.17/cwt for the $1.00 deductible or $.61/cwt for the zero deductible.
So what about corn and other feed? If you have just cut silage or have wet corn in a bunker, you need to feed it. So, an option strategy or the LGM-Dairy can be used with the lowest amount of corn. If you do not have feed purchased, then LGM-Dairy can be adjusted to essentially buy corn for the operation. Remember, the LGM-Dairy feed portion is similar to a call option. So, if feed goes up, you have some protection but if feed goes down, you can buy it cheaper.
Think about this simple approach. Thirty-three percent of your milk is forward-contracted if you can price it above breakeven. Thirty-three percent of your milk is covered with LGM-Dairy or CME options. Thirty-three percent of your milk is left open. What could happen? If the milk market goes down, you have 66% of your milk priced. If the market goes higher, you only have 33% of your milk priced. Obviously, the percentages can be changed to suit your specific financial goals.
Look at the example below of the LGM-Dairy calculator for December 2011 through July 2012. The final prices will be calculated on Oct. 26, 27 and 28. The next LGM-Dairy sales date is Oct. 28, 2011.
Carlson input header 10 25 11
 Carlson chart 10 25 11
  Carlson Summary chart 10 25 11
Carslon Sensitivuty chart 10 25 11b
Marv Carlson and Ron Mortensen are with Dairy Gross Margin LLC in Sioux Rapids, Iowa. Contact Carlson at or (712) 240-8395. You can reach Mortensen at (515) 570-5265 or Visit the firm’s website for more information:
Mortensen will be a panelist at Dairy Today’s Elite Producer Business Conference Nov. 7-9 in Las Vegas. Learn more about the conference at:


Good, Bad or Ugly: Exploring Dairy’s Price Scenarios for 2012

Oct 15, 2011

We’ve developed an opinion about next year’s prices. However, we’re not as focused on where prices are going as we are on getting you prepared for whatever prices do.

S Schulla Bio PictureBy Steven Schalla, Stewart-Peterson
Events like World Dairy Expo are a welcomed chance for many producers and industry people to recharge the batteries and get excited about the coming year for the dairy industry. In our discussions with producers at Expo, there seemed to be a more cautious feeling about 2012. As we looked at the Class III futures for next year, the reaction from each producer was strikingly similar: “Those prices are not very exciting.”
The second most popular phrase we heard was in the form of a question: “Are 2012 prices going to be good, bad or ugly?”
Some Expo goers were a bit taken aback by our answer: “We’re not as focused on where prices are going as we are on getting you prepared for whatever prices do.”
That’s the outcome of great marketing: having a plan in place that flexes with the markets and puts you in a position to avoid the major downtrends while remaining close to the highs.
“What? You don’t have an opinion on prices?”
Sure we do. We’ve analyzed all the available information, and our team developed an opinion about next year’s prices. After the uptrend of 2011, historical price patterns suggest that 2012 could be down as much as 20-30%, meaning that as 2011 prices close the year at an average of $18.00, next year’s average price could be in the range of $14.40 to $12.60 as a base Class III price.
That’s our opinion. However, there are so many moving parts that will impact what milk prices will be and determine whether they are good, bad, or ugly. In each potential scenario, there are many things that will have to fall into place in order for that scenario to play itself out.
Here are some of the key developments on our radar that could push prices towards a specific result:
Good price scenario
·         International demand continues to expand and exports provide strong demand pull.
·         Milk per cow struggles and limits production growth as feed costs and feed quality plague many dairy regions. 
·         The Federal Reserve continues easy money policy through stimulus and drives commodities higher as a whole.
Bad price scenario
·         U.S. consumers continue to tighten their belts in a stagnate economy and dairy demand softens.
·         International milk production is plentiful as Oceania achieves its aggressive growth goals, leading to international prices declining.
·         Feed prices maintain lower levels relative to the summer highs, encouraging some production growth with better margins. 
Ugly price scenario
·         Global debt challenges boil over and cause a double-dip recession, taking financial markets, including commodities and milk, sharply lower. 
·         The U.S. dollar rallies as it is still perceived to be the safest currency, pressuring export opportunities.
·         U.S. production jumps as producers follow through from strong prices in the second half of 2011.
Of course, the definition of whether prices are good, bad, or ugly is subjective. The definition of great marketing is less subjective to us, and that’s why we focus there. Great marketing is maximizing the difference between your price and the “bad” or “ugly” prices, while staying as close to the higher “good” prices as we can.
If you have a solid understanding of all the marketing tools available, it is possible to evaluate how various positions, often in used in combination, can achieve this goal of “great marketing.” In fact, we can “pressure test” potential strategies against price swings, and in the process build confidence that we are prepared for whatever the market brings—good, bad or ugly. We call this Market Scenario Planning.
The table below illustrates an example of this process with current 2012 prices, although please remember it is simplified and designed as an educational example.
In the table, we assess different marketing positions and how they will impact the base Class III price received. For the purposes of evaluating results, let’s say that:
·         A base Class III price of $16.00 or higher is a “good” price, meaning that after adding milk plant premiums we are over breakeven costs and in profitable territory. These prices will be in green.  
·         “Bad” prices are in yellow and are less than $16.00, but higher than $15.00, representing breakeven to manageable losses for the year. 
·         Finally, the red boxes show “ugly” prices, where devastating losses will be sustained as prices move below $15.00.
·         The goal of our marketing is to increase the green area and reduce as much red and yellow area as possible. 
In the Market Scenario Planning Table, the prices below each column heading represent the effective prices received when each strategy is implemented. With this table, it is easy to see how a given position will perform if different actual prices materialize. 
For example, in line one where no action is taken, the effective prices will be the same as the actual prices. However, by implementing a combination of small forward contracts and purchasing Put Options in line two, it is possible to start separating from the lower prices, eliminating a red box and assuring the breakeven level is achieved at the $14.00 level. 
Moreover, in line three, by being a bit more aggressive with forward contracts and using fence positions, it is possible to assure the breakeven level is hit regardless how much the market declines. Naturally, some upside potential is lost by obtaining this coverage, which needs to be acknowledged. 
Like many others in the dairy industry, we have studied the spectrum of milk price indicators and have offered our best opinion on prices for 2012. However, we believe that taking your marketing to the next level means going beyond opinions, beyond attempting to outguess the market. It means knowing in advance what your revenue stream is going to be, because you planned for multiple price scenarios. Using Market Scenario Planning, great marketers can transform 2012 from uncertain to predictable, and in doing so turn concern into confidence.
Steven Schalla is a Market Advisor for Stewart-Peterson, Inc. He can be reached at 800.334.9779 or 
Schalla   Market Scenario Planning Table 10 11b 
© 2011, 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 2011 Stewart-Peterson Inc. All rights reserved.


