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Why Active Management Beats “Set It and Forget It”

May 08, 2014

Regretting that you locked in your prices and missed the record rally? Here’s a smarter approach to price-risk management.

MikeRusch   Copy

By Mike Rusch, Stewart-Peterson Inc.

As I visit with dairy producers across the country, there is a distinct group of producers who have locked in what were said to be "good" prices late last year and are now questioning this decision. Back in November and December of 2013, based on a gut feel, suggestion or view of a profit margin between milk and feed, they may have sold 50%-75% of their milk production for all of 2014 through their milk plant or in their hedge account, with the mentality of "lock in a good margin and move on."

Now as this milk rally has picked up steam, each month brings new regret and frustration about the rally they are missing. Justifiably so. This approach simply doesn’t work for price risk management, unless your goal is to achieve a certain price level and not the best possible price level.

I am reminded of one of the infomercial world’s biggest stars on late-night TV, Ron Popeil with his Ronco Rotisserie oven. If you’ve heard of him, perhaps his famous line is ringing in your ears: "Set it and forget it!" While this feature may be attractive for selling his brand of convenience cooking, it should not be the way you approach any market to manage price risk.

The way to achieve the best possible price levels for feed or for milk is to actively manage your price risk. A producer who is actively managing market risk for milk will go ahead and make sales incrementally that will lock in favorable prices. Then, if there is opportunity for the market to rally, those sales can be covered with call options, providing the opportunity to participate in a rally. You continuously -- actively -- monitor price levels and put strategies in place for future price moves.

Dairy producers manage this way in almost every other area of production. You create a nutrient management plan, and then you monitor soils to make sure all is going according to plan. You make adjustments as needed. You plan your ration, and then you monitor feed quality to make sure the cows are getting what you planned, or adjust if something changed. You build a new facility and install new equipment, then monitor to be sure the equipment is working as promised. You go back to the builder or installer if necessary. You fine-tune and debug until you get the results you want.

So it is with price risk management. You wouldn’t accept a "set it and forget it" mentality to manage the day-to-day production operations on your dairy. It should not be the approach to markets, either.

Adding more active management of markets to a dairy producer’s workload may not be a welcome thought; neither is the alternative of weathering a price drop unprotected. With each step the milk market goes up, we are at greater risk of it coming down, and coming down fast.

The chart below shows the final January through December Class III milk futures average price for each year, 1998 through 2013. The 2014 price reflects where the average is at this point in the year. We also highlight the percentage declines that we have seen in the past from the market’s peak to its trough. Note that after every peak there is a pretty sizeable decline.

It’s also worth noting, beyond the peaks and troughs, that milk has been on an overall steady climb upward, with each high climbing a bit higher. Those who take an active approach to price risk management can take steps to secure good prices as they head upward, thus protecting against the catastrophic drops. With this approach, you will not always sell at the top of the market, however, you should be able to follow the general upward trend, achieve better than average prices, and avoid the deep troughs.

Source: Stewart-Peterson Inc. and ProphetX

 

"Set it and forget it" may be dangerous, and so is "ignore it." These days, lenders and dairy owners recognize the risk of being fully exposed to a price collapse. Somewhere between "set it and forget it" and "ignore it" is a middle ground that dairy producers are very familiar with, and very good at. It’s called "active management."

Mike Rusch is a business development consultant with Stewart-Peterson Inc., a price management firm based in West Bend, Wis. You may reach Mike at 800-334-9779, or email him at mrusch@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.

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