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February 2014 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.

Protect Your Milk Price in Either Direction

Feb 20, 2014

Whether milk prices rise or fall, the Livestock Gross Margin for Dairy program is a good choice for managing risk. Here’s why.

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

Managing risk involves answering questions regarding a dairy’s financial situation. What is your break-even? What do your cash flow projections look like? What milk price does it take to meet your objectives?

These questions are a little different than market-oriented topics. That is another can of worms. Are milk prices in an uptrend? Is demand growing or shrinking? Are there new highs in milk prices (or new lows in feed prices) that should be considered in a marketing plan?

In answering both the financial and market questions, we have always talked about blending marketing tools to reduce risk for your dairy operation. For example, the blend could be up to 33% in forward contracts, 33% in USDA’s Livestock Gross Margin for Dairy program (LGM-Dairy) or put options and 33% open. The reason for the mix: If prices go higher, you only have 33% sold. If prices go lower, you have 66% covered with LGM-Dairy (or put options) and futures. Blending provides the opportunity for managing financial risk, while still benefitting from strong prices if they occur.

LGM-Dairy and options strategies have worked great for the past few months. You may have paid a small premium. But the market moved significantly higher, giving you a big cash flow boost over the minimum price protection from the LGM product.

The last few months were a big win for those of you who set up the marketing strategies with something open on the top. Why is this important? Because everyone needs to earn back some of the losses for the past tough years and/or build cash reserves for the future.

A picture seems to say it all. Margins are good from a historical perspective. How long they last is still an issue. This chart does tell us, once we get to the high end, that margins do move lower. Selling into a big discount or lower prices can be hard. The advantage of using LGM or options is that, if the milk futures markets do move higher, you do not get trapped. If markets do move lower, you have coverage.

Mortensen graph 2 20 14

 

The big question: What if I could take these margins and have a minimum guarantee? Would it give me good cash flow?

A final thought: It can be hard to sell into a discounted futures market. This is the situation right now, with milk prices lower almost every month for the next 10 months. The discounts can turn out to be correct, and cash milk prices can go lower. However, prices can climb higher if strong demand continues. LGM-Dairy or options are a great choice. If prices go lower, you have coverage. If prices move higher, you can capture the gains.

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

Cull Cows Have Ceilings, Too

Feb 14, 2014

Cull cattle prices are at record highs. Here’s how to hedge cull cow and steer sales.

WarrenWagner Stewart PetersonBy Warren Wagner, Stewart-Peterson Inc.

When the market offers historically high prices for any commodity, it is a good idea to put protection in place, even if your bias is that the price cannot go down. That is the case for cull cattle prices right now.

Milk and feed price risk management get the lion’s share of attention; meanwhile, cull cow and steer sales have become larger line items for dairy producers. It’s possible to hedge this production.

Here’s how it works:

There is no direct hedge for dairy cull cattle prices, so a "cross hedge" is used. In this case, the market we use is the Live Cattle (LC) market. As you can see from the chart below, dairy cull prices and LC futures track fairly closely.

Live Cattle futures are much more volatile than dairy cull prices, in both direction and magnitude of price changes. Volatility has increased in recent years, and, as a result, there are times when the markets do not move in sync. So, for this reason, selling LC futures to lock in dairy cull prices is not the recommended approach. A simpler and more worry-free approach is to buy LC put options.

S P Live Cattle vs Cull Cull 2014When you buy a put option, you are protecting the value of a commodity you intend to sell at a future time. Buying put option gives you the right (but not the obligation) to sell a futures contract at a certain price (called the "strike price"). That right comes with a cost—a premium.

Here is an example of how a put option can protect cull prices:

One LC put option contract covers 40,000 lbs. Let’s say you as a dairy producer cull the equivalent of 20,000 lbs. per month and want to protect against a pullback in the cull price through October of this year. A producer may choose to buy one LC put option for each of these months leading up to October: April, June, August and October. Buying one 40,000-lb. contract every other month matches the producer’s expected culling of 20,000 lbs. monthly.

To break this down further, let’s look at the month of April. April Live Cattle is currently trading at $140.775 per cwt. The April LC put with a strike price of $140 can currently be purchased for $1.35 per cwt. or $540. Should the value of the April LC contract fall even a small amount, say, to its November low of around $132, the LC put option would net $6.65 per cwt. (not including fees and commissions). The math goes like this:

$140 strike price - $132 futures price - $1.35 put option premium = $6.65

That equation represents an additional $6.65 per cwt. for the cows culled during the two-month period of April and May. Historically, much greater sell-offs than this modest price drop example have occurred. This is especially true when you consider the possibility of a dramatic drop in the LC futures prices off of their record highs. If the Live Cattle market does indeed have a significant drop, the gains in these puts, especially later in the year, could be significantly higher than this example.

Why act now? Cull cattle prices are at record highs, and from a supply side standpoint, many people see no reason for cull cattle prices to fall any time soon. So why would a dairy producer want to act?

