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Know Your Market

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

Opportunity Knocks: Current Margins Available for Hedging

Apr 15, 2013

Many dairy producers now have an opportunity to protect profits for the rest of the year.

Katie Krupa photoBy Katie Krupa, Rice Dairy

More often than not when I am talking about hedging milk and feed, the current futures prices are less than desirable to many producers. Although there is not an across-the-board definition of good when it comes to hedging, in my opinion, there are currently good hedges available for the milk-feed margin.

As you’ve heard me say before, you’ll want to make sure the current prices line up well with your farm’s financials and risk management needs, but many of you now have an opportunity to protect profits for the remainder of the year.

Rather than take my word for it, let’s examine the current prices. The milk-feed margin that I am referencing is roughly one hundredweight of milk, minus 0.81 bushels of corn, minus 0.009 tons of soybean meal.

Looking at the first chart, you can see the volatility of the milk-feed margin over the past five years with the red line showing the current milk-feed margin based on CME futures trading prices. The red line is essentially the current hedging opportunity for dairy producers. In order to get a better idea of where there current opportunity stands relative to the historical information, I broke the chart down into three sections; bottom 50th percentile, top 25-50th percentile, and top 10-25th percentile.

Krupa graph 4 15 13

As you can see, the current milk-feed futures are trading above the 50th percentile mark through most of 2014, and above the top 25th percentile mark for the end of 2013. While there are only a few months where the milk-feed margin is above the top 10th percentile, there are many month where it is below the 50th percentile mark.

The second chart shows the daily price for the milk-feed margin trading on the CME for August 2013, and December 2013. These margins have been steadily moving higher in the past year with a more noticeable gain made in recent months. While the trajectory is up, what happens in the future is anyone’s guess. We’d all like to think it will keep moving higher and producers will be paid well for their hard work, but unfortunately we all know what has happened in the past, and it’s not always pretty.

Krupa graph 2   4 15 13 png
The biggest reason I like hedging the milk-feed margin is because it protects the most volatile input cost – feed, along with the milk price. The reason I like hedging both the milk and the feed price is because the volatility is extreme for both. If we simply hedged the milk price and ignored the feed, you would only have a partial hedge, and you are still at risk.

Because I am in the business of risk management, my job is not to guess the market but to protect against the unforeseen. When prices are this high, it gives many producers the opportunity to protect against the margin moving lower, while still being able to capture some of the market’s upside potential. These high prices make the job of a risk manager easier in many ways, but we all must be cautious of the greedy green-eyed monster.

Although hedging is not for everyone, I suggest that everyone at least review their current opportunities in order to make the best decision for their business. While no one knows what the future will bring, historically, high prices don’t stick around for too long.

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 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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