If January’s volatility has shaken your confidence, you don’t have to spend the entire year feeling that way. Take steps to seize some control and build your best possible weighted average price for 2011.
By Steven Schalla, Stewart-Peterson
The dairy markets roared into 2011 with action that helped bring about the strongest four-week upward move in Class III prices since April 2007.
There’s an old saying on Wall Street, “As goes January, so goes the year.” Will that hold true for the dairy markets? Let’s take a look at what happened, and what might be ahead for us in dairy.
After the collapse of cheese prices mid-December, cheese buyers finally returned to the spot markets following the first of the year, lifting prices off the $1.30 level—a level which many deemed a “good value” buy. Renewed confidence kept nearby milk prices from breaking below a critical, long-term support of $13.00 and gave the Class III futures price a much-needed bounce higher.
Also during the first week of the year, the bi-weekly Global Dairy Trading event saw a jump in powder prices ranging from 10%-20%. This jump was largely attributed to weather problems in the Oceania region, which limited gains in milk production (compared to last year). As a result, Dry Whey and NFDM futures broke into new high prices and have been extending gains. USDA describes domestic supplies of these products as “adequate,” while supplies remain tight in some local areas.
Cold storage inventories continue to show slashed butter stocks, and after a brief set back to $1.80/pound, spot butter price moved back to $2.10/pound on the CME to further encourage production. Between the developments of powders and butter, Class IV prices quickly strengthened and processors saw strong margins for these products.
In response, cheese prices needed to rise simply to compete for available milk. Cheese futures contracts made the first move by jumping 10 cents in two weeks to raise the six-month forward average from $1.50 to $1.60/lb. Naturally, this fueled the first major jump in Class III futures for 2011. In addition, Block and Barrel spot cheese prices broke over the pivotal $1.50 level, propelling further gains in the first and second quarter prices.
It is also noteworthy that the bullish grain reports on Jan. 12 have supported milk prices. By the week ending Jan. 28, the milk complex finally seemed content to slow down, at least for a day or two. Both powder futures and Class III prices backed off the highs from earlier in the week in consolidating price patterns. The result, as mentioned in the beginning, is the strongest four-week move higher we’ve seen in Class III prices since April 2007.
So what’s next?
In short, with how dramatic this run up has been, a correction lower is a reasonable expectation. However, prices could continue to sprint higher, for several reasons having to do with cheese. The spot cheese price has done a great job of coming up to the level of our February and March milk futures price. Now that these are more in line with each other, any increase or decrease in cheese should be reflected in the milk price for February and March, because of the way the Class III formula is calculated.
For the rest of 2011, prices have started to signal a correction is likely due. As we analyze this cycle, a sideways price pattern would give the most supportive look to the price charts. A pull-back of 50 cents to $1/cwt., however, is a realistic possibility. For example, the May contract closed last Friday at $16.75 and could come back down as low as the $15.50 area, which is long-run support and the breakout point for this explosive move higher.
I’ve been pleased to talk with many dairy producers who are anxious to use this rally to either start hedging their 2011 milk or add to their current positions. I would agree that now is a great time to implement the right strategy. The challenge many are recognizing is that the recent volatility has inflated option prices, making it cost prohibitive to simply buy Put options or use Call options to complement forward contracts at the milk plant.
Milk is not the only market with this issue. The grain markets have been dealing with this issue of high option costs for months. Our grain clients, however, have found that it is possible to get attractive option strategies in place. I would offer two pieces of advice to address this issue.
· Learn about and look at more advanced options strategies. These could include Fence Positions (Min/Max) or Bear Put Spreads for downside coverage, or a Bull Call Spread for re-ownership positions. If you have a good understanding of basic options, these strategies are not difficult to grasp.
· Secondly, and especially when using advanced option strategies, it is critical to understand how any marketing decision will impact your overall milk price. Specifically, how much will a given strategy help your price if a new downtrend occurs, and how much would it limit your upside potential if prices can continue to rally higher? You may be surprised how some strategies will be more or less effective to your overall price than they initially appear. A little time invested in Market Scenario Planning will help you see the benefits of each strategic choice.
The only thing not to do is “wait and see what happens.” I continue to encourage producers to evaluate the opportunities at hand and to make an informed decision whether it is the right time for you to engage the milk market. Understanding how your decision will play out in any market development will give you the confidence to make the decision that puts your dairy in the best position to succeed. If January’s volatility has had you less than confident, you do not have to spend the entire year feeling that way. Take steps to take back some control and build your best possible weighted average price for 2011.
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 2011 Stewart-Peterson Inc. All rights reserved.