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November 2012 Archive for Know Your Market

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Dairy trading experts offer strategies and practical perspectives to optimize market performance.

What Is the Real Price of Playing the Odds?

Nov 30, 2012

Getting caught up in “lottery ticket” emotion is what causes many dairies to leave so much at risk.

Stewart Peterson   Mark LudtkeBy Mark Ludtke, Stewart-Peterson

As I write this column, the organizers of the multistate Powerball lottery are waiting for two lucky people to claim one of the largest prizes in lottery history. I already checked my ticket. I didn’t win. And chances are you didn’t either if you are reading this column right now.

Lotteries can be a fun conversation piece because they get people thinking and talking about what they would do if their life suddenly changed overnight with a mindboggling amount of money. The bigger the jackpot, the more the buzz, and the more people buy tickets pushing the jackpot even higher.

So my odds of winning were something like 1 in 176 million. That’s crazy. When I go buy my ticket wearing my rational hat, I know I’m not going to win.

When a dairy producer is evaluating whether or not to price milk or feed, you have to wear your rational hat as well. That’s not always easy to do, because the dollars involved in establishing a marketing approach are so different from the way we think about our operating dollars. Let me illustrate using some round numbers:

The owner of a 2,500-cow dairy operation produces 700,000 cwt. at $20/cwt., giving him about $14 million in revenue to manage. He considers a risk management approach that would require him, due to the size of his operation, to put up about $1 million in margin money. He could secure that through a line of credit that is separate from his operating line, and that $1 million would be available to secure the lion’s share of the $14 million.

But he likes the milk price where it is. All the fundamentals point to the milk price staying where it is. He thinks about that $1 million in margin money and thinks about what he could do with $1 million if it was operating money and he didn’t “spend” it on marketing.

The risk is this: If the milk price were to drop to $15/cwt., he would be giving up more than $4 million in revenue. That’s a real loss, as opposed to the $1 million in margin money, which is there to secure positions as needed.

This producer has gotten caught up thinking about what the $1 million hedge line of credit means and lost sight of the real dollars at risk. It’s difficult to keep our rational hat firmly in place when the markets are abuzz and prices are good.

Numbers can play tricks with our minds in other ways, too. Let’s say you are trying to protect your price for protein purchases. The trading range for protein has been in the $300-$550 range. After careful management and incremental marketing strategies throughout the year, you are now sitting with a $325 average price for your 2012 protein purchases. You are well within the bottom 20% of the range, and much lower than what your price could have been had you not carefully managed your purchases. You’re pretty happy with that.

On the flip side, if the trading range for milk for the year is $15-$20, and you manage to build a weighted average price of $19, you kick yourself for having achieved “only” $19,” even though $19 is in the top 20% of the trading range. You see the deduction on the milk check and start thinking about what those “lost” dollars could have bought.

It’s this kind of emotion that causes so many dairies to leave so much at risk. True, when prices are high, you may be giving up some real money to protect risk, but as a percent of gross and net, what you give up is not nearly as impactful as what you have at risk. It is the price of protection in this economically uncertain world.

I’ll end with a note from Jim Collins’ best-selling business book, Great by Choice, which I have been quoting regularly in this column. Collins’ observation of successful companies shows that they are successful because they “engage directly with evidence rather than relying upon opinion, whim, conventional wisdom or emotion.” Understanding the empirical evidence is a safeguard against making emotional decisions.

So if you know that your chances of winning the lottery are 1 in 176 million, and you are wearing your rational hat, you probably won’t buy a ticket. (Unless you are buying something else with that $2, like the opportunity to joke and talk about dreams with others who joined in the hoopla.)
If you’d like a copy of Collins’ book Great by Choice, I’ll be happy to send you one if you email me. Just don’t rib me about buying a lottery ticket. Compared to those who didn’t buy one, I had a 100% better chance of winning!

Mark Ludtke consults with dairy producers nationwide concerning their choices for risk and opportunity management. He can be reached by calling 855.334.0700 or at mludtke@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 2012 Stewart-Peterson Inc. All rights reserved.
 

LGM-Dairy Now Two Thirds of CME Futures Volume

Nov 24, 2012

A closer look at the risk management insurance program as the Nov. 30 sales period approaches.

ron mortensen photo 11 05   CopyBy Ron Mortensen, Dairy Gross Margin, LLC and Advantage Ag Strategies, Ltd.

