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February 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.

To Act or Not to Act? It’s Your Question to Answer

Feb 26, 2012

Sideways markets tend to keep many producers on the sidelines when it comes to risk and opportunity management. That’s not going to protect your equity.

WDE D10106a DoorninkBy Liz Doornink, Stewart-Peterson
In the sessions and the hallways of the Dairy Business Association meeting in Wisconsin last week, I talked with dairy producers about their opinions of the current dairy markets. Here’s my general takeaway: Sideways markets tend to keep many producers on the sidelines when it comes to risk and opportunity management.
In the days since that conference, as the markets started to head south, producers I talk with are starting to question whether or not they ought to be "doing something," and what value they would get for the time and cost of marketing. I’ll address that, but first, here is a summary of the recent market trends:
  • January milk production was up 3.4%, which had the markets all a-buzz last week. That is the largest year-over-year increase for January milk since the 5% increase seen in 2006.
  • The last two months cow numbers have seen strong increases with 10,000 head added to the herd in December and another 13,000 head added to the herd in January. This is the highest rate of growth over a two-month stretch since Dec. 2010 to Jan. 2011, when 35,000 head were added to the US herd. Total cow numbers are still 99,000 head below the 2008 high of 9.335 million head.
  • Total cheese stocks for January were estimated at 977.835 million pounds which is down 7% year-over-year and down 1% month-over-month. This is the lowest January figure going back to 2009 when total cheese stocks came in at 865.259. January is now the fifth consecutive month that stocks have declined year-over-year.
  • The January Livestock Slaughter report showed 264,000 head removed from the herd. This was unchanged compared to the previous month and up less than 1% compared to January 2011. This marks the third consecutive month slaughter has been up compared to the previous month, but the rate has declined during the same time period.
  • Looking forward, watch for the March 9 dairy export report, as exports remain crucial to sustaining milk prices. The next commercial disappearance report comes out the morning this column is distributed, Tuesday, February 28.
For a complete summary of the markets via Dairy Today video, click here.
What to be thinking about:
Those producers who are engaged in a strategic, disciplined marketing program for milk and feed are likely prepared for a market downturn. Typically, at this point in a price cycle, a strategic marketer will want to get more aggressive about pricing, to try and protect the best price possible, for as much milk as possible, for as long as possible. How you do that depends on a variety of factors:
  • your risk tolerance,
  • your cash flow,
  • your level of comfort with the various tools available.
 
On the feed side, we’re continuing to watch the spread between milk and grains, looking for opportunity to book feed.
Should I act?
Producers always ask us why they should act now vs. later. I always tell them that we’re not in the business of predicting, we’re in the business of informing and preparing. Up until this week, we’ve had the kind of up or sideways markets that create indifference when it comes to preparing marketing strategies. We can’t always predict with 100% accuracy, but we know from history that the market has the potential to go from sideways to down in a hurry.
I can’t tell you whether you can ride out a downturn or not. That’s a business decision that may involve your lender. And that reminds me of another conversation I had at the DBA meeting.
A lender talked with me about the changing face of agricultural credit and that loan officers now want to see that dairy producers have some sort of strategies in place to protect their prices. That’s the point I want to drive home. Sitting on the sidelines is not going to protect your equity. What’s more, dabbling in the market to protect a certain price for a certain period of time is not a sound, long-term business strategy.
To be fully prepared for whatever is next, I encourage producers to sit down with your lender and business partners and talk about your business goals, your risk tolerance, and what opportunities lay ahead if you manage your risks and opportunities well. Then decide whether marketing has a place in your business.
Of course I’m biased because I believe it does have a place. In my experience as a producer, a consistent approach to marketing is what saved us during the ‘09 downturn. Aside from my own experience, I can show you charts dating back to when Stewart-Peterson Inc. first started advising dairy clients, and those charts depict how consistent, disciplined marketing over time protects against the devastating milk price lows even as you track close to the market on the way up.
Marketing is not something you decide to do with a little bit of your production for a short period of time. It’s a management philosophy. So, if you’re wondering, "Is creating a risk management plan worth it? Will I be OK if I just ride this out?" sit down with your lender and a strategic advisor, assemble the facts and prepare to take control of an uncertain situation.
Liz Doornink is in Dairy Business Development for Stewart-Peterson, Inc. Liz can be reached by calling 800.334.9779 or at ldoornink@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.

