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February 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.

Are Milk, Feed Prices for Real?

Feb 28, 2011

There’s reason to be bullish. Yet, while the current rally may stick around for a while, do what you must to prepare for its departure.

 
Copy of S Schulla Bio PictureBy Steven Schalla, Stewart-Peterson
 
It’s amazing how a simple question can have a not-so-simple answer. In less than two months, milk futures have experienced one of the most dramatic rallies since the futures market opened in 1996. March milk began 2011 at a mere $14.06. By Feb. 16, it was at $18.98. Despite fundamental changes that the market has started taking into account, this change of nearly $5/cwt. has a lot of people scratching their heads and asking a lot of good questions.
 
Let’s start with what everyone wants to know: Are these prices for real? More to point, are we actually going to see these high prices when these future months expire? While no one knows for certain, our analysis shows there is a strong possibility for current prices, or higher prices, to be had this spring and summer. 
 
Prices like these don’t come around very often. Over the past 11 years, only 14 months have shown us a base Class III price over $18.00/cwt. It definitely takes the right mix of conditions to see the highest end of milk prices. I personally feel, with the fundamentals at hand, now is as good a shot as you’re going to get. 
 
That said, keep emotions in check. It would be foolish to blindly assume that $20 milk is coming and you therefore don’t need to be engaged in marketing. On the other hand, knee-jerk selling at the first sign of weakness may also get you in a pinch. Now more than ever, it is critical to have your action points laid out ahead of time so that in the heat of the moment, decisions are made with a steady hand and without emotion.
 
Similar to 2008, the challenge may be in feed costs erasing much of the profitability that high milk prices would otherwise bring. I will acknowledge that some operations are more exposed to this situation than others, but, everyone will feel the effects, directly or indirectly, if grain prices rocket higher this spring or summer.
 
While USDA released projections last week of 92 million corn acres and 78 million bean acres for the coming spring, cotton has become the wild-card crop after its historic run-up in prices. If there is a shift in acreage this spring with more land going to cotton, you will see that much more pressure on a perfect growing season for corn and beans. 
 
If that perfect growing season materializes, expect grain prices to be at significantly lower levels by harvest. With prices already near historic highs, protecting feed purchases with a put option position is a great strategy to learn and entertain.
 
Looking ahead, it certainly appears the price rollercoaster will continue for both milk and grains into spring. With some planning now, and with the right strategies, it is very possible to navigate the loops and twists that lie ahead, and arrive at a better financial position when the ride is finally over.
 
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.

LGM for Dairy – How Do You Calculate the Cost of the Premium?

Feb 18, 2011

Here are online links and instructions to help you estimate your premium quote for this risk management plan.
Marv Portrait 4

By Marv Carlson, Dairy Gross Margin, LLC


Nearly the first question milk producers ask me is, “How much does it cost?”

Well, I really can’t tell you until the last business Friday of the month when USDA’s Risk Management Agency (RMA) posts the prices for milk, corn and soybean meal, but I can give you an estimated quote based on the last three business days.

As agents licensed to sell Livestock Gross Margin (LGM), we do not know how much the premium costs until the last business Friday or sales day for LGM.  That’s because LGM for Dairy’s premium is based off the volatility from the three day averages of Wednesday, Thursday and Friday’s closing CME market commodity prices. The premium quote is available after the computations have been completed.

How do you or I obtain an estimated quote? We have set up a link to access the premium estimator at www.dairygrossmargin.com. Click on “premium estimator.”

For those who would like more background information before going to the premium calculator; go to http://future.aae.wisc.edu. This is the homepage of the University of Wisconsin Dairy Marketing and Risk Management Program and is maintained by Professor Brian W. Gould of the Department of Agriculture and Applied Economics.

Find and Click on “LGM-Dairy.” From there, click on “Supporting Software.” LGM – Dairy Analyzer (V 2.0) is the software to run for premium estimator quotes leading into sales day. I suggest that you view the “Tutorial Video.” After clicking to go to the “Analyzer,” read the Documentation page. Click on the Premium Estimator link and peruse the site to see what all it includes.

