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August 2012 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.

The Spread Widens between Milk Prices and Feed Costs

Aug 30, 2012

Although projected price indexes are fairly stable over the next year, the spread between milk and feed prices may further tighten margins for producers.

Kristen SchulteBy Kristen Schulte, Iowa State University Extension Farm and Agribusiness Management Specialist

Margins continue to tighten as the 2012 year proceeds, but the milk price outlook provides some relief. Although milk prices have increased over the summer, they have not kept pace with feed commodity price increases. Dairy product exports and prices have remained strong so far in 2012, helping to support higher milk prices despite the continued increase in milk production.

Historically feed input costs have been 40% to 60% of total variable costs. Current outlook prices push the upper limit and in some cases may surpass 60%. Feed input costs have ratcheted up over the past few years with the per-bushel corn price increasing over 200% since 2005, while the per-ton alfalfa hay price has doubled in the same timeframe.

The first graph below shows prices for milk (announced Class III), corn and alfalfa hay as a price index from 1980 forward. When comparing corn and alfalfa hay prices, with the exception of the mid 1990s, prices were fairly stable until mid-2000s. Since the end of 2009, alfalfa hay has increased from a 1.71 to over 3.0 price index where it has remained since August 2011.

Schulte chart 1

Similarly, the corn price index increased from the end of 2005 to 2008, subsided until late summer 2010, then started to climb and has been between a 2.25 and 3.00 price index since February 2011. These feed price indexes are compared to the announced Class III milk price index, which has ranged from 0.75 to 1.91 since 2000. The spread of price indexes between feed inputs and milk continues to widen.

In the graph below, the dashed lines represent projected price indexes out to August 2013 based on futures or projected prices. Projected corn and alfalfa hay price indexes surpass current and historical record-high price indexes over the next year. However, Class III milk futures prices are at levels comparable to early 2008 and 2011 and below the record-high milk price index in August 2011.

Schulte chart 2

Although projected price indexes are fairly stable over the next year, the spread between milk and feed prices may further tighten margins for producers. These prices represent U.S. average prices. Price indexes and spreads will be different for regions across the U.S.
 

The USDA-NASS August crop report indicates U.S. corn yield is estimated to be reduced to 123.4 bushels per acre, down 23.8 bushels from last year. Soybean yield is also expected to be down, with the average bushels per acre at 36.1 bushels per acre, down 5.4 bushels from last year. Alfalfa hay production is down 16% across the U.S. compared to 2011. Tightened supplies of all feed input commodities will continue to push prices upward, further tightening margins for dairy producers.

Looking ahead, adequate feed inventory and financial planning may be crucial for producers to survive the coming year. Fields affected by drought may have less forage tonnage yield and, specifically, corn silage may have varying nutrient quality due to low grain yield compared to a typical growing year. Corn silage and forage inventories will need to be assessed to determine need to purchase additional forage or feedstuffs or to alter rations to have sufficient feed inventory for the year.

Increasing feed efficiency is one way to alleviate financial strain from increased feed prices. Purchase of additional feed at current projected market prices may affect cash flow and liquidity of the operation. Although milk price outlook is positive for coming months, feed commodity prices continue to increase at a greater rate. Re-evaluating cash flow and liquidity positions given the current commodity price levels and making needed adjustments will be key for producers to remain in a financially healthy position over the next year.

Kristen Schulte is an Iowa State University Extension farm and agribusiness management specialist. She can be reached at 563-547-3001or kschulte@iastate.edu.  

Strike While the Iron Is Hot

Aug 25, 2012

Rare opportunities for producers to protect milk prices at historically high prices mean it’s time to take a serious look at risk management strategies for the rest of 2012 and 2013.

Katie Krupa photoBy Katie Krupa, Rice Dairy

This summer has been a time of uncertainty for many producers across the country. Between the drought devastating crops, the heat hampering milk production, and lower milk prices this spring, many producers had to tighten their belts and become even more innovative.

One silver lining is that milk prices for the end of 2012 and 2013 are currently providing producers with some notable hedging opportunities.

Firstly, your financial situation for the upcoming 12 months will most likely be driven by your feed availability and weather this summer. For example, those in the Midwest who did not receive nearly enough moisture this summer will be needing to buy more feed and subsequently paying more for that feed, while those in the Northeast who had a good growing year will be in somewhat better shape (although purchased feeds will still be higher, regardless of location). In short, now more than ever you want to make sure you are looking at your unique operation and cost structure to determine what price is “good” for your farm business.

