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May 2010 Archive for Know Your Market

RSS By: Dairy Today: Know Your Market, Dairy Today

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

Does Your Marketing Have Horsepower?

May 22, 2010

By Steven Schalla, Stewart-Peterson

 

I had a real treat this past weekend with a trip down to the local festival. We arrived just in time for the tractor pull, one of my favorite summer events. What’s not to love? Great competitors, great fans and more horsepower in one place than anyone knows what to do with!

 

Yes, there’s a tie to marketing here. To be successful as a puller, you have to be consistently on top of your game, and the same is true with commodity marketing.

 

Does your marketing have the horsepower to pull the financial load on your dairy operation? After the last 18 months, you’ve likely got a heavy load to haul and much financial ground to regain. Many folks have watched equity erode. Consequently, many have been forced to stack extra debt onto their financial sleds. Horsepower in their marketing efforts has never been more important than now.

 

In addition, every farm has financial goals it would like to move toward. Whether it’s chipping away at the debt load, stabilizing the cash flow situation, improving facilities or becoming a more competitive bidder on cows or land, the marketing decisions you make (or do not make) can seem increasingly stressful and might even weigh you down further. You may have family or partners in the business who are counting on you for their financial livelihood, adding extra weight to the already difficult decisions at hand.

 

So, what kind of tractor are you hooking up to pull your financial sled?  Is it running at full power? If you’ve ever been in a vehicle that has lost a cylinder, you know right away that something isn’t right. It will still run, but the ride is rough, frustrating, and the overall performance is dismal. I hope this doesn’t describe your marketing experiences. If you haven’t made a full commitment to marketing, you’re probably sputtering.

 

Here’s why: Good marketing is not an occasional activity. You can’t choose to market only when prices are “good” (or only when they are “poor”) and expect consistently good performance. It takes a steady effort to pull the load.


Case in point
: This spring, many producers who may have been doing “a little marketing” (i.e., using “a couple cylinders”) have been frustrated by futures prices dropping off as each month came to a close. With great anticipation, they saw $15 prices in December, then $14 in February and near or below $13 when the milk check finally arrived. As prices were falling, the stress began to build for these producers, who were hopeful that prices were recovering. Now memories of the lows of 2009 weigh heavy in their mind.

 

Contrast this mindset with the producers who have a structured approach to marketing in place and who have run some price scenarios in advance of this market drop. They know the price triggers at which they are going to take action, and they have determined, before the emotion of the price fall sets in, that they will take action at those price points.

 

The producers who have gone through this process with us have been prepared with specific points to act and were able to proactively make forward sales or hedges as prices softened. While still having a certain percentage of their milk open to higher prices (based on their risk tolerance and other factors), they were able to cushion the price declines for a stronger weighted average price.

Lenders and financial consultants are telling us that good marketing is part of the consideration when evaluating whether a farm has the financial wherewithal and management capabilities to sustain a loan. Having a consistent marketing approach in place can, for example, reduce the amount of working capital lenders require.

 

My analogy continues: Consistency is a characteristic of good dairy management, as well of good competitive tractor pulling. Good pullers love to win, and they also recognize that a top 3 or top 5 finish is a solid result. For competitors in a season-long circuit, it is critical to be consistent week-in and week-out. A good strategic marketer has the same mindset.

 

My analogy is nearly out of steam. But I hope I’ve sparked some thinking that will help you and motivate you to add some horsepower to your marketing efforts, to work toward your own long-term goals.

 

Steven Schalla is a Market Advisor for Stewart-Peterson, Inc. He can be reached at 800.334.9779 or sschalla@stewart-peterson.com.

 

The data contained herein is believed to be drawn from reliable sources but cannot be guaranteed. Neither the information presented, nor any opinions expressed constitute a solicitation of the purchase or sale of any commodity. Those individuals acting on this information are responsible for their own actions. 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. Any reproduction, republication or other use of the information and thoughts expressed herein, without the express written permission of Stewart-Peterson Inc., is strictly prohibited. Copyright 2010 Stewart-Peterson Inc. All rights reserved.

 

The Ideal Hedging Tool for Dairy Producers

May 07, 2010

By Jon Spainhour, Rice Dairy

 

Last month, we talked about using “futures” or fixed price contracts to hedge the price of our expected milk production. While fixed price contracts are a very useful hedging tool, there are other tools you can use that offer a little more flexibility. Those tools are called “options.”

 

There are two types of options. One is a “put.” The other is a “call.” Puts are essentially an insurance policy against prices moving lower. Calls are essentially insurance against prices moving higher. For the purpose of this discussion, we will focus on puts.

 

Puts are essentially like car insurance. To protect yourself against losing the value of your car if you get in a car wreck, you spend money to buy an insurance policy. Clearly, you don’t want to get in a car wreck, but if you do, you are protected. Puts act in a very similar way, only instead of protecting yourself against a car accident, you buy an insurance policy against the price of milk going down. 

 

In last month’s example, our producer makes 1 million pounds of milk per month. Each Class III contract is for 200,000 lb. worth of milk. That means that in order to hedge himself completely, he will need to purchase five contracts worth of puts. Puts can be purchased on any price level in $0.25/cwt. increments. For example, that would be $13.00/cwt., $13.25/cwt. or $13.50/cwt.

 

In last month’s example, we sold all five July contracts at $14.25/cwt. by selling futures. In that fixed price contract arrangement, the net price that we would receive for our milk would be $14.25/cwt., regardless of what the mailbox milk price was for July. With puts, we can buy insurance against the price of milk moving below $14.25/cwt., while at the same time getting to participate in the higher prices if the price of milk in July is higher than $14.25/cwt. 

 

Let’s go through two examples. In both examples, we will buy five July $14.25 puts. Just like car insurance, you have to pay for the right to protect your milk price. That price is referred to as the premium. We will assume that the premium that we spent to buy the $14.25 puts was $0.30/cwt. 

 

In the first example, we will pretend that the mailbox price of milk for July ends up at $12.50/cwt. We bought insurance against the price moving below $14.25/cwt., and we paid $0.30/cwt. for that protection. So, our net mailbox price is going to be $13.95/cwt. While we will only receive $12.50/cwt. from our cooperative, we have $1.45/cwt. of profit ($14.25/cwt. options - $12.50/cwt. milk check - $0.30/cwt. premium) in our options account that we can apply toward our $12.50/cwt. milk check. This brings our net price to $13.95/cwt. ($12.50/cwt. milk check +$1.45/cwt. options profit). 

 

In the second example, we will pretend that the price of milk for July ends up being $17.00/cwt. In this case, our net milk check will be $16.70/cwt. ($17.00/cwt. milk check - $0.30/cwt. premium). In my opinion, this is the obvious ideal situation. This producer was able to know as the beginning of May that the lowest price that he would receive for his milk would be $13.95/cwt. ($14.25 puts - $0.30/cwt. premium), while at the same time getting to participate in the higher prices if the price of milk went higher. 

 

I see puts as the ideal way for producers to hedge their milk, and we typically advise them to try and buy puts at levels that at least protect their breakeven costs. That way, while they may not be making money if the price of milk plummets, they will at least not be losing money, which will reduce the risk of them going out of business. 

 

Jon Spainhour is a broker/trader 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 Spainhour at jcs@ricedairy.com. Visit www.ricedairy.com.

 

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