Dairy Herds Will Be a Tough Sell

Published on: 10:31AM Aug 20, 2012

A surprise in the July milk production report has dairy industry watchers rethinking their market outlook.

USDA’s recent milk production report may change the thinking of the industry to some degree. The perception has been -- and is -- for a substantial tightening of milk supply through the end of the year. The combination of a hot, dry summer with escalating grain prices sets the stage for lower milk production as adjustments are made in feeding. Increased culling is expected as feed inventory is assessed.

Milk production in July did not decline as expected. USDA reported 23-state milk production up 0.8% over July 2011, with 50-state milk production up 0.7%. This was a surprise as a decline was expected. July was a brutal month in much of the nation as milk production was suppressed by hot weather. Milk receipts at the plant level declined upwards of 15-20% in some areas as cow comfort was severely affected. Cow numbers in the U.S. during July declined by 12,000 head. Despite this, milk production remained higher than last year, resulting in 30 consecutive months of year-over-year milk production gains.

This may indicate milk production may remain stronger than anticipated for a while longer. Cooler weather will improve cow comfort and thereby improve milk production. However, the rebound may be limited as farmers deal with significantly higher feed prices. Some are considering liquidating their herds rather than paying high feed prices over the next year.

There may be some difficulty in this as most everyone is in the same position, making it difficult, if not unlikely, for another farm to purchase these cows. Very few will want to take on more mouths to feed with limited feed available. With that, feed expected to be very expensive.

Some feed suppliers are not offering forward contracts as they are not sure of being able to get supply or at what price. This is reminiscent of 2008 in the soybean and soybean meal market. That year, as a result of the inability to contract meal, farmers were reluctant to hedge milk prices, unsure of what they were going to pay. We all know what happened in 2009 when Class III milk prices fell below $10.00. I am not suggesting this will happen again. It just will be difficult for dairy farmers to sell out unless most of their cows are sent to slaughter.

If grain futures decline due to greater-than-expected yields or lower demand resulting from these high prices, it likely will not help local feed prices. Cash prices will retain a significant premium over futures due to the need to find supply any place it may be available. Some areas that normally have sufficient grain supply will have to truck it in from farther away, as local supply will not be sufficient. Hauling and available supply will add significant premiums to cash prices. I already know of one area in the Southeast that is paying $1.00-$1.50 over futures for corn. Alfalfa prices are going through the roof as farmers are scrambling to obtain supply now rather than wait until later.

The recent increase in milk futures -- pushing October through December contracts above $20.00 -- surely is good news, but it may only get us back to an average milk/feed ratio seen over the past year.

My hedging recommendation for feed is to purchase call options or call option spreads in corn and soybean meal for at least 50% of your feed, if you have not already done so. The grain markets have been moving sideways, waiting for harvest results to come in. For those who have milk hedged, consider selling put options at least $1.00 below the market to capture premium. I normally would not recommend the sale of put options by themselves, but it currently does not seem as if the milk market will see any significant decline anytime soon. Adding 40-55 cents to your hedged price by the sale of these options can reap significant benefits. This is a strategy that needs to be monitored closely.

Upcoming reports:
- July Cold Storage report on Aug. 22
- September Federal Order Class I price on Aug. 22
- July Livestock Slaughter on Aug. 24
- Consumer Confidence on Aug. 28
- Agricultural Prices report on Aug. 31

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.