Identifying Pricing Opportunities as Volatility Approaches

Published on: 11:27AM Jun 11, 2012

Perceptions of growing tightness in both milk and grain supplies point to an explosive and volatile market ahead.

Dairy futures have been impressive over the past few weeks. Class III futures continue to rebound from the lows established at the beginning of May.
Technical traders have turned more bullish as futures prices reach for new highs since setting a bottom. In my opinion, technical trading in milk futures is very inaccurate due to the lack of liquidity in this market. Technical trading works well in a market that has significant activity because many traders follow the same or similar technical studies. The more traders following a technical study, the more buying or selling will take place at certain prices. The main ingredient in a market that follows these indicators is the large fund traders that buy and sell a large amount of contracts. Dairy futures do not have this. Although technicals can be watched, it is generally not something that one should spend much time with.
Dairy futures are not a price discovery mechanism as many of the other futures contracts are. The price discovery mechanism is the cash markets, which set the weekly AMS prices. Compilations of these prices set the announced prices for the Federal Orders broken down by class. These class prices set the base for our milk checks. The futures market is an anticipation of what the underlying cash prices will be for each month.
Nevertheless, dairy futures have been trending higher. Fundamentally, not much has changed. Perceptions have changed and that is all that is needed to set market direction. Once spring flush ran its course and production began decreasing, manufacturing plants began seeking milk as they now had excess capacity. The days of having plentiful supply and the ability to purchase extra milk at a discount ceased. The perception changed from one of “plenty” to one of “tightness.” There is potential for increased tightness if the forecasts for above-normal temperatures this summer continue.
Couple that with the potential of reduced grain yields if dry weather persists. With an already tight grain supply, we have all the makings for an explosive and volatile market.
We need to realize that this year has been, and is, no different than previous years. The market is always filled with the unknowns. It is always filled with could haves, should haves, would haves and wish I wouldn’t haves. These feeling are always in hind sight. We will never figure the market out or be able to hit either the top or bottom. The main goal of each farm is to protect prices that work, prices that will pay the bills and, hopefully, build equity. Yes, sometimes that that can be difficult when looking at current prices. That is why it is important to always think ahead.
Let’s look at the June Class III contract as an example. It is almost fully priced now that we are near the middle of the month. The current price is near $15.50 and certainly a better price than it had been at the beginning of June. However, looking back in time, we can see that that contract traded at over $17.50 for about a week early in the year. I do not propose that we all could have sold the top, but it did trade above $17.00 for nearly two months. All of the other Class III contracts through December spent some time above $17.00 during January. Of course, the jury is still out on where prices will end the rest of this year. If hedges were placed in January and prices through the rest of the year average $17.00, you would be no worse for the wear. The benefit would have been peace of mind that you were hedged at a price that would keep you in business. 
Now that milk futures have moved back up to mid-$16.00, look at fence strategies consisting of purchasing at-the-money puts and selling call option $1.00 or so higher. Late last year into the beginning of this year the spreads could be done at a $2.00 spread, but the time value has eroded, making the calls less valuable. However, fence strategies continue to be very viable for price protection while allowing for some upside price potential.
Upcoming reports:
- World Agricultural Supply and Demand report on June 12
- May Milk Production report on June 18
- Fonterra auction on June 19
- July Federal Order Class I price on June 22
- May Cold Storage report on June 22
- May Livestock Slaughter 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 website at
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.