What To Do When the Futures Markets Offer Little Hope

February 8, 2016 03:10 PM
What To Do When the Futures Markets Offer Little Hope

Shoulda. Woulda. Coulda. That’s the best that can be said about dairy futures prices now through the summer months, at least.

And the scary part is, there’s no guarantee the stronger prices offered for the second half of 2016 will materialize. “We’re in a perfect triple storm,” says Chris Atten, a principal with Atten Babler, Galena, Ill. “China and Russia are out of the market, the European Union is up 5% in milk production, and the United States has a 9.3 million cows with replacement numbers up 3%.”

So there is some potential for markets to soften further, he says. You might have to spend some money to get downside price protection, placate your lender and avoid $1,000 per cow losses, he says.

Most farms in the Midwest had a break-even year in 2015 and they likely are sitting on a good pile of working capital. “If they have $700 to $900 per cow in working capital, they should be able to get through the next six to nine months without too much of a problem,” says Steve Bodart, Principal Business Consultant and Dairy Industry Specialist with AgStar Financial based in Baldwin, Wis.

“But further east, we’re already drawing down working capital so the solutions are much tougher,” he adds. Even those farms that had risk management plans in place aren’t seeing huge benefits. 

“With the marketing that has been done, the marketing is only adding 20¢/cwt,” Bodart says. “Many implemented fence strategies (selling calls and buying put options) with big gaps and so the payoffs haven’t been large.”

The critical thing now is that farmers understand what their cash flow needs will be this spring and summer, and talk to their lenders sooner rather than later about their financial situation. That will give them time to perhaps restructure or refinance loans, or go to interest only payments.

Bodart is reluctant to advise producers to look to the futures market now because you could actually be locking in losses. But there may be some creative ways to at least protect prices from falling out of bed, say brokers.

One approach would be a “put spread,” where you sell an option at the money and then buy a put  $1.25 below, says Robin Schmahl, a hedge and marketing specialist with AgDairy based in Elkhart Lake, Wis. For example, you might buy a $15 put at 70¢ and then sell a put at $13.75 for 20¢. If the market drops to $14.50, you get your 50¢ premium back. If it drops to $13.75, you get your 50¢ premium plus 75¢. And if it drops below $13.75, you’re only out the amount it drops below that level.

It’s not a great strategy, acknowledges Schmahl, but at least it offers some downside protection without capping the upside.

An alternative might be to look at some cross-hedging opportunities with cheese or butter futures, says Atten, depending on where you’re located and the Class III and IV utilization of your milk check. If cheese is trading at $1.65, for example, a put at $1.50 might only cost a few cents. None of these will be perfect hedges, but they will offer some downside price protection at low cost.

The critical thing is that you discuss strategies with your broker, understand the strategy you decide on, and be able to discuss that strategy with your partners and your lender.  “This is the time you as the Chief Financial Officer of your operation takes over and drives the business through the next 12 to 18 months,” he says. 

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Spell Check

John Bergwerff
oakdale, CA
2/12/2016 01:42 PM

  I would like to see more on the western milk markets. The eastern market doesn't help much.


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