Besides the supply side picture, there is another side to the cull cattle price picture, and it has to do with the correlation to Live Cattle prices. Currently, boxed beef prices are being supported by strong demand and strong exports. It’s important to remember that there is always something that can change the demand side. Higher beef prices could start to curb consumer taste for beef in favor of less pricey proteins. Our beef export market, which is sensitive to changes in the US Dollar or any sort of trade dispute, could also be disrupted at any time. Any of these things could change the supply-demand balance in beef and send LC futures lower.

We’re not saying that any of this will happen; we’re saying that it could happen. We are recommending that producers have cull cattle price coverage for the latter half of this year. It’s important to examine every avenue to protect good prices for everything that is produced on your dairy operation.

Warren Wagner is a dairy advisor with Stewart-Peterson Inc., a commodity marketing consulting firm based in West Bend, Wis. You may reach Warren at 800-334-9779, or email him at wwagner@stewart-peterson.com.

The data contained herein is believed to be drawn from reliable sources but cannot be guaranteed. This material has been prepared by a sales or trading employee or agent of Stewart-Peterson and is, or is in the nature of, promoting the use of marketing tools, including futures and options. Any decisions you may make to buy, sell or hold a futures or options position on such research are entirely your own and not in any way deemed to be endorsed by or attributed to Stewart-Peterson. 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. Copyright 2014 Stewart-Peterson Inc. All rights reserved.

Record-Breaking Dairy Prices and a Historical View

Feb 06, 2014

Class III futures, spot cheese and nonfat dry milk prices have surpassed all previous highs – and their strength is backed by real demand.

By Katie Krupa, Rice Dairy

So far, 2014 has already brought record high dairy prices and an optimistic outlook for producers for the year to come. With the higher prices, many producers are wondering how high these prices will go and if these prices will last. While no one knows the answer to those questions, and I am not willing to offer any prognostications, I thought I would offer some historical data on dairy prices.

As of Feb. 4, 2014, the average block-barrel spot cheese price is trading at a record high price of $2.34. This price is a new high for the spot cheese market. Also reaching new highs are the spot nonfat dry milk prices, trading at or above $2.00 for both the Grade A and Extra Grade prices. These spot prices for cheese and nonfat dry milk are helping push the Class III and Class IV futures prices to record highs levels.

In recent days, the Class III futures price for February 2014 reached $23.29, and the Class IV price reached $23.56. To give you some historical perspective, the highest settlement price for Class III was $21.67 in August 2011 and Class IV settled at $21.05 in June 2011, and more recently $21.54 in December 2013.

Starting this rally were the powder prices and the Class IV price. The result was more milk was being pulled out of Class III and into Class IV to meet the growing demand. As supply decreased to Class III, up went the price to catch up and compete with the Class IV market. While I am not sure what will happen from here, the current market seems to have taken a breather, and many people are asking, "Are we at the top," and "Can this rally continue?"

Examining the spot cheese market, this is the 10th time since 2008 that the spot cheese block-barrel average has been over $2.00. This current streak is on its 20th trading day, and that makes it the third longest streak -- 26 trading days in 2008 and 53 trading days in 2011. While we are in unchartered waters at $2.34, prices above $2.00 are not shocking and can stick around for many more weeks.

As previously mentioned, what is most unique about this rally is the strength in both the cheese and nonfat dry milk markets. During the 2008 rally, when the spot cheese average was just under $2.27, the nonfat dry milk price was roughly $1.60-$1.65, whereas today the nonfat dry milk price is over $2.00. Driving this rally is a steady to slightly growing domestic demand and a growing international demand.

As with 2008, the international demand comes with a risk of uncertainty as dairy demand is heavily reliant on a strong international economy, and the economy in many parts of the world is less than stable. But the good news in that the market seems stable today, and we aren’t hearing any rumblings of economic downfall ahead. But you often don’t get much warning for those things.

The three charts below offer a glance of the cheese, nonfat dry milk, Class III and Class IV markets for 2008, 2011 (these two years were chosen because of their higher prices), and the futures market prices for 2014. Because they are futures trading prices, you’ll notice that 2014 prices are all much closer together, which is expected. All three charts have the same scale so you can see how much higher the 2014 futures prices are than the 2008 and 2011 prices.

Krupa chart 2 7 14a

Krupa chart 2 7 14b

Krupa chart 2 7 14c

Another very important factor in 2014 profitability is the cost of feed for dairy producers. Generally speaking, feed prices, especially corn, are lower than 2008 and 2011, and they look to remain that way for the upcoming months. Obviously the weather will dictate what this year’s crop will bring, but the current outlook is favorable for most of the country besides the West, where the drought will likely take its toll on crop production.

The first quarter of 2014 is shaping up to be a profitable time for dairy producers. While no one can accurately predict the future and there are no guarantees, producers do have the opportunity to utilize risk management tools to protect themselves from a turn in the market.

 

Katie Krupa is a broker 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.

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