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July 2012 Archive for Know Your Market

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

Risk Management: It’s More than Just Milk

Jul 27, 2012

Producers’ concerns for the future are often eased by examining and hedging the margin between the milk price and feed prices rather than just one side of the equation.

Katie Krupa photoBy Katie Krupa, Rice Dairy

I started this discussion earlier month by introducing the importance of hedging the milk-feed margin.

In this column, I’ll provide some more details to give you a better idea of the current price situation. To review, it is important to hedge both the milk price and feed price to limit your risk exposure to price volatility on both inputs and milk sales. If you hedge only your inputs or only your milk price, you are exposing yourself to price volatility, and therefore not implementing a complete risk management strategy.

In recent days I have received many phone calls from producers who are panicking about higher feed prices. If you are one of those producers, let’s review the current milk-feed margin. The higher feed prices, while scary to see, are less alarming when you look at the relationship between milk and feed.

Below are four graphs, each showing trading prices on the Chicago Mercantile Exchange (CME) since May 1, 2012.

The first graph shows the December 2012 Class III futures contract, which has increased roughly $3.00 per cwt. since May 1. The second, December 2012 corn futures, shows an increase of roughly $2.50 per bu. since May 1. The third, December 2012 soybean meal futures, indicates an increase of roughly $100 per ton since May 1.

The first three graphs have an upward trend that is easy to see. But the last graph, December 2012 milk-feed margin, doesn’t seem to show much of an upward or downward trend since May 1.

The milk-feed margin graph plots the milk minus feed price (the formula is roughly 1 cwt. of milk, minus 45 lb. of corn, minus 17 lb. of soybean meal). This is simply a default model I use to get a better understanding of the milk price relative to the feed costs. It is not a perfect fit for any specific dairy. The milk-feed margin graph shows a variation in price since May 1 but not a clear trend. The price has mostly fluctuated between the $8.00 and $9.00 range, with it recently trading around $8.50.

Many producers call and say, “I guess I should have contracted a couple months ago.” If we compare the milk-feed margin on May 1 to July 26, the margin has actually increased about 40 cents. So, although the feed prices have increased considerably, the increase in the milk price has been strong enough to actually outpace the feed price increase.

Unfortunately, I do not know if the milk-feed margin will continue to increase or will change direction and decline over the next couple of months. Therefore, I recommend that producers take a look at the margin, and see how it compares to their unique farm financials.

For example, the current milk-feed margin for December 2012 is trading around $8.50. That may return a $1.00 per cwt. profit for one farm, while it may be a loss for another farm. If that $8.50 is a profit for your farm, you have some opportunities to either lock in or protect that margin, and effectively protect your profits. This type of hedging is new for most producers across the country, so don’t feel overwhelmed if you are not hedging both your feed prices and milk price.

But I would recommend taking some time to talk with a professional and gain some more knowledge on what your risks and opportunities are relative to milk and feed price hedging.
While it is easy to look back at the past, looking ahead to the future is uncertain and scary. My advice is to take some time to review the milk-feed margin and see what hedge strategies are currently available. I find that producers’ concerns for the future are frequently eased by examining and hedging the margin between the milk price and the feed prices rather than just one side of the equation.

Krupa chart 1   7 27 12
Graph 1 shows the December 2012 Class III futures contract, which has increased roughly $3.00 per cwt. since May 1.












Krupa chart 2   7 27 12
Graph 2, December 2012 corn futures, shows an increase of roughly $2.50 per bu. since May 1.












Krupa chart 3   7 27 12
Graph 3, December 2012 soybean meal futures, indicates an increase of roughly $100 per ton since May 1.












Krupa chart 4   7 27 12
 Graph 4.











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 There is risk of loss trading commodity futures and options.  Past results are not indicative of future results.


Dissecting the Current Milk Market Rally

Jul 23, 2012

As temperatures and prices soar, discussions of dairy herd liquidations grow.

By Will Babler, Atten Babler Commodities

The catastrophic drought of 2012 has propelled corn and soybean prices to new all-time highs. Milk prices have also started to climb, though not as rapidly (Figure 1). This article will look at some of the supply side drivers of the current milk market rally.

Drought Impact
babler feed leading 7 23 12 copy
Figure 1: Source: FutureSource, Atten Babler Commodities.

The July USDA report cut corn yields a full 20 bushels per acre to a 146 bushel per acre, national yield. Many grain producers and private analysts expect additional yield reductions as the hot and dry weather has failed to improve.

