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December 2012 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.

Capture the Upside or Protect Your Profit?

Dec 17, 2012

Although no one likes to miss out on the market's upward movements, a strategy that protects the price from falling often means missing out on some of the market's upside.

Katie Krupa photoBy Katie Krupa, Rice Dairy

Last month I discussed the importance of consistency in your risk management strategy but noted that another key to a successful risk management plan in setting appropriate goals. When discussing risk management, I often hear dairymen say they “lost” money in their past risk management endeavors. When I hear that statement, it is typically because the producer’s goals and expectations were not properly established and reviewed.

When establishing a risk management strategy, your goal should be profitability for your business. Or, to put it another way, your goal should be to make money as a business (as opposed to simply making money on your trades/hedges). As a dairy producer, you produce a product, and you have a cost to make that product. Whenever you can sell that product for more than your cost to produce it, you make money. So your primary goal in risk management should be to receive a milk price that exceeds your cost of production. When you do this, you make money, even if that means you missed out on some upside potential in the market.

For example, you may have hedged your Class III milk price at $18.00 with a futures contract, so your price was fixed at $18.00. If your Class III equivalent cost of production was $17.00, that would be an estimated return of $1.00 per cwt. Now, if the Class III price settled at $10.00 or $25.00, you would still receive the $18.00 price, and still make money as a dairy business. Frequently, people think they are making money when the Class III price goes to $10.00 and losing money when the Class III price goes to $25.00. But in reality, you are making money in both situations because you hedged your milk price at $18.00, and your costs were $17.00. In this example, your goal was to make $1.00 per cwt. and to be profitable. That goal was met.

Rather than protect profit, your goal may be to protect yourself against devastatingly low milk prices. Most commonly this can be done by purchasing put options for Class III milk. A put option will provide a level of protection for a premium payment. If the milk price moves significantly lower, you will be protected, but if it moves higher, you will receive the higher price (less your premium payment).

Many think of this type of strategy as catastrophic insurance. Many times with this strategy, there is not much profit that is protected, but the goal is more often to protect the break-even, or even slightly below break-even at a sustainable level. Although this strategy allows for you to benefit from higher prices, you still need to pay the premium for the downside protection. At first, it may be frustrating to pay that premium when the milk prices are higher and you did not need the protection. But like an insurance policy, you pay the premium and hope not to use the coverage. If the milk price is higher than your level of coverage, that ultimately means more money in your milk check.

Although no one likes to miss out on the upward movements of the markets, when establishing a risk management strategy to protect the price from moving lower, it often means having to miss out on some of the market’s upside. It is important to remember that you made the decision to miss out on some upside because you need to protect against the downside and operate a profitable business. As the old saying goes, no one ever went broke making money. Keep your eye on the long-term goals, and keep running a profitable business and you will successfully remain in the 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. 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.

Use a Seasonal Approach to Buying Feed Protein

Dec 08, 2012

Consider buying soybean meal now for winter and looking to buy summer meal in the February/March 2013 periods.

Carl BablerBy Carl Babler, Atten Babler Commodities

Commodity prices are constantly being affected by a growing number of domestic and global market fundamentals. A dairy’s commodity procurement manager continues to face a very challenging assignment, especially when making purchasing decisions regarding feed protein needs. Because soybean meal is often the price driver of other feed protein prices, for this article we will focus on a buying strategy for soybean meal.

The meal market since 2003 (shown below) has posted all-time historical high prices: in 2008 at $455 per ton and again in 2012 at $551 per ton. Each price peak was a result of a $200-plus per-ton price increase followed by a $200-plus per-ton decline. These price moves dramatically influenced dairy ration costs and surely have got the attention of those responsible for feed protein buying decisions. With price movement of the past 10 years seemingly becoming the expected norm, it is good to know there is a practical approach that can be followed when buying meal.

Babler 12 11 12 a

Source: FutureSource

The Seasonal Price Chart for Soybean Meal (see below) shows relative price levels for given periods of the 12-month calendar. 

Babler 12 11 12 b
Source: Atten Babler Commodities

Soybean meal has been known for many years as a commodity market with a strong seasonal price tendency. The chart above provides a simple visual of the best time of the year to buy bean meal. A seasonal approach to buying meal would direct the purchase of meal needs for winter to be procured in October/November and the meal needs for summer be procured in February/March each year.

While the past is no guarantee of the future, the seasonal price pattern provides a very clear expectation for buying opportunities to be offered in the February/March and October/November calendar periods each year. This seasonal approach does not depend on a price level to trigger the purchase; thus, there is not a price that is expected, rather just a time of the year in which the price has historically been opportune for a buyer.

Buying soybean meal based on its seasonal price pattern is a simple approach that provides a buyer a foundational reason for action. It is advised to analyze the fundamental conditions of the market and use this analysis along with seasonality.

Babler 12 11 12 c

Source: FutureSource

Part of “Knowing Your Market” is understanding your market’s seasonal price pattern. The July 2013 Meal (chart above) shows that price direction has followed the expected seasonal pattern since it began trading in January 2011. Consider buying soybean meal now for winter and looking to buy summer meal in the February/March 2013 periods.

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 commissions and fees. Selling futures and/or options leaves you vulnerable to unlimited risk. Transaction cost used throughout this report includes both commissions and fees. 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. Unless otherwise stated the information contained herein is meant for educational purposes only and is not a solicitation to buy futures or options. The author of this piece currently hedges for their own account and has financial interest in the following derivative products mentioned within: soybean meal.

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