High Feed Prices Mean High Milk Prices – Maybe

Published on: 12:18PM Oct 18, 2010

Milk prices do not have to go up because feed prices are higher. We should not be complacent that high feed prices will automatically increase milk prices next year.  

Over the past few months, one statement had been prevalent among dairy farmers and that is: “With corn price going higher, milk price just has to go higher.”
This certainly is a valid statement and one that has historical basis. Higher feed prices will result in heavier culling and changes in feed rations, which can have a definite impact on farm output. Theoretically and historically, this has been true in many cases. However, there have been some exceptions to the rule as there always are when dealing with an uncontrolled environment. Let’s take a closer look to see what has happened in the past and what we may be looking at in the future.
First, a low milk price does not automatically mean a low milk/feed ratio. In 2000, the average Class III milk price was $9.78/cwt., but the average milk/feed ratio was 3.06 due to low grain prices. In 2007 and 2008, milk prices reached record highs while the milk/feed ratio dropped to an average of 2.80 and 2.01, respectively. In essence, we were trading dollars for dollars if all feed was purchased hand-to-mouth, but it was an indication that higher feed prices resulted in higher milk prices. Last year, milk prices fell further than grain prices, resulting in an average milk/feed ratio of 1.78, the lowest since I have records back to 1985.
Another aspect that helped propel milk prices to new highs was solid demand from a strong economy. However, we all know what has happened in the economy over the past two years, and it has had a dramatic impact on demand. Milk prices would not have been as low in 2009 had it not been for a struggling economy and high unemployment that reduced disposable income.
Great strides have been made in other areas such as cow comfort, production per cow, sexed semen, feed efficiency, etc., which have resulted in a better income over feed costs on many operations. Forward contracting feed when there are opportunities, or those who grow much of their own feed, improve income over feed costs significantly.
So, do high corn prices automatically mean high milk prices? Historically there have been many years of higher milk prices when corn prices were higher. However, the partnership of higher corn prices and higher milk prices has been shared about equally with times of higher milk prices and lower corn prices or higher corn prices and lower milk prices.
The bottom line is that it all comes down to supply and demand. High feed prices can definitely have an effect on supply, resulting in high milk prices, but slower demand will cause an increase in supply, which will need to clear the market. Right now, we have a large amount of cheese in storage that will need to be reckoned with at some point. Demand will need to increase or milk supply decrease to keep from adding more to these storage levels next year.
Milk prices do not have to go up because feed prices are higher. Many times they will, but various other factors need to be considered. We should not be complacent that the high feed prices will automatically increase milk prices next year.  
The decrease in block cheese prices last week ended a streak of steady to higher prices that began June 29, ultimately leading to a rally of 37.25 cents. Buyer demand may be satisfied for the time being, and a retracement in price could be experienced in the near-term.
My hedge recommendation is to implement fence positions for the first half of 2011. Purchase $14.00 puts and sell $16.00 calls for 40-50 cents on no more than 50% of production. This is a marginable position that will establish a floor at $14.00 and a ceiling at $16.00, minus the initial cost. Look for opportunities to hedge feed prices if the market retraces, or purchase call options that will protect against increasing prices while leaving the bottom open to purchase at lower prices if markets fall back.
Upcoming reports:
-          September Milk Production report on October 19
-          Fonterra auction on October 19
-          November Class I price on October 22
-          September Livestock Slaughter report on October 22
-          September Cold Storage report on October 22
-          Consumer Confidence on October 26
-          Commercial disappearance on October 26
-          October Agricultural Prices report on October 29
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.