This unfolding supply shock has caused a drastic increase in corn and soybean meal prices that, without the corresponding increase in milk price, would have otherwise forced increased pressure for lenders to liquidate many dairy producers. While the relationship of these prices is usually unstable, under these extreme circumstances, milk prices seem to be pushing higher due to a stronger correlation with feed prices.

Babler chart 7 23 12b
Figure 2: Source: USDA, Atten Babler Commodities

Milk prices are also being influenced by reduced supply on a per cow basis (Figure 2). In the short run, the high temperatures are expected to continue to reduce per-cow production levels. Over the longer term, feed quality and feed availability are likely to influence rations and also potentially reduce productivity. It is fair to assume that a portion of the milk price increase is also driven by realized and expected losses in productivity.

Herd Size
babler3   7 23 12 milk cows vs class iii

Figure 3: Source: USDA, Atten Babler Commodities.

Any sustained reduction in herd size has the potential to drive milk prices higher. The current market has been very difficult for dairy producer profitability, especially for those in the West, and discussions of liquidation are very common. The industry has been closely scrutinizing slaughter, replacements and overall herd size. Historically, as herd sizes have peaked and then entered periods of liquidation, much higher milk prices have followed (Figure 3). The last two USDA milk production reports have shown the first potential signs of liquidation since the summer of 2009. Much of the data available has a considerable lag and anecdotal evidence would suggest further herd declines. Taking this into account, the prospects for a sustained decline in the herd, while still not yet fully confirmed, are certainly contributing to the current price rally.

Hedge Considerations

Commodity price volatility has been relentless on dairy producers, and it appears that the coming year will be a difficult one with many trap doors. While we can assess some of the reasons for the rally in milk prices, it is much more difficult to anticipate the factors that may lead to a rapid change in the trend. This is especially true when contemplating a grain market that is working to ration demand.

It is within this environment that dairy producers should lean on option-based hedging strategies. On the feed side, a focus should remain on strategies that cap out feed prices while leaving all of the downside open.

On the milk side, producers should look to either minimum price strategies or min/max strategies. Min/max strategies should leave plenty of upside opportunity on milk to allow for a favorable margin if prices improve. In all cases, producers should look to maintain matched hedge positions to avoid getting stuck with high-priced feed if the market collapses, or to avoid being capped out on milk without also having a workable feed price secured.

Will Babler is a principal of Atten Babler Commodities of Galena, Ill. Contact him at 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.

Preparation Pays Off

Jul 12, 2012

A lesson in preparing dairy producers for what might happen later this year.

Stewart Peterson   Mark LudtkeBy Mark Ludtke, Stewart-Peterson

An icy-cold story of preparation and survival might be refreshing amidst this summer’s heat. In his best-selling book, Great by Choice, Jim Collins tells the story of Roald Amundsen, the first explorer to reach the South Pole and survive the trip.

The secret of Amundsen’s success in 1911 was preparation. He had eaten raw dolphin meat just to see if he could do it in case he became shipwrecked. He had spent time with Eskimos, learning how to avoid excessive sweating that could turn his clothes to ice.

“You don’t wait until you’re in an unexpected storm to discover you need more strength and endurance,” Collins writes about Amundsen’s philosophy. “You prepare with intensity all the time, so that when conditions turn against you, you can draw from a deep reservoir of strength.”

Amundsen’s trek into uncertain conditions parallels dairy producers’ journey into uncertain milk and feed markets. Internet news sources have been abuzz with news of the latest USDA crop report, weather and crop conditions, and speculation about what impact each day’s developments will have on milk and feed prices. I could add my opinions and the opinions of our advisory team to the piles of commentary. However, I thought it might be more instructive to step back and look at patterns, and the kind of preparation that pays off.

First, let’s look at developments in feed prices—corn in particular. All the fundamentals for corn this year, including USDA’s Planting Intentions Report and progress reports, have pointed to a big crop and affordable feed for 2012. Despite this conventional wisdom, our strategizing back in February had clients buying call options for July and August corn for feed, and in April we recommended calls for September – December corn feed needs (See Electronic December 2012 Corn Futures Chart).

Stewart Peterson chart072012

Now, at the time we had recommended buying these calls, some questioned why. “All the fundamentals point to a big crop,” they reasoned. “My gut tells me save the money on calls. . . .”

True. And if you’ve read this column through the years, you know that it is our philosophy not to make recommendations based on market outlook alone. There is just too much risk in that approach.

Early in 2012, no one knew how high or how low feed prices would go for the year. Tight ending stocks meant good weather and good crops were needed to keep prices low. Unless you were able to predict the weather with extreme accuracy, there was just no way to know.

