Temporary Measures May Have Long-Term Consequences

Published on: 12:47PM Jun 09, 2009

By Robin Schmahl

We are nearly to the half way point of the year and a milk price rally has yet to materialize. There has been much anticipation for stronger milk prices through the second half of the year, which stemmed from the idea that heavier culling and the implementation of the CWT herd retirement program would be enough to cause milk supply to tighten. The theory was correct, but the anticipated effect has not yet materialized  

It seems that a significant price rally may have difficulty materializing during the remainder of this year. For one thing, we are not alone in this. Dairy farmers around the world are facing similar difficulties as a result of low milk prices. Europe has revived their exports subsidy program and the U.S. has revived the Dairy Export Incentive Program. Dairy farmers in the Oceania region do not have any type of subsidy program and feel they are at a disadvantage. They feel the actions by Europe and the U.S. will prolong the low milk prices. One thing we need to realize is that milk prices are not low in-and-of-themselves but are the result of the world economic situation.

The severe downturn in the world economy is something that was not anticipated a year ago. A recession was looming, but not as severe as what has taken place. I am hoping that the economy turns around resulting in people going back to work and demand for dairy products will increase.

I do see a potential downside if prolonged low milk prices remain and measures are implemented to curtail milk production through various means. Measures that will eliminate cows, eliminate farms or reduce milk pick-up to force milk prices higher domestically will be a short-term fix which may put us at a disadvantage in the long run. A higher domestic price and a lower world price will only open up for increased imports. Don’t get me wrong. I would like to see high milk prices along with everyone else and as soon as possible. However, if drastic measures are implemented eliminating milk production potential or the desire to produce milk, this market share may be filled by other countries. We have seen this in industrial manufacturing to some extent. Much of what we produced now comes from other countries as they can produce it cheaper than we can resulting in the loss of domestic market share.

There is no easy answer to the dilemma currently facing dairy farmers. A stronger economy will go a long way to accomplish higher milk prices. It has only been a short period of time since we had record high milk prices. In 2007, the average Class III milk price was $18.04. The average Class III for 2008 was $17.44. Yes, cost of production has increased significantly over the past two years requiring a higher milk price for profitability.

This brings us to the point of the need for marketing and hedging milk above the cost of production when those opportunities exist. If one is consistent with marketing cash flow will continue and equity will grow. For a period of two months last year the average Class III futures price for 2009 was above $18.00 and reached a high of $20.59 by June. The difficulty faced by farmers at that point was projections for higher feed prices and anticipation of milk prices increasing to $25 or even $30 per cwt. Estimates were bullish because of the trend, and those analysts were doing a huge disservice to the industry. Common sense suggested consumers would not continue to purchase dairy products as heavily if prices continued to escalate. High prices cure high prices and this was clearly seen. The effect of higher prices was magnified by the falling domestic and world economies.

My current recommendation is to those who have extra grain to sell from their farm and those who would like to protect the worth of the crops they have planted. Purchase put options or put option spreads to protect against falling prices. I feel the market psychology is turning, similar to last year, and prices will erode. I recommend a December put option spread by purchasing a near the money put option and selling a put option with a strike price 70 cents below. For soybeans, use a similar strategy by purchasing a near the money put and selling a put $1.00 lower. This will protect the worth of your crop in the event prices decrease allowing you to still feed your crop.

Upcoming reports to watch for are the World Supply and Agricultural Demand report on June 10; the Export Sales report on June 10; the California Class I price on June 10; the May Monthly Milk Production report on June 18; the July Advanced Class I price; and the May Cold Storage report on June 22.

--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 Web site 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 may not be suitable for everyone. Those acting on this information are responsible for their own actions.

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