The Livestock Gross Margin (LGM) for Dairy October sales period covered 20.6 million cwt. of milk. This is significant considering that CME Class III milk (December to September 2013) has 30.2 million cwt. of open interest. Once again, the LGM-Dairy concept has encouraged producers to manage risk. Remember, the open interest at the CME includes hedges from dairymen and long hedges from commercial interest and speculators.

Ten million dollars in subsidy money will be available for Nov. 30, 2012, and subsequent months if it is not used in Nov. 30, 2012. In October, $4.8 million was used. The most milk was covered in Wisconsin, Minnesota and California. Wisconsin dairymen covered almost 6.4 million cwt., or 31% of the total. Minnesota was 14.5% and California was 13.3% of the total.

Margins for November will not be set until Nov. 30, 2012, but halfway through the month, it looks like there will be a slight decrease in margins. As of Nov. 15, the low corn and meal margins slipped by $.17 per cwt. The biggest change was in the first few months. The projected margins have flattened out. See the first chart below. The second chart is from October, which shows stronger margins in the first months. Remember, the next time LGM-Dairy can be purchased is Nov. 30, 2012.

November Margins 

Mortensen graph 11 19 12a
October Margins

Mortensen 11 19 12b

Think of 2013 as a long football game. It will take lots of good, sound plays. Each play does not have to be a touchdown. You will have to put together three plays to get a first and ten. Yes, you will need to score, but a consistent game plan can keep you in the game. Coaches, players and stakeholders all need to be on the same game plan. Develop the plays. Review the plays. Execute the plays.

The plays:

Review your operation’s breakeven, feed inventory and financial situation. What financial ratios are important to your lender? An important number in the short term would be your current ratio (divide current assets by current liabilities).

Mitigate feed price volatility. If your operation still needs to make feed purchases, consider corn call options or meal call options—whatever is required.

Sell some milk with cash contracts or futures if prices are over your breakeven. Remember to include an estimate of basis (the difference between the futures price and your cash price) when evaluating sales.

Include milk put options or LGM-Dairy to cover milk price volatility. You will want to have a high percentage of your risk to be covered with options or LGM-Dairy. Why? If margins do get better down the road, you will benefit from higher profits. You need these higher margins in the form of profits to flow to the operation.


Ron Mortensen is principal of Dairy Gross Margin, LLC, an agency that specializes in LGM-Dairy products, and owner of Advantage Strategies, Ltd., a commodity trading advisor. Contact him at ron@dairygrossmargin.com or visit www.dairygrossmaragin.com.

Tried and Failed at Hedging? Reconsider Your Approach

Nov 19, 2012

If you’ve tried hedging in the past and haven’t had the best experience, think again. You may be surprised by all the options that are available.

Katie Krupa photoBy Katie Krupa, Rice Dairy

I recently attended an industry meeting with many successful dairy producers, and to my surprise, when the topic came to risk management, many of them made a similar comment: Tried it once or twice, but never made any money. Sound familiar?

I am always alarmed to hear about producers who ‘tried’ contracting once or twice. This type of statement indicates that their risk management approach was spotty and spontaneous rather than planned and consistent. It also indicates an expectation that is inconsistent with hedging. In order to be successful with risk management, there are several steps producers should follow. Appropriate goals and consistency are among the most important. In this month’s article, I will address the importance of consistency. Next month, we’ll tackle the topic of appropriate goals and expectations.

A good risk management plan should set up your business to be profitable, account for volatility in both the milk and feed markets, and be consistently utilized and reviewed. Unfortunately, many producers who tried hedging in the past have not truly set up a risk management plan. Instead, they simply hedged their milk price because they thought it looked good (with no reference to their cost of production), or the hedged price was higher than the price they were currently receiving, or the price was 20 cents higher than what the neighbor hedged.

Unfortunately, these strategies usually don’t end well. You should be hedging a price that works for your farm’s unique financial situation, you should be managing both your milk and feed risks, and you should be consistently reviewing your plan.

It is important to note that being consistent does not mean always being hedged. You may review your financials and the current market conditions and determine that your best strategy is to remain in the cash market, i.e., not hedge. Even though you are not hedging, you are still utilizing your risk management strategy, and therefore being consistent.

To illustrate the importance of consistency, I have pulled some historical data for Class III put options trading on the Chicago Mercantile Exchange since 2007. The table shows the premium prices for a $13.00, $14.00, and $15.00 put strike price. In order to add some uniformity, I pulled the price for the contract month six months into the future, and I did that every six months. So, on the first trading day in April, I took the prices for October, and on the first trading day in October, I took the prices for the following April. Although this data does not account for every trading month, it does give a good snapshot of the historical prices.