So, facing uncertainty and risk, we looked at all the possible scenarios, and we assumed that any one of them could happen. We created strategies for each scenario and we showed our clients the math. Together, we looked for the sweet spot of protection—one that offered the best protection for the most reasonable cost, for the most logical scenarios, with an exit strategy in case one of the unexpected scenarios happened.

Why was the scenario planning process so important for feed this year? Because the potential swings for feed prices were so great. When we analyzed the average percentage rallies and declines of the last six crop years, we could see that $8.00/bushel corn and $3.50/bushel corn could not be ruled out, and neither could $400/ton soybean meal or $260/ton soybean meal. For dairy producers buying all their corn and protein needs, the difference in the size of their 2012 feed bill was huge.

So, after doing the math, our clients could choose the price protection strategies that best fit their risk tolerance. Many of them chose calls for fourth-quarter corn, as described above. They are now in a position to have a weighted average price for corn of under $6, even if the prices soar all the way up to $12. And, had the rain fallen and prices fallen along with it in anticipation of a bumper crop, there was also a strategy in place to exit those calls. Before the heat was on, the producers had analyzed the numbers, prepared for various price scenarios, and chosen the price scenario that best fit their risk tolerance.

My point here is NOT to say any particular recommendation was the right one. It is to illustrate the strategic process. Why? Because a similar situation is shaping up for milk, and producers need to do a little more math now to prepare themselves for possible scenarios ahead.

Milk price scenarios

The big picture prediction for 2012 milk was that prices were going to eventually fall apart. Milk production had been strong right up to the recent record heat wave. Many producers had contracted milk in some form, fearing prices would crash. If producers who have contracted milk have not prepared strategies for exiting those positions, they could find themselves locked into lower prices as feed prices climb.

For example, if you are holding positions for August-December milk, it will be important for you to choose a trigger price at which you will exit your futures positions, and replace it with a put option that will offer protection while allowing you to take advantage of higher prices.

Or, if you have a fence position in place, buy back your sold call options. If your milk is sold via forward contract, consider a call option strategy. Do it soon, before the next wave of news hits and it’s too late.

Yes, analyzing all these price scenarios and developing strategies for every potential price direction takes work. But in the face of uncertainty, there is no substitute for preparation.

Prepare now for what might happen later this year.

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

Market Scenario Planning is a service mark of 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 2012 Stewart-Peterson Inc. All rights reserved.

Dairy’s Six-Legged Milking Stool

Jul 06, 2012

A look at the additional factors that influence feed prices today.

ron mortensen photo 11 05   CopyBy Ron Mortensen, Dairy Gross Margin, LLC

In the old days (5 years ago!), when we talked about the price of feed, we talked about the three-legged milking stool. Corn and soybean meal prices were basically determined by three things: feed demand, exports and weather.

Today feed prices are being influenced by six things – yes, a six-legged milking stool. The legs are exports, feed demand, weather, ethanol production (including the price of gasoline), China and the value of the dollar. Let’s talk about each issue.

A cheap dollar helps dairy exports around the world but it also helps others looking for feed see U.S. grain as cheap.

China’s demand for soybeans has become almost overwhelming. Now China takes nearly two-thirds of all the soybean exports in the world. Plus, they purchased a sizeable quantity of U.S. corn (when prices were much lower).

Ethanol production has grown exponentially the last few years. This year is different as we have not seen any new plants. In fact, lower gasoline prices and slack demand from the driving consumer has slowed ethanol demand. In the last few months, we have seen a few plants close, or go to 65% production. Some have gone to “hot idle” (just keep the vats warm so they can bring it back online quickly). Also, this year the big export demand for ethanol to Brazil has slowed.

Why is important to understand the ethanol slowdown? When an ethanol plant slows down, it can come back online very fast. It is not like killing a sow or a cow, which reduces feed demand for a year. Long term, ethanol use should be capped until the U.S. consumer drives his or her car more miles or when E-15 becomes more readily available.

The weather – well, it was the fifth warmest June in history. Dry conditions have impacted production in southern Illinois and a large part of Indiana. (See map which shows percent of normal rainfall for June 5 to July 5.)

Mortensen chart   rainfall percent juen 5 to july 5 2012 copyFor feed demand, the USDA did provide some data in the grain stocks report on June 29. It showed corn stocks at 3.148 billion bushels. This was close to expectations and implies feed use during the third quarter of the marketing year was close to last year’s number. There is less corn available for feed for the fourth quarter, so presumably there will be more wheat feeding.

The stocks report showed lighter stocks (on a proportional basis) in Illinois, Minnesota and Nebraska compared to last year. There are implications of tighter basis levels for Illinois and surrounding states because of the sizable processor demand centered in Decatur, Ill. These tight basis levels could continue if the Eastern Corn Belt crop size keeps shrinking.