Having said that, currently there are some hedging opportunities that are near historical high prices, and I urge any of you interested in risk management to review the strategies currently available. I will compare what is currently available for the end of 2012 through 2013, to what was available in the summer of 2008 for the end of 2008 and the 2009 year.

Currently Class III futures prices trading on the Chicago Mercantile Exchange for October-December 2012 average $19.85. This compares to the October-December 2008 average Class III futures price of $19.85 that was trading on July 15, 2008 (if you recall dairy prices peaked in 2008 toward the end of July). Currently, a producer can purchase an $18.00 put option (protects against prices declining, but does not limit the upside) for October-December 2012 for around 20 cents per cwt. Back on July 15, 2008, the $18.00 put option for October-December 2008 was 40 cents. The current opportunity offers tremendous price protection for dairy producers. Although each producer’s cost structure is unique, to protect an $18.00 Class III price for only 20 cents per cwt. is a rare opportunity.

Looking out to 2013, the Class III futures average for January-June is around $19.15. Producers can purchase a $17.00 put option for roughly 45 cents per cwt. Although the premium is more expensive and the coverage level is a little lower than what is available for the last quarter of 2012, this is still good price protection for many producers. This price is comparable to what was available in 2008 for the first half of 2009. On July 15, 2008, the Class III futures average for January-June 2013 was $19.35, and the $17.00 put option could have been purchased for 52 cents per cwt.

Where the current market differs most from the opportunities of 2008 is for the back half of the upcoming year. On July 15, 2008, the July-December 2009 Class III futures were trading just over $20.07, while today the Class III futures for July-December 2013 are around $18.25 – nearly a $2.00 difference. In 2008, the $16.00 put option for July-December 2009 could have been purchased for around 40 cents per cwt. Today, the $16.00 put option for the back half of 2013 is nearly 70 cents per cwt.

I bring up this comparison to 2008 because that is the last time we saw prices this high for the upcoming year. This year differs greatly from 2008, most notable to me because 2008 was a bubble inflated by higher world fuel prices and what was perceived to be a growing economy and growing demand. Today we are driven by lower milk production numbers and higher feed prices due to a lack of supply rather than a seeming growth in demand.

History is not guaranteed to repeat itself, but it could -- and if it did, wouldn’t you like to be prepared? There are currently opportunities for producers to protect their milk prices at historically high prices, and, although every operation has a different cost structure, I encourage interested producers to take a serious look at current risk management strategies for the remainder of 2012 and 2013.

Katie Krupa is the Director of Producer Services 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 klk@ricedairy.com.Visit www.ricedairy.com. There is risk of loss trading commodity futures and options. Past results are not indicative of future results.

What Is Happening with Dairy Cow Numbers?

Aug 17, 2012

The latest data seem to indicate a change of thinking among Midwest and California dairy producers.

By Will Babler, Principal
AttenBabler Risk Management LLC

With high feed costs, negative margins and feed supply reduced by heat and drought, a significant decline in U.S. cow numbers is expected.

U.S. dairy cow number trends are key to fundamentally analyzing the milk market for expected supply and price direction. As cow numbers cycle, we assume the reciprocal impact on milk price (see chart below). It is good to know what is happening to dairy cow numbers.
Babler chart 1   8 17 12
 

In the current cycle, cow numbers climbed from 9.082 million in December 2009 to a peak of 9.271 million in May 2012. Class III milk declined from $21.67 in August 2011 to $15.23 in May 2012. The historical dynamic associated with declining milk price is a reduction in cow numbers. Combining the milk price decline with sharply higher grain and protein costs, drought conditions and historically very negative margins for many producers, the expectation would be a major decline in cow numbers to be taking place now.

In the past we have seen the following cow number declines:
• 172,000 head decline June 2002 to January 2004
• 28,000 head decline June 2006 to September 2006
• 246,000 head decline June 2008 to January 2010

Currently cow numbers have declined 44,000 head since April. To match USDA estimates, cow numbers need to decline an additional 117,000 head to 9.10 million by early 2013. This would equal a total decline of 161,000 head from peak to trough. Is this type of decline occurring? What is happening to cow numbers today?
 babler chart 8 17 12b

babler chart 8 17 12c

Dairy cow slaughter has been steadily above the prior five-year average and was seasonally sharply higher in July. This largely accounts for the 44,000-head decline in milk cow numbers thus far. It is reasonable to assume that Western slaughter would be up due to the spike in feed costs and the regions negative margins. Drought, heat and uncertainty with feed supply would be expected to impact Midwest producers.