A producer using this strategy would have paid an average of 15 cents per cwt. for the $13.00 put, or 36 cents for the $14.00 put, or 77 cents for the $15.00 put. The bottom half of the chart shows the payment that would have resulted from these contracts. As you can see, there would have been no payments in October 2007 because the announced Class III price of $18.70 was higher than all the put strike prices ($13, $14, and $15). For the months shown below, the only months that would have had a return are during 2009 and early 2010. That is just three out of the 11 months in the table. Although the puts were only in the money (payment due) for three months, the payment amounts were substantial. In fact, the payments in those three months were large enough to result in a positive net gain for the $13.00 put and $14.00 put, and a breakeven for the $15.00 put for all 11 months of data.

I like this chart because it shows how quickly the market can change. If this producer had utilized put options for 2007 and 2008 but not for 2009, he or she would not have had protection when it was most needed. Unfortunately, even the best analysts cannot guarantee the future, so it is important to plan for both the highs and the lows.

If you have ‘tried’ hedging in the past and have not had the best experience, I recommend sitting down with a professional to reevaluate your risks. You may be surprised by all the risk management options that are currently available, and you may find a risk management approach that will suit your business and your personality so that you can consistently protect your operation and survive well into the future.

Krupa chart 11 19 12 copy

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 Katie at klk@ricedairy.com.Visit www.ricedairy.com. There is risk of loss trading commodity futures and options. Past results are not indicative of future results.
 

Have to Buy Feed?

Nov 10, 2012

With fundamentals providing dairies with compelling reasons to be active feed buyers, here are strategy recommendations.

Carl BablerBy Carl Babler, Principal, Atten Babler Commodities LLC

Corn and protein feed end-users continue to face supply and price challenges. Feed procurement decisions must be motivated by current market fundamentals:

• Both global and domestic stocks-to-use/carryout of corn and beans are historically tight.
• Globally tight supplies provide no supply cushion for 2013 new-crop production problems.
• U.S. corn and soybean meal prices are in the upper part of their historical price ranges.
• Regional U.S. corn supplies are very tight due to production shortfalls.
• Aggressive U.S. end-users of corn and beans continue to offer strong basis bids to acquire needed supplies.
• As harvest concludes, a seasonal buying opportunity may be offered.
• U.S. prices have dropped $1.00 + per bu. in corn and $60+ per ton in soybean meal off summer highs.

Until dynamics affecting supply/demand balances change, the above fundamentals provide compelling reasons to be active as a feed buyer. With this in mind, we offer the following strategy recommendations.

Corn Origination

1. Purchase 100% of cash corn feed requirements needed for April through September 2013 now in the spot market and take to your storage or secure commercial storage.

2. In addition to strategy above, contract cash corn for October through March deliveries to be fed and paid for upon delivery.

3. If end-product margins are satisfactory, then milk, hogs or cattle can be contracted or hedged with options to secure a margin and remove corn inventory risk.

4. For all feed corn inventory not involved in a margin lock, hedge with corn put options to manage the downside price risk of feed corn in ownership:

Example - Purchase corn puts to protect the purchased corn (based on Oct. 30, 2012 prices):
1. March, May and July $7.00 put is 28 cents or $10.00 per ton
2. March, May and July $6.80 put is 21 cents or $7.50 per on
3. March, May and July $6.50 put is 13 cents or $4.65 per ton

5. If storage and margin is not available and the decision is to buy corn “hand to mouth” rather than contracting forward, we recommend owning corn calls and buying option protection on the end-product.

Example - Purchase corn calls and stay open in the cash market (based on Oct. 30, 2012 prices):
• March, May and July $8.00 calls are 33 cents or $11.80 per ton
• March, May and July $7.50/9.00 vertical calls are 36 cents or $12.85 per ton

Example - Purchase milk puts and stay open in cash market:
• January through June - buy the Class III $17.00 put for 36 cents

Example - Purchase milk min/max options:
• January through June - buy the $18.00 put and sell January through June $21.50 call for 43 cents

Soybean Meal Origination

1. Contract meal needs through March 2013 in the cash market now (seasonal buy after $60/ton drop).

2. If meal and corn hedges are matched with contracted milk at a satisfactory margin, then meal ownership risk is removed.

