A Rising Tide Lifts All Boats – Until It Collapses
Jul 24, 2014
Dairy prices, exports and the stock market have surged, but a ‘Black Swan’ event could change all that. Have you developed a way to protect your milk price from a sudden downturn?
By Katie Krupa, Rice Dairy
The old saying goes, ‘A rising tide lifts all boats,’ and in many ways this statement can be applied to the recent surge in the dairy market.
In recent years, the strength of the dairy market has been heavily reliant on the world economy with a significant amount of our domestic dairy production meeting the demands of the international market. While this rising tide is helping push domestic dairy prices higher, a growing world economy is not a guarantee for higher prices.
The first chart (below) shows the USDA announced the Class III milk price and the Dow Jones Industrial Average. Prior to 2008, there doesn’t seem to be much correlation between the Class III milk price and the Dow Jones average, but that changes in 2008. The rise in both the milk price and the Dow Jones in 2008 followed by the crash in 2009 start a trend of prices moving closer together. Starting in 2010, the trend is the same for both Class III milk and the Dow Jones Industrial Average, but the statistical correlation is not very high – it is around 0.70 (the closer to 1.0 the higher the correlation).
You can look at various charts for different economic indicators compared to the Class III milk price, and you will find the same pattern for many of those charts. The economic crisis of 2008 had a noticeable impact on many industries and the dairy industry was certainly one of those industries.
The underlying issue for much of the dairy industry’s troubles in 2008 and strength in recent years has been the strength of the export market. The second chart shows the annual dairy exports. As you can see, the exports drastically decreased in 2009 and then have been at historic high levels in recent years. The export market chart and the Dow Jones Industrial Average charts both have the same trend – decreased in 2008 and then increasing since 2009.
While both of these charts show the same trend, these charts are not a guarantee of the future weakness or strength of the dairy industry. Unfortunately, our dairy industry is dependent on various factors that are both domestic and international issues. And worst off, there are many issues that can occur that have nothing to do with milk production, cows or the feed situation, but still have an impact on your milk price.
For example, several things that can turn the industry around are a geopolitical issue (here or abroad), a significant weather or world event, such as an earthquake or tsunami, or continued economic growth in developing countries. These are what I call Black Swan events, and there are many more that could potentially occur. The trouble with these Black Swan events is that you can in no way predict them. Unlike a change in the milk supply due to cold weather, poor feed quality or a change in cow numbers, a Black Swan event happens fast and the impact is nearly immediate. While there are many benefits of being in the international market, there are also some negatives. It is important to remember that although the stock market may be strong, that is no guarantee that the dairy industry will be strong.
As dairy producers, you have many Black Swan events that can happen on a daily basis in your business. These on-farm events you can personally manage, and you probably have developed ways to work around these more frequent issues. The international Black Swan events may be harder to work around, but luckily there are multiple risk management strategies available to help you protect your milk price for the future months. Just as you have developed ways to manage around on-farm weather issues, cow death or employee issues, you can also develop a way to protect your farm milk price from changes in the world that would negatively impact the milk price.
Katie Krupa is a broker 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 firstname.lastname@example.org.Visit www.ricedairy.com. There is risk of loss trading commodity futures and options. Past results are not indicative of future results.