Know Your Market
Consider These Dairy Marketing Strategies to Manage Risk
Oct 22, 2012
Given higher milk prices and potential volatile feed costs, think about putting some kind of floor under your cash flow.
By Ron Mortensen, Dairy Gross Margin, LLC and Advantage Ag Strategies, Ltd.
The marketing challenge continues with continued volatility and high costs of production. All of the marketing strategies used last October or November yielded no net gains over the 10-month period. Yes, option strategies, futures strategies and LGM did not yield a net payment to producers. The whipsaw of the market in the 10-month period produced offsetting gains and losses for all of the strategies.
How do I manage risk now? Build a strategy to put some kind of floor under cash flow. Make sure all of your stakeholders have input. Include spouses, family members, partners and lenders.
Milk income over feed has improved slightly over the last few months. It is not enough, however, to make up losses from past months. Margins are strong because of the higher milk prices. Even with high corn and soybean meal prices, the strong milk prices have overshadowed feed costs.
Given the higher milk prices and potential volatile feed costs, look at some of the following strategies.
1. Buy LGM-Dairy as a baseline of protection or buy put options for milk.
2. If you use the low feed LGM-Dairy or milk put options, review your feed inventory and fill in the gaps by purchasing corn and/or soybean meal options.
History of LGM-Dairy for the October period
When in the past has LGM-Dairy paid? Between 2002 and 2011, policies purchased in October paid an indemnity four times using the zero deductible. The years are 2002, 2005, 2008 and 2009. The $1.00 deductible paid off in 2005 and 2008. 2012 policies (purchased last October) could receive some payments if they had a zero deductible.
The total indemnity paid for the four years using the zero deductible (average feed) was $6.64. Premiums would have been $5.39. With the $1.00 deductible, 2005 and 2008 paid an indemnity of $3.10 with premiums of $1.25. The $1.00 deductible was the winner with a payoff ratio of nearly 3 to 1 due to the 48% government premium subsidy.
Current LGM-Dairy Numbers
These margins are some of the best available since LGM-Dairy was initiated. Looking at the charts, there are only a few months that have better values. Look at the percentile rankings below from Oct. 2012 to May 2013. In most cases, these are the highest or the second highest rankings for five or 10 years.
The red line (below) is the average of the last 10 years. The green line is the top one third of the same range. Note that the pink line to the far right is the anticipated margins for the October sales period as of Oct. 16, 2012.
LGM–Dairy can be part of the plan. This product is lower cost than purchasing options. Purchasing a zero deductible LGM (vs. options) could save $.74/cwt. Why is it cheaper? Part of the savings is due to the government subsidy and part is the fact the indemnity payout is based on a weighted average of all months covered. Another big plus – the premium payment is not due until October 1, 2013.
Additional feed comments
The corn and soybean markets are transitioning from supply to demand-driven issues. Many think a short crop has a long tail and believe corn and meal would simply trend lower until August 2013. This scenario is not so simple. Especially for soybeans/soybean meal, U.S. supplies could be record tight by March 1. Then, the world will need to rely on South American supplies. These supplies will be slow to move to the world market because of slow trucking/shipping logistics in Brazil. By the time next spring/summer arrives, it is possible the U.S. may need to import soybeans to finish the late summer and fall crush. This sort of razor-thin timing equates to volatile prices. For corn, the same scenario applies. It already looks like Southeast U.S. hog and chicken producers are importing Brazilian corn to meet their needs.
Ron Mortensen is principal of Dairy Gross Margin, LLC, an agency that specializes in LGM-Dairy products, and owner of Advantage Strategies, Ltd., a commodity trading advisor. Contact him at firstname.lastname@example.org, or visit www.dairygrossmaragin.com.