The Hidden Value in Hedging

Oct 10, 2011

Option premium costs and end-of-year hedge profit-and-loss statements don’t tell the whole story of hedging costs and benefits.


By Will Babler, First Capitol Risk Management, LLC
During the last several months, we have laid out the case for implementing a margin-focused, commodity hedging strategy. We have discussed both hedging fundamentals as well as detailed discussions of important dairy-specific, margin-management issues, including:
·         Hedging Philosophy – What we do know and don’t know about markets and what to expect from a hedging program.
·         The Right Tool at the Right Time – how to selecting the best available tool for a given market circumstance.
·         Creating a Risk Management Plan – key questions that must be answered when devising a risk management policy.
·         Revenue Hedging and Milk Basis – understanding your milk basis and the ability to tie down the biggest variable in profitability – milk revenue.
·         Feed Hedging with Cash and Futures – controlling prices within a complex ration by coupling corn and meal futures hedges with cash forward contracts.
·         Executing the Margin Management Plan – consistency required to run the plan on a day-to-day basis.
The last topic in this series, Hidden Value in Hedging, identifies some of the advantages of engaging in a structured, margin-focused hedging program. In many cases, the pros and cons of engaging in hedging activity can be spelled out clearly in black and white. Daily futures statements, quarterly financials and year-end tax returns will make it quite clear the costs and benefits of a hedging program from a pure profit and loss, or P&L, perspective.
Hedgers realize costs for transferring their risks to the marketplace. These costs include both out-of-pocket option premium expenses and financing costs for marginable futures and options strategies. Given the cyclical nature of commodity markets, in some years there will be costs without any price insurance claims, while in other years the claims may keep your business afloat.
For this reason, it is important to look at the costs and the value of a hedging program over the long term. A multi-year window that spans several market cycles is the only way to provide a fair view of how hedging can benefit your business. It is in this context that we will look at a few of the benefits of hedging that go beyond simple P&L’s.
·         Operational Consistency – During severe market downturns, it is common for commodity industry participants to look for any angle they can find to contain costs and generate cash flows. In some cases, there are rational choices that can be made. In other cases, the choices may save money or raise cash today, but come at a great cost to future efficiency and profitability. At times, these decisions are forced by outside parties. In other cases, the damage is self-inflicted because there are no other alternatives. A consistent hedging program can help avoid these tough decisions by always keeping price and margin protection in place to buffer the inevitable downturns. These benefits aren’t easy to quantify when looking at the upfront premium expense of a milk or corn or soybean meal option, but, over the long term, market stability that affords operational stability has proven to be a significant benefit.
·         Long-term Planning – Short-run operational consistency and long-term planning are both important to the success of any commodity producer or processor. Hedging programs that smooth out cash flows and provide a safety net on margins can help producers take on long-term facilities, herd, management and expansion programs with greater confidence. Giving up some margin and price peaks to mitigate the valleys can allow for a larger and more efficient operation over the long term. Again, these benefits are difficult to identify up front when putting cash to work in a specific hedging transaction, though over the long term the major decisions that can be entered into with confidence can greatly impact the legacy of an operation.
·         Improved Financing – Risk reward tradeoffs must be considered in all hedging transactions. This is also true from the lenders perspective when evaluating the risk/reward of working capital or long-term financing provided to a dairy. If the lender can see a written plan and demonstrated track record of smoothing cash flows through a hedging program, this can result in greater access to financing at potentially more favorable rates. This is a potentially quantifiable benefit to hedging which over time helps reduce the total cost of the hedging program.
·         Emotional Clarity – The final intangible of a sound hedging program is ability to remove some of the worry and concern about how unfavorable market conditions may impact your business. Executing on a structured hedging program will mitigate a good deal of downside risk and extend the capacity of any operation to make it through difficult market cycles. It is difficult to measure the monetary benefit of being able to sleep at night, but some hedgers will attest that this is at times the most valuable aspect of a hedging program. When taking the edge of the fear, greed and anxiety that markets can induce, a hedging program can help provide greater clarity of thought and more rational decision-making. This shifts the focus away from outside market events that can’t be controlled to operational and planning decisions on the dairy that can be controlled. It may not be easy to put a price tag on this aspect of hedging, but it certainly helps skew the cost benefit in a favorable direction.
Will Babler is a principal partner at First Capitol Risk Management, LLC. Contact him at 815-777-1129 or at Visit the company’s website at