To run a premium estimation calculation for your operation, put in the hundredweights of milk you produce each month.  Select the year, month and deductible.  Enter the hundredweights of milk and amounts of corn and soybean meal in tons you wish to include. If you want to do this faster, just enter tons of milk, then click “lowest allowed” at the top.  At this point, you have a defined  Monthly Gross Margin.

To see what the preliminary premium will be, click on “Calculate LGM Premium” at the bottom. Then expand this result by clicking “Show per cwt Results.” The third-to-last column on the right will show you the “Net Premium per cwt. of Covered Milk” in $/cwt.  Your premium cost will be determined by the deductible you choose to insure and the hundredweights of milk you want to include using LGM for Dairy as part of your risk management plan.

Take special note and read closely. The original amount of feed you enter does not change in the yellow boxes as you change the percentage of milk and feed you wish to include in your calculation. The amounts are changing live as you enter monthly changes.  Read the fine print to see the new milk and feed amounts for your preliminary estimate sample.

I like to print out the three most likely Premium Estimator calculations and then circle the changes for a quick refresher when making further analysis of the runs.

Final premium quotes will be available from a Crop Insurance Agent who sells LGM, or if you want to check for yourself, see “RMA’s Premium Calculator.” A link to this is available on Dr. Gould’s site.

One final note: USDA/RMA has publicly said the LGM products (LGM-Dairy included) have a $20 million allocation. About $12 million has been used. The largest amount has gone to pay subsidies for LGM-Dairy. Officials said, at the current rate, the $20 million could be gone before June 30, 2011. Starting in July, an additional $20 million would be put in place.

The sales pace in February will give us a better idea of how fast the money will be depleted. USDA/RMA said when the funds are gone, sales will stop until new funds are available on July 1, 2011.

The next sales day opportunity is Feb. 25, 2011. The March sales date is March 25, 2011.

Marv Carlson is with Dairy Gross Margin, LLC, in Sioux Rapids, Iowa. Contact him at marv@dairygrossmargin.com or (712) 240-8395. Visit the firm’s website for more information: www.dairygrossmargin.com.

Why I Fear Dairy’s Bull Market

Feb 14, 2011

My concern is that dairy producers across the country will see these higher milk prices and get comfortable, nervous or even greedy.

Katie Krupa photoBy Katie Krupa, Rice Dairy
 
Dairy farmers across the country are breathing a little easier these days since higher milk checks will soon be hitting their mailboxes. The recent run-up in milk prices trading on the Chicago Mercantile Exchange means that farm milk checks will be the highest seen in two years.
 
Both Class III and Class IV futures are currently trading in the high teens to low 20s for the remainder of 2011. Although higher input costs will eat away some of those prices, if prices stay where they are, dairy farmers should have a profitable 2011. Additionally, many market analysts are calling for prices to continue to climb due to low dairy powder inventories and a growing export market.
 
So with all this good news, why would I fear the current bull market? My concern is not that the market will change direction and prices will decline. Inevitably that will happen. My concern is that dairy producers across the country will see the higher milk prices and get comfortable, nervous or even greedy.
 
Comfortable -- Around this time, many producers are now able to pay their bills, maybe (hopefully) even able to start to save a little, buy a new piece of equipment, or enjoy that long-awaited family vacation. All of these things are great, but unfortunately many people don’t think about setting up a risk management plan when things are going well. It’s easy to think about risk management when the milk price is $12, but not so easy when it’s $20.
 
Like insurance, you want to get protected before the incident occurs. No one wants to think about health insurance on a beautiful sunny day when you are in the prime of your life, but that is when you should. The sunny, healthy days don’t last forever, and you should be protected for the road ahead. Your business’s risk management plan works the same. Although prices are good now, will they be down the road? Now is the time to at least evaluate your risk management options, talk to industry professionals; a broker, banker, cooperative, feed dealer, etc. Be prepared for the road ahead – it may be bumpy!
 
