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Know Your Market

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

A Time to Reap, a Time to Hedge

May 29, 2014

Understanding seasonal tendencies can help refine strategies to protect both feed costs and milk revenues.

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By Chip Whalen, CIH

Many producers know that there are certain times of the year which are more profitable than others.

After all, agricultural commodities follow seasonal trends that can either pressure or support prices of the goods they use and produce. For example, crop producers often find that the value of their crops can be depressed at harvest time as an abundance of supply hits the cash market all at once. Likewise, dairy producers may find that milk prices tend to be depressed during the "spring flush" season, which pressures margins in the early part of the year.

Understanding seasonal tendencies can play an important role in how a producer may want to approach managing forward profit margins.

For example, if you are heading into a period where margins tend to be under pressure, it probably is a good idea to have a fair amount of coverage in place to protect those margins – even if the margin itself may not be historically strong. Moreover, if you understand the reason why the margin tends to be depressed, this may help guide you in the strategy selection process.

As a dairy operation exposed to increasing feed costs, you know that the greatest period of uncertainty surrounding crop production is upon us. From how many acres will be planted to what the weather will be like during germination and reproduction to how many bushels will ultimately be harvested, this uncertainty can lead to increased volatility in crop prices over the summer.

Understanding this, you may want to retain flexibility in the strategies you use to protect your feed costs. On the one hand, if there is a drought like we experienced a few years ago, you want to make sure you’re protected against significantly higher prices. On the other, should we harvest a large crop later this year, you want to participate in the lower prices that could minimize your feed expense and improve your dairy’s bottom line.

While seasonality can certainly play a role in the decision-making process, it is important to remember that the market does not always behave according to seasonal tendencies. In any given year, the fundamental backdrop unique to that period may trump any seasonal pattern. Moreover, historical patterns are based on past price movements, so seasonality itself is changing every year as new price activity gets added to the ongoing history.

The profit margin itself should be the main driver of any strategic decision to manage forward profitability. Understanding seasonal tendencies can help refine strategies to protect both feed costs and milk revenues, though seasonality itself should not be the main decision making consideration.

Understanding the seasonality of price movements or of overall profit margins can certainly assist in tactical strategy selection and position management over time. This may include decisions to include more or less flexibility at certain times of the year, taking on more cost in option positions, or even increasing coverage levels. A strong understanding of how seasonality affects prices and profit margins can help you make better decisions and give you more control over your dairy’s profitability.

As Vice President of Education & Research at CIH, Chip Whalen is responsible for developing and conducting all of CIH’s Margin Management seminars. He is also the editor of CIH’s popular Margin Watch newsletters. Whalen can be reached at (312) 596-7755 or cwhalen@cihedging.com.

 

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