Strategies for Information Overload

Feb 17, 2012

Bombarded with the daily flow of news and information? Keep your eyes on margin management and use available tools.

 
ron mortensen photo 11 05   CopyBy Ron Mortensen, Dairy Gross Margin LLC
 
In this technology-driven world, the news just keeps coming at faster and faster speeds. And there is more and more of it. Email, texts, newsletters, magazines and good old word of mouth all bombard us with news. Sometimes it is good, sometimes it is bad. When the market is down, all we hear is bad news. When the markets are good, all we hear is the good news. European news, Greece, the economy, unemployment and politics seem to dominate the major news channels.
 
What to do with the information flow? Some may be important, while some is just noise. How do you separate the wheat from the chaff?
 
Sometimes the information flow is a way to confirm what has happened, but it is not a good predictor of the future. Look at the news and see how the various markets respond to that news. Sometimes markets respond to bearish news with a bounce. Sometimes bullish news gets a big push lower in the markets. It comes back to a market classic—buy the rumor, sell the fact. In that case, maybe it is time to move on and pay attention to the next market moving piece of information.
 
Keeping a Steady Course
 
Given the constant flow of information and opinions, what are you to do? Sometimes it is best to worry simply about your operation and what your goals are. Keep watch over your profitability, your margins. Forget about how the information world is bombarding you with all sorts of bullish and bearish factoids!
 
The tools are out there--options on milk, corn and soybean meal are all available to you. Without worrying about market highs and lows, simply think about protecting cash flow. A simple options strategy will protect from milk prices moving lower and leave the top open if prices move higher. If you buy a call option on corn, you will be protected if prices move higher and benefit in the cash market if prices move lower. The bottom line is--manage your margin. LGM-Dairy is not available at this time but similar risk management results can be achieved by using options. The benefit of LGM-Dairy is the cost of the premium is cheaper.
 
Feed Facts I - South American Weather 
 
Weather in Argentina and southern Brazil is having the biggest impact on potential world feed supplies. Rainfall for December registered 2 to 4 inches below normal for most of Argentina and southern Brazil. This was worse than the drought of 2008-2009. In January, southern Argentina received above normal rainfall, but the main growing areas received near normal rainfall. So far in February, rain for Argentina has been near normal. Temperatures have generally been normal or above normal. Most traders believe Argentina has stabilized. The risk is second crop corn and soybeans will need good rains until April.
 
Southern Brazil and Paraguay are now the areas of concern. Rainfall departures from Dec. 1 to Feb. 12 indicate most areas in Parana, Rio Grande do Sul and Paraguay have had rainfall deficits of 5 to 9 inches. The trade will continue to monitor reports from this area. If we do get a significant reduction in the soybean crop in South America, it will force the market to bid for more soybean acres in the United States. 
 
Feed Facts II - USDA Baseline Projections
 
As usual, the USDA publishes long-term estimates in February. Most traders ignore them because this is not based on any survey. The markets may trade the information for a few days. Highlights in the USDA baseline projections for 2012 include projected corn planted acres at 94 million with 86.8 million harvested. Yield is projected at 164 bu./acre, making a 14.2 billion-bushel corn crop. Projected ending stocks would be 1.68 billion bushels versus this year’s current estimate of 801 million bushels. Soybean planted acres are projected at 74 million acres, with harvested at 73.1 million acres. Using a yield of 44 bu./acre gives a 3.2 billion bushel crop and ending stocks of 209 million bushels.   
 

Is It Too Late to Hedge Milk Prices?

Feb 13, 2012

Put options, feed price management -- there are strategies producers can employ today to protect their price from moving even lower. But also be prepared for when profitable hedging opportunities once again emerge.


