The calendar is nearing the end of 2015 and one certainly needs to be thankful milk prices have not been any worse than they have been. Yes, farm income has been reduced drastically from the record high of 2014, but milk prices have not been as bad as feared earlier this year. I am not indicating that it has been an acceptable year as some operations have had difficulty with cash flow depending on various reasons. If you can recall back in January, the price outlook was bleak as March, April, and May 2015 Class III contracts fell below $14.00 for a brief period of time. Fortunately, they did not remain at that level for very long with contracts rebounding nearly $2.00 shortly thereafter with prices eventually settling at $15.56, $15.81, and $16.19 respectively. December Federal Order prices will be announced on December 30 with the current average Class III price for 2015 being $15.80. Class IV average price for the year should be close to $14.93.
Currently, a similar price pattern seems to be unfolding however, fundamentals are different. Instead of milk futures falling below the underlying cash calculation due to a bearish attitude and relentless selling, futures are holding a bit of price premium to the underlying cash. That has been the reason for the recent futures contract weakness even though spot prices have shown brief periods of price strength. The overall trend is down with butter now leading the charge.
Market fundamentals are hitting the proverbial wall that had been looming for quite some time. A period of slowing demand that unfolds at the end of the year after holiday and January buying is finished and continued slowing exports of cheese and butter were not supportive to the price outlook. No help is coming from the international market either as overall supply of dairy products and floundering world dairy prices leaves little hope for a turn anytime soon.
There has been some idea that the lows are near or have been reached, but that leaves little consolation for stronger milk prices. If the lows have been reached, that would be great. However, if prices remain at current levels for an extended period of time it would not be so great. Current futures indicate a January Class III price of $13.48, so if the lows have been achieved and prices remain at these level, subsequent futures contracts and resulting milk prices will erode as they converge to the underlying cash. This becomes a huge concern as spring and summer contracts could loose another $1.00-$1.50 per cwt. So if a bottom has been reached, it leaves little consolation for higher prices under current market fundamentals. I do not want to be the bearer of bad news, but this is the current reality and I certainly do not want to provide false hope.
Rabobank changed their earlier forecast of stronger milk prices to show a recovery by mid-year and are now pushing it to near the end of 2016. They have expectation for China dairy demand to improve, but certainly not to levels it had been. Even though New Zealand is expected to decline another nearly 3% this year on top of the around 3% production decline last year, this is being offset to some extent by production in other countries. Milk output in the top seven milk producing countries is only expected to decline only 0.1% during the first half of 2016. A base will be building for milk prices according to Rabobank, but it may build more slowly that earlier anticipated.
So what is there to do? Many producers have held the idea that prices could not go lower and held off using hedging strategies when Class III milk prices were over $16.00 due to 2014 being a vivid memory. When futures fell to $15.00 the idea was that prices were too low. The same held true for $14.00 and now we are staring at Class III futures below $13.50. I have my doubts that that will be as low as price can go giving the current state of spot markets and I certainly hope I am wrong. I continue to recommend put option spreads consisting of purchasing put options near the current market price and selling put options $1.25 lower. It limits downside coverage to the sold put option while at the same time leaving the upside completely open. The only risk is the premium paid. This strategy has paid off immensely in this market and remains a viable strategy for the second quarter and later contracts.
-November Cold Storage report on December 22
-November Livestock Slaughter report on December 23
-November Agricultural Prices report on December 30
-December Federal Order class prices on December 30
-November Dairy Products report on January 6
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.
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