A Great Time to Protect the Milk-Feed Margin

Oct 02, 2011

Katie Krupa photoTo protect the risks that threaten the profitability and sustainability of a dairy, look at milk and feed prices in relation to each other.

By Katie Krupa, Rice Dairy

In my recent travels across the country, I have spoken with many dairymen (and lenders) who are growing increasingly nervous about the 2012 milk price.

This makes sense considering that the last time the dairy industry saw record-high milk prices, it was shortly followed by a devastating milk price cycle that some are still recovering from. The good news is that it's not too late, although the milk price has lost some ground in recent weeks, as have feed prices. In short, the milk-feed margin is trading at a decent level for dairymen.

In a calculation I use to judge the margin between the milk price and the feed cost, the 50th percentile is my benchmark for "good" or "bad" prices. The 50th percentile is currently around $9.00. As of the end of September, the average milk-feed margin trading for January-June 2012 is around $8.75, and the average margin for July-December is $9.45 (making the annual average $9.10). Although this margin may not look too enticing, for most dairies, that margin exceeds their break-even and enables them to protect profits and reduce volatility.

Let's examine where that margin price has settled in recent years. In 2010, the average margin settled at $8.72, and in 2009, it was $5.46. That is a significant swing in a short time frame. Obviously, 2009 was not a profitable year for the dairy industry, but was 2010? For a quick calculation, a dairyman could assume that if 2010 at $8.72 was a profitable year, 2012 with a margin of $9.10 will also be profitable. This is a quick, oversimplified calculation, but assuming no major changes to the operation or debt structure, it will work for most dairies. 

By using a risk management strategy that hedges the milk price and the feed prices, we are able to protect the margin between the two. Given the volatility in both the milk price and feed costs, I think it is crucial to hedge both milk and feed -- in other words, hedge a milk-feed margin.
Where to start? Although the 50th percentile mark is currently around $9.00, that number should not come into play when making a hedge decision for your farm. The percentile mark should be replaced with profitability. So, if a milk-feed margin of $8.00 results in the farm breaking even, $8.00 is the lowest margin price we want to protect. If $8.00 is break-even, maybe $8.50 is a "good" price for your farm. Determining a "good" price is based on the financials and goals of the business. Creating a hedge strategy focused on your farm’s financials will enable you to make the best risk management decisions for your farm.

How is the margin calculated? The numbers I have here are based on current trading prices for milk, corn and soybean meal. To determine an appropriate relationship between milk, corn and soybean meal, I analyzed feed rations for dairies across the country. For the rations fed, I converted the energy and protein in the ration to corn and soybean meal equivalents. This process allows me to hedge the majority of my feed needs by contracting only two commodities: corn and soybean meal. This process can be completed fairly simply for a dairy, so that it’s analyzing a milk-feed margin that is specific to its operation.   

Looking to the future, I see the continued need to hedge milk prices and feed prices to protect the dairy business. The volatility shows no signs of decreasing. Although it is still popular to look at milk and feed separately, I no longer think that is a good hedge strategy.

To protect the risks that threaten the profitability and sustainability of a dairy, we should look at the milk and feed prices in relation to each other. The good news is that the current trading prices for the milk-feed margin are at levels that are historically "good," and, more importantly, are probably "good" for your farm’s financials.

Katie Krupa is the director of producer services for 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 her at Visit


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