Nervous -– This is the opposite of comfortable. Some people get very nervous about price volatility, for both inputs and milk price, and they make rash decisions. Rather than investing the time talking to industry professionals and making a decision that is in your business’s best financial interest, some people quickly jump on what looks like a “good” price. Unfortunately that “good” price can sometimes turn into a bad price for the business. With increasing price volatility, “good” and “bad” prices are relative to the operations cost structure. Your business’s risk management plan should include both the milk and input prices, and should not be a rash decision.
 
Greedy -- This one is tough. Obviously no one wants to leave money on the table when it comes to milk price, but if you are greedy you may miss out on the profit margin altogether. It is easy to get caught up in the market’s upside movement, and there will always be at least one analyst who is calling for the market to move higher. If you are always waiting to contract at the market’s peak, chances are you’ll miss it altogether.
 
This situation has occurred in the past, most notably in the summer of 2008. Although the Class III price was trading at $20, many were calling for it to go higher, so most people waited. Ultimately the market crashed, leaving producers with sub-$10 Class III prices in 2009. Again, you should be making your contracting decisions based on the risk management strategy unique to your business.
 
Risk management decisions can be difficult at first. My best advice is to create your risk management strategy based on your farm’s financials, and the decisions will be easier. Your risk management strategy should be based on protecting a profit margin, and while your strategy will need to be adjusted as the market changes, you should not be making rash decisions, or getting too comfortable and neglecting risk management all together.  I recommend working with the right team of professionals to help create and implement a risk management strategy that protects your business and your future.

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. You can reach Krupa at klk@ricedairy.com.Visit www.ricedairy.com.

Dairy Margin Management: A Focus on Profit Rather than Price

Feb 07, 2011

Producers who embrace a structured margin management approach will be well prepared for the heightened volatility, increased competition and uncertainty on the horizon.

 
By Will Babler, First Capitol Risk Management
 
In today’s market, dairy producers face unprecedented volatility and risk. Commodity price volatility for milk, dairy products and feed are on a rollercoaster with no end in sight. This can prove overwhelming for the producer who, aside from financial management responsibility, is already fully occupied with operational tasks.
 
Still, the management of commodity price risk is perhaps the most important determinant in the financial success of a dairy. Few other factors in the operation are as volatile or as big a lever on earnings as feed and milk prices.
 
Some dairy producers have responded to this challenge by taking time to learn about risk management tools and their application. Over time, these producers often proceed along a spectrum of experience and confidence that entails hedging milk, feed or both, using some combination of cash forward contracts, futures or options. At the end of this learning curve is a structured hedging approach that we believe will be necessary for producers to succeed and compete going forward. We refer to this approach as a structured Dairy Margin Management program.
 
Dairy Margin Management Definition
 
Dairy Margin Management is the process of cutting through the noise and the fog in the marketplace to purposefully and directly limit commodity price risk while also taking advantage of opportunities created by volatility.
 
A producer engaged in structured Dairy Margin Management takes matched hedge positions that simultaneously protect input and output commodity prices. This approach allows for a focus on profit rather than price. It also eliminates the need to be right on the timing, direction and price level of each individual leg of the profit margin spread.
 
The Case for Dairy Margin Management
 
Over the coming months, via a series of articles in this column, we will seek to build the case for implementing a margin-focused commodity hedging strategy. Future articles will cover hedging fundamentals as well as detailed discussions of important dairy-specific margin management issues:
·         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 select 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;
·         Hidden Value in Hedging – Option premium costs and end-of-year hedge profit and loss statements don’t tell the whole story of hedging costs and benefits.
 
Moving Forward
 
On the horizon, we see great opportunity in commodity markets and dairy production. However, this opportunity also includes the likelihood of heightened volatility, increased competition and uncertainty. We feel strongly that the producers who embrace a structured margin management approach will be well prepared for this environment. We look forward to providing insights which will allow producers to progress upward on the risk management learning curve.
 
Will Babler is a principal partner at First Capitol Risk Management, LLC. Contact him at 815-777-1129 or at wbabler@firstcapitolrm.com. Visit the company’s website at www.firstcapitolrm.com.
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