Katie Krupa photoBy Katie Krupa, Rice Dairy

In recent weeks, the milk market has moved significantly lower, while the anxiety among dairymen across the country is moving significantly higher. Current milk futures prices are below breakeven levels for many dairymen. If this is the first time these producers are looking at risk management strategies, unfortunately their current opportunities aren’t that great.

So what can producers do now to protect themselves? Below are several strategies and thoughts to keep in mind.

Protect your milk price from moving lower. Although the current Class III futures price for March and April isn’t very attractive (currently around $15.60), it is important to keep in mind that this price could move another $2-$4 lower. While this drastic of a drop is not likely, it has occurred before (remember 2009?). Rather than locking in the price and missing out on any possible upside, I recommend buying a put option to protect the price from moving lower. Currently a Class III $15.00 put option can be purchased for about $0.25 per hundredweight for March and April. That would offer net price protection at $14.75 ($15.00 – $0.25) Class III. I know that $14.75 isn’t a price that meets or exceeds break-evens for most dairymen, but this type of price protection should be looked at like catastrophic insurance. Coverage at this level may enable your business to survive if the milk price dropped to $10 or $12 per cwt.

Make sure you are protecting your margin. While it is very important to protect your milk price from moving lower, it is also important to protect your feed prices from moving higher. If you grow most of your feed, you are somewhat insulated from price changes in the feed market – at least until next harvest. For these producers, I typically just try to protect their protein needs. If you purchase most of your feed, typically your feed price is completely unknown 30-60 days out. So what do you do? You may have some hedging opportunities with your feed suppliers that are worth looking into, and you have numerous contracting strategies available through the Chicago Mercantile Exchange (CME). Although hedging on the CME does not provide a perfect hedge, it does provide a good hedge.

Make sure you are prepared for the next price upswing. What will you do if Class III futures rally and move up $2 within the next month? Do you have an account established with a broker, co-op or milk plant? Do you know your breakeven Class III price? We have experienced many milk-price cycles in recent years, but still many dairymen become complacent when the milk price is at a profitable level. They tend to think that the milk price will stay high, or at least stay high enough. While I wish that was true, we both know it’s not. Going back to the insurance analysis – you need to purchase your insurance before the car accident, medical issue or house fire. You can’t get coverage after the incident has occurred. If the milk price is low, at least become prepared for when the milk price is again high. Take some time to talk with risk management professionals and learn more about available risk management strategies. 

When establishing risk management strategies, it is very important to be proactive rather than reactive. When the market offers you an opportunity to hedge or protect a profitable margin, take it! For months, we have seen really good hedge opportunities available to dairymen, but sadly many did not take advantage of those opportunities. There are strategies that producers can employ today to protect their price from moving even lower, but my biggest piece of advice is to be prepared for when the profitable hedging opportunities once again emerge.

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 klk@ricedairy.com.Visitwww.ricedairy.com.

Calculate the Cost of Futures and Options

Feb 06, 2012

How much capital is required by a dairy when using futures and options strategies to manage its milk price?

Carl BablerBy Carl Babler, First Capitol Ag

Informed dairymen are increasingly comfortable with the following realities:

  • ·         There is a cost to any form of commodity risk management.
  • ·         It takes both initial premium and working capital to use futures and options strategies for milk price risk management.
  • ·         Cash and operating accounts are commonly insufficient to fund milk hedging strategies.
  • ·         A separate line of credit is required to properly fund milk hedging activity.
  •  
The amount of capital required for a dairy to meet the financial obligations of holding hedge positions is dependant on three prime variables:
1.       Hedge strategy - There are three general types of hedge strategies commonly used by dairies, and they each have distinct financial obligations associated with them:
·         The straight long (purchased) put strategy is used to establish a minimum price. It requires only the cost of the premium and no margin obligation is incurred.
·         The long (purchased) put combined with the short (sold) call is used to establish a min/max “fence” strategy and requires both a premium and a margin obligation on the sold call in the strategy.
·         Sold futures are used to “fix” a price and require an initial and ongoing margin obligation.
The marginable strategies have unlimited financial exposure as there is risk that the market may move dramatically opposed to the position requiring producers to meet margin calls through the duration of the position. At term the position will be cash settled against the announced USDA price for the given month, resulting in the position’s final P/L with all excess margin return to cash in the dairy’s hedge account.
2.       The duration and volume, where the larger the position and the longer the position is held the greater the exposure to time and price volatility. This increased exposure results in a larger potential margin obligation.
 