3. If meal is contracted forward and margin is not secured, we recommend buying meal put options to manage the risk of meal ownership.

Example - Buy December 2012 meal $475 put options and March 2013 Meal $420 put options for $7.00/ ton premium plus transaction cost to hedge cash contracted meal quantity

With the key motivators being fundamental supply tightness and seasonal opportunity, dairies are encouraged to address their corn and protein needs. The procurement strategy should fit your capabilities relative to cash flow, contracts available in the cash market and understanding of various strategies.

Carl Babler is a principal with Atten Babler Commodities of Galena, Ill. Contact him at cbabler@attenbabler.com or 877-259-6087.

Risk in purchasing options is the option premium paid plus transaction. Selling futures and/or options leaves you vulnerable to unlimited risk. Atten Babler Commodities LLC uses sources that they believe to be reliable, but they cannot warrant the accuracy of any of the data included in this report. Past performance is not indicative of future results. The author of this piece currently hedges for his own account and has financial interest in the following derivative products mentioned within: corn and soybeans.

Dairy Producers Can Benefit from “Productive Paranoia”

Nov 03, 2012

Research shows that business leaders who consistently ask, “What if?” – and then act with productive steps – are bound to succeed.

Stewart Peterson   Mark LudtkeBy Mark Ludtke, Stewart-Peterson

We’ve been getting great response from our discussions of the business book Great by Choice with dairy producers. Jim Collins, the author of Good to Great, offers research-based characteristics of high-performing companies.

In my last column, I talked about “fanatic discipline” as a characteristic of great marketers. This month, I have to talk about “productive paranoia.” That’s because everywhere I go, many dairy producers I talk with, if they haven’t already begun a disciplined risk management program, are unsure what to do right now. There is a large chorus of people saying that the milk price cannot go down. There is also another section of the choir saying that feed prices will only go up. That has producers nervous.

Being nervous for the next year sure doesn’t sound like a fun (or healthy) proposition. And yet “paranoia” is a good thing among today’s top business leaders, according to Jim Collins, when it is “channeled into extensive preparation and calm, clearheaded action.”

In other words, good business leaders can be nervous. And they can turn those nervous feelings into something good by taking action. The “productive” part of paranoia is “preparing, developing contingency plans, building buffers, and maintaining large margins of safety,” Collins writes.

Great marketers recognize that an adverse price move could be right around the corner. They don’t abandon their marketing goals because prices are good. That’s tempting when you are feeding expensive feed and need every dollar you can get from your milk, and everyone is singing The Hallelujah $20 Milk Chorus. If you knew for certain $20 milk would stay around for the next 10 or 12 months, you’d probably do nothing. The productively paranoid among us ask, “What if it doesn’t? What does that mean for my business? What can I do to prepare for a downturn?”

Right now the U.S. cheese price is at a significant premium to world cheese prices. Milk production in the southern hemisphere is said to be going well. What if the European crisis comes to a head and there is a flight of money to the safety of U.S. treasuries, buoying the dollar and hurting exports? What if South America has a big crop and feed prices fall, bringing milk along with it?

For all these reasons, we are recommending that producers put that nervous energy to productive use and get some forms of price protection in place for 2013 milk. The tools and strategies you use can vary depending on your farm’s financial situation.

On the feed side, the trend is still up for corn prices, so there is still the risk of seeing higher prices. Yet, $7.00 and higher per-bushel corn prices have not lasted long in the past. It is said that “high prices cure high prices,” and, in the past, every rally over $7.00 per bushel has eventually been followed by a selloff into at least the $5 per-bushel range. Therefore, there are dollars per bushel of risk and opportunity in both directions from the current corn price of about $7.50 per bushel. Buying the physical corn protects against higher prices, and using tools such as put options can effectively reduce your final price on the physical corn should it sell off.

The point is, Collins’ research shows that those business leaders who consistently ask, “What if?” – and then act on that paranoia with productive steps – are bound to succeed because they are ready for the unlikely events that no one else wanted to think about.

If you’d like a copy of Great by Choice, I’ll be happy to send you one. And, if you’re attending the Elite Producer Business Conference, be sure to look me up there, and we can talk about productive steps you might take for your dairy’s future.

Mark Ludtke consults with dairy producers nationwide concerning their choices for risk and opportunity management. He can be reached by calling 855.334.0700 or at mludtke@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 2012 Stewart-Peterson Inc. All rights reserved.

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