The data supports both of these hypotheses, but what is interesting is variation between the Midwest and West coast slaughter data. The Midwest is accounting for the bulk of recent rise in cow slaughter, indicating that the drought conditions have trumped the poor margins of Western producers in terms of slaughter numbers. In addition, production caps and quotas have steadily been eliminated in California after the squeeze last spring. It is possible that given the improved outlook in profitability, California producers are looking to at least maintain herd sizes heading into the fourth quarter in hopes of capturing higher prices and improved margins.

Looking at daily cow slaughter data that doesn’t separate by cow type (dairy or beef), or capture every cow slaughter like weekly data does, indicates the sharp liquidation in July has reversed course in August. This data can be volatile but, given the jump in milk prices and forward margins, it may also indicate that fewer cows are being sent to market. If so, maybe Midwest producers aren’t as concerned about the drought’s impact on feeding capacity after getting a better assessment of silage and forage potential.

babler chart 8 17 12d

Dairymen nationwide have had the proverbial “book thrown at them” with uncertain feed supply, higher costs, historically negative production margins, balance sheet pressure and uncertain farm policy. In light of all of these unfavorable conditions, dairy cow liquidation has been historically mild thus far. Therefore, it seems likely that either forward profits or milk cow number forecasts will need to change in the months ahead, given the existing data and market signals.


Risk in purchasing options is the option premium paid plus commissions and fees. Selling futures and/or options leaves you vulnerable to unlimited risk. Transaction cost used throughout this report includes both commissions and fees. Atten Babler Commodities LLC uses sources that they believe to be reliable, but they cannot warrant the accuracy of any of the data included in this report. Past performance is not indicative of future results. Unless otherwise stated the information contained herein is meant for educational purposes only and is not a solicitation to buy futures or options.

Will Babler is a principal at Atten Babler Commodities LLC. Contact him at (815) 777-1129 or Wbabler@attenbabler.com. Learn more about Atten Babler Risk Management
 

Price Milk Incrementally Now to Avoid Regret

Aug 10, 2012

When milk prices eventually do descend, you don’t want to be among those who are scrambling to take a position.

Stewart Peterson   Mark LudtkeBy Mark Ludtke, Stewart-Peterson

The Summer Olympic Games have been a nice diversion from watching the weather maps and the sky for rain clouds. It always amazes me to think about the discipline those athletes have years before an Olympic event, so that they can perform under pressure and top a previous “best.”

Yes, there is a parallel to your dairy business here. And it has to do with how you handle the pressure of making pricing decisions.

Most of the discussions I am having with dairy producers this summer revolve around whether or not they should take any action to protect their milk price when feed prices are so high. They like the idea of some protection in place, but some can’t bring themselves to take action because there is much news out there pointing to higher milk prices. The culling pace is picking up and, with higher feed prices, it logically follows that production will drop off and support the milk price.

That may be true in the near term. We see reasons, however, to be cautious that milk will hold.

First of all, the nature of the rally is supply-driven due to the heat and lack of feed. The wider economy is not strengthening, so once prices get to a point where demand drops, we’ll see a pull-back.

Second, from a technical perspective, whenever corn prices have been high, it has historically been a good time to price milk. The chart below illustrates this. When corn prices start to fall apart, milk prices tend to start falling as well.

Stewart Peterson   Milk and Corn Price Correlation, 2007 2008   8 10 12

And so, when milk prices eventually do make a turn lower, you don’t want to be among those who are scrambling to take a position. Rather, as the milk price is rallying, we want to incrementally take something from each step up. And, as we reach certain levels, we want to have a downside safety net in place. Put options are a good choice, because they set a minimum price while keeping the topside open in the event that prices keep moving up.

Consistent and disciplined incremental pricing is part of an overall strategy that, like those training for an Olympic race, has you prepared for any given moment. An athlete who doesn’t train in a disciplined and consistent manner risks injury or misses the opportune moment. We encourage you to adopt a training program that has you consistently working toward your own “personal best.” In running, time is your measurement of success. In marketing, it’s your weighted average price received for milk (or paid for feed) for a quarter, year or three-year period.

With consistency, discipline and strategic creativity, you can gradually work to raise that weighted average price for milk, and lower it for feed. Last month I wrote about the enviable position of producers who had protected their corn price earlier in the year. Those who did not act at that time are struggling now. We don’t want to see that same regret happen for those who hesitate to start pricing their milk.

As with any training program, you have to start somewhere. There is no external news or authority that is going to tell you that now is the time to act. It has to come from you deciding that you want to begin a disciplined and consistent program that always drives toward achieving a new “personal best” for your operation.

