Know Your Market
Amid the Noise of Dairying, Focus on the Matter at Hand
Nov 04, 2013
Seven tips for hedging your milk.
By Dave Kurzawski, FCStone
Traders at Chicago’s futures and options exchanges have often told me the term "trading pit" is an appropriate name for where they work. Pushing, shoving, sweating and yelling while trying to concentrate on prices and orders sounds like the pits to me. Say what you will about working conditions, these people do have an uncanny knack for excluding the noise and focusing on their current situation right in front of them. They find order in the chaos.
There is another place we see a lot of chaos right now – the U.S. dairy farm. Still-high overall feed costs and tight lending, among other hurdles this year, have producers around the country up against the ropes fighting for their livelihood. But amid the turmoil, producers ought to take a cue from the guy in the colorful trading jacket. Find order in the chaos.
Part of finding order is to boil down the sum of your business into manageable parts and focus on those parts one at a time. Most of those parts you’ve worked on since you started dairying years ago. They are critical matter of your dairy, the guts of the operation that keep it going every day. Most importantly, they are second nature to you.
But an equally important piece to your business – the one that causes the most agitation for some – is hedging. Now that the cheese and NFDM prices are trading in the high $1.80s to low $1.90s, and the corn market is making three-year lows, it’s time to refocus some energy in the direction of profit-making for the dairy. In all the commotion, ask yourself the question: How do I hedge my milk?
1. Educate yourself. There are many different strategies, but only a few that will suit your personality. Take some time to learn what those are and stick to what you’re comfortable with.
2. Know your cost of production. Before you lock in a portion of your income, you have to have a handle on what it takes to produce a hundredweight of milk.
3. Look at Milk and Feed. Be aware that risk-management tools have fixed contract sizes. One milk contract is the equivalent of 200,000 lb. of milk. A corn contract, for example, is the equivalent to 5,000 bu. of corn. Multiple contracts will likely be needed to protect milk prices and feed cost.
4. Decide on a strategy. Every dairy is different and, though it seems like all producers are in the same boat, most producers have a different risk tolerance level. How much price volatility can you live with?
5. Talk to your bank. You wouldn’t neglect to tell your bank that you added 200 cows, so don’t neglect to tell them of your plans to use risk-management tools to ensure profitability. Plus, there is a cost involved in risk-management and you will need your lender’s assistance in covering them.
6. Take the emotion out of your decisions. A change in feed rations may take months to expose itself as a good or bad decision. Markets are in a constant state of flux, margin calls can be a part of the program, and producers may fret over unrealized hedge losses. They lump them into the "bad decision."
7. Keep it consistent. One of the problems that plague hedgers is that they’re not consistent with their hedging activities. They leave money on the table by hedging one year so they do nothing the next, and that next year they end up losing because they weren’t hedged. If you have a plan to hedge 40% of your milk one year, do the same (when profitable margins present themselves) the next.
Whether you decide upon forward contracting directly with your co-op, use of futures and options or perhaps an over-the-counter product to minimize price volatility and bring profit home, remember to keep your strategy simple. Complexity breeds confusion. Confusion will keep you on the roller coaster of price volatility. And roller coasters are fun, but you don’t have to ride one every day of your life.
David Kurzawski is a Risk Management Consultant with the Chicago office of INTL FCStone. INTL FCStone offers comprehensive risk-management and margin hedging programs and services to dairy producers, processors, traders and end-users. You can reach Kurzawski at 312-456-3611 or firstname.lastname@example.org.