For exports, the U.S. may be saying, “Thank goodness Brazil grew a huge corn crop.” While price has recently reduced the pace of U.S. exports, there is a large, cheaper crop available from Brazil. This will be a welcome supply for buyers seeking a source of supply in the face of the potentially smaller U.S. crop

Over on the soybean side of things, reduced production in Argentina and Brazil is having a big long tail. Reduced supplies down south means increased demand up here for both whole bean exports and crush. Many think soybeans and meal will be tight until February of 2013 as the U.S. will need to supply the world. This makes the current US. crop in the field very important. It will take very large South American production to make the soybean market more comfortable with supplies.

Ron Mortensen is a founder of Dairy Gross Margin, LLC, which was formed in 2006 to sell Livestock Gross Margin Insurance to dairy producers. Mortensen’s firm is now licensed in 23 states. He is also president of Advantage Agricultural Strategies, Ltd., which he founded in 1985, to provide individual risk management advice for farmers and agribusiness using futures, options and cash trading strategies. Contact him at 515-570-5265 or


Why It’s Important to Hedge Your Milk-Feed Margin

Jul 02, 2012

Milk prices are improving, but, in reality, the milk-feed margin is shrinking. Protect your profit margins now.

Katie Krupa photoBy Katie Krupa, Rice Dairy

Given the current volatility for milk and feed prices, now would be a good time to review the importance of hedging the milk-feed margin. Some people only hedge their milk price, while others only hedge their feed price. Due to increasing price volatility, it is important to understand and manage both the milk and feed prices.

While there are several different strategies you can employ to hedge your milk, the concept and process is fairly consistent. Producers make milk and sell that milk. Risk management is used to protect the future sale price of that milk.

On a broad scale, feed hedging is more popular for dairymen than milk hedging, but it often happens more naturally or even without notice. Many producers will book several months’ worth of purchased feed with their supplier, grow a portion of their feed needs, or even fix their basis.

While these types of hedges may be done without a lot of preparation, they are still hedges and will ultimately impact the feed price.

When hedging either milk or feed, you want to make sure you are managing both sides of the equation: milk and feed. For example, if you only hedged your feed price, and then milk and feed prices declined drastically, you can end up with high feed prices (which are hedged) and low milk prices. Or if you hedge only your milk price, then prices move significantly higher, you may be stuck with low milk prices (hedged) and high feed prices.

Both of these scenarios could have been avoided if the milk-feed margin was analyzed and both the milk and feed prices were hedged when the opportunity existed. Although it is not necessary to hedge your milk and feed on the same day, it is important to understand the current relationship between the milk price and feed price, and it is important to be realistic about your price volatility risk. In other words, if you catch yourself thinking, “There is no way the milk price will go to $13.00,” that should not factor into your risk management strategy. Both milk and feed prices can drop or rise rapidly, and without a foreseeable reason, so create a strategy that works at all price points.

So where do you start? I suggest starting from scratch and assume you have nothing hedged for milk or feed, and that includes no home-grown feed. To get a better idea of what our opportunities are to hedge milk and feed, and the margin between the two, I look at a milk-feed ratio.

In order to do this, I convert the protein and energy requirements in your ration to just corn and soybean meal equivalents. This milk-minus-feed calculation gives us an idea of where the milk-feed margin has been in recent years and where it is currently trading in the futures market. While each farm is different and their price needs will vary, we can get a pretty good idea of what the future opportunities are by looking at this margin, and some basic farm financial data.

Recently the corn futures price for the upcoming month has increased nearly $1 per bu. in less than two weeks. While the milk futures price has also increased, it has not increased as quickly as the corn price. This discrepancy had resulted in a decrease in the milk-feed margin. I point this out because many producers are relieved to see milk prices improving, but in reality, the milk-feed margin is shrinking. While this may not be an issue if your feed prices are already fixed for the upcoming months, if you have to purchase some, or all, of your feed needs, your profit margins may be negatively impacted.

To get started I suggest working with someone who has an understanding of both your milk and feed price risks for the upcoming months and upcoming years. A professional should be able to help you get a better understanding of your risks, and once you understand your operation’s risks, you can then work to manage them. Producers who are managing the milk and feed risks often hedge further out, and are even hedging 2013 prices. Your risk management choices are plentiful, and while that might seem overwhelming at first, it allows you to get a better hedge strategy for your unique operation.

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 There is risk of loss trading commodity futures and options. Past results are not indicative of future results.


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