Mark Ludtke consults with dairy producers nationwide concerning their choices for risk and opportunity management. He can be reached by calling 855.334.0700 or at mludtke@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 2012 Stewart-Peterson Inc. All rights reserved.

 

The Ripple Effects of the Shrinking U.S. Corn Crop

Aug 06, 2012

A closer look at the global dynamics of drought-driven corn and soybean prices, the ethanol industry and the concept of rationing supplies to meet demand.


ron mortensen photo 11 05   CopyBy Ron Mortensen, Dairy Gross Margin, LLC
 

The drought of 2012 has become so serious that the corn and soybean markets must confront the concept of rationing—allowing prices to rise high enough to reduce demand. Chances are there will not be enough crop around to meet everyone’s needs.

For corn, there are three main components to demand: feed/residual, ethanol and exports. Currently, the most attention has been devoted to ethanol production.

It could take reductions of nearly 20% of the industry, which means 25 large plants may need to shut down. A few plants have already shut down or gone to hot idle. Reductions of about 900 million bushels of corn use may be needed to get the supply and demand tables to balance. There may well be excess renewable identification numbers (RINs) to allow this reduction to occur.

Rumors continue to swirl regarding the Renewable Fuels Standard (RFS) and whether or not (or when) a waiver will be requested. If an official waiver is requested, EPA will take comments from the public for 90 days. The last time a waiver was requested was in 2008 by Texas Governor Rick Perry. It was denied. The rules are such that getting a waiver is very difficult.

What if the EPA does reduce ethanol requirements? Refiners have become more dependent on ethanol for the octane boost to get low-grade gasoline to meet the requirements at the pumps. Ethanol is the cheapest octane booster around, so refiners could bid up the price of ethanol, making it profitable to produce. So, how much does ethanol demand really decline?

From a feed standpoint, if ethanol production is reduced, more corn or soybean meal will be needed to replace the DDGs. This is relevant for both the domestic feed situation and exports. Exports of DDGs have been strong, especially to China, so these would need to be replaced with corn or soybean meal.

For feed demand, USDA did provide some data in the grain stocks report on June 29. It showed corn stocks at 3.148 billion bushels. This was close to expectations and implies feed use during the third quarter of the marketing year was close to last year’s number. There is less corn available for feed for the fourth quarter, so presumably there will be more wheat feeding. Remember there was a time when wheat feeding penciled out, so cattle and hog feeders did book wheat.

The stocks report showed lighter stocks (on a proportional basis) in Illinois, Minnesota and Nebraska compared to last year. There are implications of tighter basis levels for Illinois and surrounding states because of the sizable processor demand centered in Decatur, Ill. These tight basis levels could continue if the Eastern Corn Belt crop size keeps shrinking.

A small U.S. crop could mean liquidation, slaughtering sows and cows, besides feeding animals to lighter weights.

For exports, the U.S. may be saying, “Thank goodness, Brazil grew a huge corn crop.” While price has recently reduced the pace of U.S. exports, there is a large, cheaper crop available from Brazil. This will be a welcome supply for foreign buyers seeking a source of supply in the face of the potentially smaller U.S. crop. Brazilian corn may find its way into the US. as some southeast chicken feeders are already talking about having made purchases.

Foreign buyers can simply try to scrape by with smaller purchases. And China figures in here, too. The Chinese may cancel or re-sell the new crop corn they had purchased earlier.

Over on the soybean side of things, there is a potential new wrinkle regarding soybean meal. Due to the sub-par monsoon, India last week announced it would drop the import tax on soybean meal. This would allow for soybean meal imports for the first time in history. This is dramatic when a traditional soybean meal exporter turns into an importer. The meal would most likely come from China (likely crushed from U.S. soybeans), which has excess soybean processing capacity. Indian meal prices have doubled since the spring, while U.S. prices are only up 30% to 40& in the same timeframe.

Reduced soy production in Argentina and Brazil is also rippling through the markets up in the U.S. Reduced supplies down south means increased demand up here for both whole bean exports and crush. Many think soybeans and meal will be tight until March 2013 as the U.S. will need to supply the world. This makes the current U.S. crop in the field very important. However, it will take very large South American production before the soybean market is truly comfortable with supplies.

Ron Mortensen is a founder of Dairy Gross Margin, LLC, which was formed in 2006 to sell Livestock Gross Margin Insurance to dairy producers. Mortensen’s firm is now licensed in 23 states. He is also president of Advantage Agricultural Strategies, Ltd., which he founded in 1985, to provide individual risk management advice for farmers and agribusiness using futures, options and cash trading strategies. Contact him at 515-570-5265 or ron@dairygrossmargin.com.

 

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