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Know Your Market

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

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

What in the World Will Affect Dairy Input Prices?

Aug 16, 2010

By Steven Schalla, Stewart-Peterson Inc.

 
While the Class III milk futures have been steady to a little higher with help from cheese and butter prices, the real action in the past two week has been in the grain markets.
 
It’s always amazing to see how quickly raw emotion can ignite a market –- most evident recently in wheat futures prices. With news of drought and wildfires in Russia and its government placing a ban on exports until the end of 2010, prices in Chicago exploded higher. As memories of the 2008 world wheat drought and subsequent price rally jumped into trader’s heads, they bought as aggressively as possible to capture the potential opportunity. 
 
Warranted or not, corn, beans and meal prices followed suit, with new crop corn futures climbing back over the $4.00/bu. mark. Even if you were concerned that your feed costs were at risk to turn back higher, it’s not likely that a Russian wheat drought was your reasoning.
 
Whether you are talking about grain or milk markets, unpredictable situations like this happen and can bring dramatic change to your profitability. This latest situation with grain prices is a textbook example of why Market Scenario Planning is critically important, not only for your milk price but also for your feed, fuel and interest rate inputs. 
 
In my previous writings, we’ve run through different Market Scenario Planning examples, the latest analyzing the impact of call option re-ownership after establishing forward contracts with the milk plant. The objective of this dynamic planning process is simple: to bring more certainty to an uncertain situation so you can make better decisions.
 
Regardless of what you think is going to happen with prices, how would an unexpected move affect your overall weighted average price? Doing this analysis helps you make other important decisions, like can I accept the potential results of this pricing strategy? Or, where is the right point to take action? Keep in mind that the factors that go into what is “acceptable” to you may be either financial or emotional, or both.  
 
Looking at feed corn inputs, there are several different price scenarios that could unfold this fall. From a fundamental standpoint, last Thursday’s USDA Supply and Demand Report estimated 2010-2011 corn carryout at 1.312 billion bushels. While this is a comfortable spot, any cut of supply or increase in demand (or vice versa) would likely cause a quick and sharp response from corn futures. At the same time, influences from outside markets such as the U.S. dollar and crude oil will continue to impact corn and grain prices. 
 
Our team believes that we’re in for another wild harvest season, with both $6.00 and $3.00 corn futures a real potential, depending on how different scenarios materialize.
 
Now I’ll be the first to admit that it’s a lot more interesting to try to speculate what will actually happen. It’s fun when you get it right and your decision-making goes well. But when any one of these different factors – or a factor no one expected -- becomes the main driver of corn price, it’s anyone’s guess what type of prices will actually materialize. And, all too often prices move quickly and your best feed buying opportunity is gone, just like that.
 
That’s where running price scenarios for feed in advance can help you. When you do this, you can be confident that you’re ready for whatever scenario unfolds. Here is a very simplified outline of steps we take to prepare for decision-making in an uncertain environment, using examples that address a concern for corn moving dramatically higher or lower:
1.      Analyze fundamentals and other market factors to develop 3 or 4 of the most likely price scenarios. Example:
a.       Scenario 1--Harvest yields are down along with a weak U.S. dollar, and corn goes to $6.00.
b.      Scenario 2--Corn hovers around the $4.25 mark.
c.       Scenario 3--China reduces buying combined with great harvest yield, and corn drops to $3.00.
2.      What is the net price of my feed inputs in each scenario, considering the following:
a.       What buying and/or hedging strategies and tools will I use in each scenario?
b.      In what time frame am I using these tools?
c.       For how much or what percent of my feed needs?
3.      What price development “signposts” will I use to trigger action? For example:
a.       If corn breaks through $4.50 December futures, then I know Scenario 1 is unfolding.
b.      If corn trades between $4.50 and $3.75, then Scenario 2 is unfolding.
c.       If corn trades below $3.75, then Scenario 3 is unfolding.
 
With a well-planned strategy and contingency plans, including specific action points as new information and price developments unfold, you are prepared and ready to act whether corn rallies or declines any amount. You’re less likely to lose precious time during a market move because you’re prepared with your strategies and tools. Good preparation avoids that uneasy feeling of what in the world just happened to prices today?
 
Take some time establish your strategy, and if you not sure where to start, consider talking over your ideas and more specific and detailed scenarios with a trusted professional. In today’s world, it’s worth your time.
 
Steven Schalla is a Market Advisor for Stewart-Peterson Inc. He can be reached at 800.334.9779 or sschalla@stewart-peterson.com.
 
Market Scenario PlanningSM is a service mark of Stewart-Peterson Inc.
 
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.
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