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AgDairy Market Update

RSS By: Robin Schmahl, Dairy Today

Robin Schmahl is a commodity broker and owner of AgDairy LLC, a full-service commodity brokerage firm located in Elkhart Lake, Wis. He provides dairy market insight.

Record Prices Did Not Improve Dairy Profitability

Jan 09, 2012

January has opened with optimism but not enough to warrant significant higher prices as the year progresses. Traders are taking a wait-and-see attitude for later contracts. The market needs to prove itself.

 
A year of record high milk prices has just been completed. Bullish attitudes have rolled over into 2012, pushing some early months near $18.00. Class III futures contracts for the first half of the year have been trending higher over the past three months. Futures contracts have moved from a discount to the underlying cash to a premium over the underlying cash over that period of time.
 
This certainly has improved the price outlook for the year. However, what is lacking is the additional premium leading into late summer contracts that we usually see. What the market is showing is a very narrow price range for the year of around 74 cents. There is optimism, but not enough to warrant significant higher prices as the year progresses. Traders are taking a wait-and-see attitude for later contracts. The market needs to prove itself.
 
Cheese and butter inventories have been declining seasonally. However, cheese stocks have depleted enough to put stocks lower than they were a year earlier. This indicates overall demand has remained good throughout the year. Cheese buyers have been a little reluctant to begin purchasing cheese for inventory building. Despite price falling the last one and a half months of 2011, buyers had anticipated further downside. But now it appears the market has established a bottom and has bounced from it over the past week.
 
Last year was not a good year for the milk/feed ratio. Despite record high milk prices, the milk/feed ratio was the second poorest in history at an average of 1.89. The worst ratio was in 2009 at 1.78. On top of this, it finishes out the year with the poorest fourth quarter ratio in history at 1.85.
 
Despite the low milk/feed ratio, milk production continues to improve over the previous year. Milk production in 2009 totaled 189.3 billion pounds, while production in 2011 is estimated to have totaled 196.1 billionpounds. 2012 is estimated to reach 198.5 billion pounds, according to the latest World Agricultural Supply and Demand report. Milk production is expected to continue to improve this year unless weather has a significant impact on cow comfort.
 
More farmers are utilizing the markets to hedge feed prices compared to 2009 and are stepping up their feed price protection this year. I had recommended forward contracting or the purchase of call options or call option spreads after the grain markets dropped in September. Current grain prices and futures are up significantly since that time and are now being fueled by the dry weather in South America. Corn and soybean forecasts for South America have been cut since the December production estimate due to dry weather that has gripped areas of the country. Rain is forecast this week and if it materializes grain prices will retrace. If it does not, futures will make another leg up as world supply will be lowered.
 
With feed prices hedged, you need to look out and protect milk prices using a fence strategy. Purchase at-the-money put options and sell $1.50-$2.00 higher call options. This will establish a floor and allow you to take advantage of some of the upside if it develops. This is the third year of a cycle that has been established and could be the year with lower prices if it were to hold true.
 
It certainly will be another challenging year and one that will not be without volatility. The goal should be to manage that volatility.
 
Upcoming reports:
 
-          California Class I on Jan. 10
-          World Agricultural Supply and Demand report on Jan. 12
-          Dairy exports statistics on Jan. 13
-          Fonterra auction on Jan. 17
-          December livestock slaughter report on Jan. 20
-          February Class I price on Jan. 20
-          December cold storage report on Jan. 20
-          December milk production report on Jan. 23
 
 
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.
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