What It Takes to “Know Your Market”

Published on: 11:36AM Feb 15, 2013

Dairy producers have been so innovative and so good at lowering your costs of production. Now you must arm yourselves with knowledge about the opportunities beyond production.

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By Scott Stewart, CEO, Stewart-Peterson Inc.

As our team visits with producers across the country during this winter meeting season, it is evident how much dairy producers want to "know their market." And they are confused by it.

At the Pennsylvania Dairy Summit this past week, I had the opportunity to speak with the group about the markets and what is needed to make good decisions in 2013. In the Q&A session, a question was asked about the disconnect between the futures market and the mailbox price dairy producers are paid. Why the disconnect? And how does a producer make decisions if there is a disconnect?

To be sure, the milk pricing system in different parts of the country is a political quagmire. Beyond the politics, the question remains whether the markets are an effective and accurate picture of what your milk (or feed) is worth. The question behind this question is, "Should I be using the markets at all, because they might not be an accurate representation of value?"

The answer is that all markets are a reflection of information and data and the price you can expect in the future, with all the fundamentals factored in. We must keep in mind that the markets are not perfect. I liken it to the relationship you have with your spouse or your children. Nobody is perfect. Your spouse will have a bad day or overreact sometimes. Your son will come home with a B+ instead of an A sometimes. And yet we respect these people for who they are as a whole. They are an important part of our lives and we have a relationship with them for the long haul. The markets are also imperfect, and it doesn’t mean we can’t embrace them.

In Pennsylvania, I made the case that managing risk through the markets is an important part of a dairy producer’s operation for the long haul. That’s because, in the commodity business, prices will always go through boom-and-bust cycles and settle near the average break-even point for all producers. Those who stay above break-even survive; those below will find something else to do. So you have to be better than the average of all producers. You have to continually look for ways to produce better, and capture even a little bit better price.

A producer came up to me after the speech and said, "That’s a tough message." I know it is. Our dairy producers have been so innovative, and so good at lowering their costs of production, that the average is getting tougher and tougher to beat. You have to turn over more stones to find opportunity. My hope for the industry is that we never lose hope that opportunity is out there. We can be determined to arm ourselves with knowledge about the opportunities beyond production, so that we can be empowered to take advantage of those opportunities.

An example of that would be applying a consistent, disciplined approach to the markets in the same way that you take a consistent, disciplined approach to improving a herd average. I remember one producer we spoke with in October was so confident that the milk price would climb that he decided to stop his previously consistent pricing activities. Since October, we have seen second-month milk come down $3.98 off of the high. I’m sure that producer is thinking, "The markets just don’t make sense." And that goes back to my original point, that sometimes the markets do not behave like we think they should.

If you’re looking for a connection between all the news and fundamentals that are available right now and the market price, you may not always find one. That’s because, again, the market has all of those fundamentals, plus expectations about future fundamentals, factored in.

Just think about the corn market. USDA’s average price projection for corn has historically been fairly accurate and it is substantially above where the corn market is today. When corn sold off a dollar after the highs this fall, we still hadn’t come anywhere close to what the USDA’s average price forecast was for the year. So as a fundamentalist and a follower of past history and a believer in the data, you would say that corn prices should be going up, up, up right now. Instead they have gone down. The fact is that high prices rationed demand. After that happened, a producer from the thumb of Michigan said to me, "The markets are efficient, aren’t they?" Yes. And they do make sense. . . . It’s just that the dots do not always connect perfectly and obviously for us as we sift through the news.

Does that mean there is something wrong with the markets? Last month I met with a very large western producer who was absolutely convinced that the markets were out of control. He was very knowledgeable about milk and cheese fundamentals, exports, imports – the whole works. Despite his vast amount of knowledge, he simply could not connect his knowledge to the price action that week. He was completely paralyzed -- not doing anything to protect his prices or look for opportunities.

The reality is that the market already had all of his information factored in, and it’s reacting to the information he doesn’t have yet. Market prices reflect reality and expected reality. And they are not always perfect. At any given moment, they might be a little higher or a little lower than actual value. It is a futile chase to try and figure it out.

Your time is better spent looking for strategic opportunities. If you are taking a consistent and disciplined approach to pricing your commodities, you can protect against risk as well as look for opportunities to be on that higher side of average. That’s proactively turning over stones to look for a competitive advantage. If you are paralyzed and do not engage, you’ve left that stone unturned.

Some do not like my competitive view of the world, and some might even say that the markets are not fair, that if I end up with an above-average price, then someone "loses" on the other side of that trade. I view that as an excuse not to engage, because buyers and sellers are in the marketplace to agree on a price for a product that fulfills a need for them at the time. The markets are a tool for the benefit of our businesses in this uncertain, ever-changing world.

One very young dairy producer in Pennsylvania posed this question: "You paint a picture of a very competitive, uncertain world. What would you tell someone who is just starting out in the dairy business?" My answer was to keep getting better. Leave no stone unturned in your quest to be better than average. For some that is a scary message. Others will embrace the challenge. In which camp do you fall?

As I stressed in Pennsylvania: You don’t have to view yourself as a victim if you set the goal of being a victor. Don’t be paralyzed by the market. Rise above it.

Scott Stewart is CEO of Stewart-Peterson, a commodity marketing consulting firm based in West Bend, Wis. You may reach Scott at 800-334-9779, or email him at [email protected].

The data contained herein is believed to be drawn from reliable sources but cannot be guaranteed. This material has been prepared by a sales or trading employee or agent of Stewart-Peterson and is, or is in the nature of, promoting the use of marketing tools, including futures and options. Any decisions you may make to buy, sell or hold a futures or options position on such research are entirely your own and not in any way deemed to be endorsed by or attributed to Stewart-Peterson. 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. Copyright 2013 Stewart-Peterson Inc. All rights reserved.