Price increases in cash cheese and butter seem to provide an opportunity to hedge some milk production.
Cheese and butter prices have had a real turn of events over the past two weeks. Both cheese and butter prices have broken out of the sideways trading ranges established since the beginning of the year.
Cheese prices may now be poised to challenge the $2.00 price level set in early March. Traders certainly think this will be the case as July Class III futures have traded above $19.00. It was thought the Class III price of $19.40 in March would be the high for the year. However, that may be challenged if buyer interest remains strong.
In the first quarter of this year, demand for dairy products was strong. Total cheese demand was 6.4% higher than the first quarter of 2010. Commercial disappearance of butter was up 7.8% and demand for nonfat dry milk and skim milk powder was up 12.0%. First-quarter cheese inventory actually decline 21.0 million pounds versus an increase of 15.0 million pounds during the first quarter of 2010. Interestingly enough, first quarter butter inventory increased 62.5 million pounds versus an increase of 62.9 million pounds for the first quarter of 2010.
Milk production has been consistently higher than a year earlier, but demand has been keeping up and, in some cases, exceeding supply. Exports have been good, with domestic prices right in line with world prices. Higher milk prices with higher grain prices will keep milk production strong for the year unless weather becomes a greater factor for yield potential. If grain prices increase above current levels, milk production may eventually decline since culling will increase significantly and rations will be changed affecting milk output.
With the recent strength of cheese and butter prices, what can we expect? Of course, price strength always brings out the “I told you so” or the “We knew this was coming” analysts. Yes, there is always a potential for higher prices as well as lower prices. I want to make a historical comparison as to previous patterns.
There were four years since 1980 when prices rallied in the months of May and June. These were 1998, 1999, 2007 and 2008. The price rallies for all of these years began right at the beginning of the month of May. The price increase lasted through July 3 in 1998, resulting in a 39-cent increase in cheese price. The price increase in 1999 lasted through June 24, consisting of an increase of 26 cents. An increase of 48 cents was realized in 2007 with the rally lasting until June 22. The rally in 2008 lasted until June 5, consisting of an increase of 22 cents. During these four years, cheese prices exceeded the May/June rally 50% of the time and 50% of the time prices never reached back to that level.
The year 2008 was very similar with strong grain prices and most reflects the current market situation. Milk price never rallied back to the spring price despite significantly higher grain prices.
These comparisons would suggest that the current price increase in cash cheese and butter is providing an opportunity to hedge some milk production. Prices will not increase forever and you need to take advantage of some good prices when they are offered. Yes, price can increase further, but our risk is to the downside.
I continue to favor the fence strategy of purchasing a put and selling a call. Spreads of $18.00 puts and $20.00 calls can readily be done at reasonable prices. In some months, even higher spreads can be established. This allows you to follow the price up to the sold call option while at the same time establishing good downside protection.
- Agricultural prices report on May 31
- Commercial disappearance on May 31
- Dairy Products report on June1
- Fonterra auction on June 1
- California 4a/4b prices on June 1
- May federal order class price on June 3
- World Agricultural Supply and Demand report on June 9
- Fluid milk sales on June 10
- California Class I price on June 10
Robin Schmahl is a commodity broker and owner of AgDairy LLC, a full-service commodity brokerage firm located in Elkhart Lake, Wisconsin. He can be reached at 877-256-3253 or through their website at www.agdairy.com.
The thoughts expressed and the data from which they are drawn are believed to be reliable but cannot be guaranteed. Any opinions expressed are subject to change without notice. There is risk of loss in trading and my not be suitable for everyone. Those acting on this information are responsible for their own actions.