3.       The amount of negative price-change “stress” relative to the strategy that is incurred during the duration of the position directly impacts funds required.
Knowing the variables that contribute to the financial obligation of a hedge position, it is therefore possible to conduct a margin stress test for a dairy and thus observe the total possible financial obligation that a dairy may incur. 
For example purposes, let us apply a “Margin Call Stress Test” to a typical 1,000-cow dairy using the different strategies or combination of strategies discussed above to compare and define, “How much capital is required by a dairy when using futures and options strategies to manage milk price?”
 1,000 cows for 100% coverage for 12 months showing the credit line needed per head:
  1. $15.25 Minimum Price Put option hedge: Total $125/hd
·         12-month strip of $15.25 puts for 0.40/cwt. premium: 13 contracts/mo x 12 months x 0.40/cwt. / 1,000hd =  Total $124.80/hd
        2$16/$20 Min/Max “fence” hedge: Total: $985/hd
·         Premium: 13 contracts/mo x 12 months x 0.30/cwt. /1,000 hd = approximately $93.60/hd
·         Initial Margin: approximately $78/hd to $234/hd
·         Stress margin: short $20.00 calls at a $22.00 stress = $625/hd
·         Total: $985/hd
        3. $17 Fixed Price Hedge with sold futures: Total: $1,794/hd
·         Initial margin: 1,500/contract x 12 months x 13 contracts/mo/1,000 hd = $234/hd
·         Stress test if futures would move from $17.00 to 22.00: $1,560/hd
·         Total: $1,794/hd
The range may be from $125 to $1,800/hd but, in practical terms, by combining strategies and managing duration and coverage, one can cut this down to $1,000/hd or less. For instance, consider the example of a 1,000-cow dairy with a $750,000 hedge line of credit ($750/hd). If they wanted to do all futures for 12 months on 100%, they would be well short of protecting against a $5/cwt. move. They could, however, still get a significant amount of coverage by mixing and matching a strategy that fits within their credit capacity -- in this case, going 90% covered and leaning more heavily on option strategies.
Hedging a 1,000 cow dairy with a combination of strategies
·         30% puts, 50% min/max, 10% futures
·         Total = 30% x 124.80 + 30% x 985 + 10% x $1,794/hd = $709/hd
Consider if the dairy’s line was only for $550,000, the positions could be the same strikes and strategies but reduced from 12 months down to nine months:
Hedging a 1,000-cow dairy with hedge duration reduced from 12 months to nine months
·         Total = $709 x 9/12 = $531/hd
The bottom line is that, for every 1,000 cows, a good rule of thumb is that a dairy needs a hedge line of credit of approximately $1 million if it wants to make use of all the available hedging tools. It is also critical to note that stress tests can’t take into account every possible price scenario.
Lenders must be willing to expand the line as necessary if futures prices run beyond initial stress levels to allow the dairy the ability to hold positions to term while waiting out the cash flow mismatch. Significant losses can occur if marginable hedge positions can’t be held to settlement due to a lack of credit. Fortunately, greater numbers of lending institutions nationwide are providing such hedge lines of credit to producers that following strict risk management policies. This is allowing more and more producers to take advantage of the best available tools, whether marginable or not, to capture opportunity and minimizing risk.
Carl B. Babler is a consultant and senior hedge specialist with First Capitol Ag in Galena, Ill. He has been involved in the futures industry as a broker, educator and hedger since 1975. Babler holds master’s degree from the University of Wisconsin-Platteville and completed agribusiness course work at Harvard University. You can reach him at 1-800-884-8290 or cbabler@firstcapitolag.com.

 

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