Prudent Choices to Consider with High Milk Prices
Jan 25, 2014
Suggested strategies for dairy producers who choose to use the Livestock Gross Margin for Dairy program.
By Ron Mortensen, Dairy Gross Margin
How high will milk go? When will it end? Can the margins get better? How long will they last?
It is hard to look forward and so easy to look back. However, looking back can serve as a wake-up call, encouraging action and guiding your decisions in the future. It can be a big help with perspective and attitude, especially with high milk prices. What is the past saying about the big opportunity presented right now?
Think of the chart below as a monthly price chart with a twist. It is a monthly chart of historical actual margins (the blue line is actual and the pink line on the right is anticipated margins). The circled areas indicate the best margins since 1998. Margins were strong for only two to three months in 2004, 2011 and 2012. However in 2007, margins remained strong for nine months.
In this discussion, you also need to consider market structure in your decision-making process. What is market structure? Notice that nearby futures prices are higher than farther out prices. February Class III is about $22.00/cwt., May is about $19.00 and December is $17.60. As a futures contract approaches expiration, it could rally sharply. While the immediate reaction may be to do nothing (because the market always rallies), the more prudent choice may be a minimum price strategy. You will benefit from any rally in the last month or so before the milk futures contract expires. It is a more flexible strategy than using futures contracts.
Again, the blue line represents the historical values of Livestock Gross Margin for Dairy (LGM-Dairy). The pink line represents the future insurable margins based on 1,560 cwt. of milk, 20.5 tons of corn and 6 tons of soybean meal. This chart also reflects the current market structure as discussed in the paragraph above. Milk prices are higher in the front months so the margins look the best in the first few months.
1. Lock in minimum cash flow. A very simple plan would be to buy LGM-Dairy or options that are above your break even. This is an easy one to do. It provides guaranteed cash flow if milk prices go lower and allows you to capture better margins if milk prices move higher. Cover a significant amount of milk with this program. Remember to factor in your basis level when evaluating the sort of minimum cash flow for your operation.
2. Lock in minimum profits. If break-evens are low enough to buy LGM-Dairy or options and lock in a minimum profit, it is even better. Be willing to spend more money by reducing the deductible on LGM-Dairy or use a higher option strike price. Once again, if milk goes higher you will get the higher prices.
3. Improve your position. If you have already done LGM-Dairy or options, it may now be possible to lock in a higher level of cash flow or profits. Essentially, you would forget the old LGM and options and start over. Do this to improve your position. Keep move up your coverage as the market moves higher.
The chart below called "Quick Looks" shows potential margins that you could establish at the end of January.
The risk of loss in trading commodities can be substantial. You should therefore carefully consider whether such trading is suitable for you in light of your financial situation.
Ron Mortensen is principal of Dairy Gross Margin, LLC, an agency that specializes in LGM-Dairy products, and owner of Advantage Agricultural Strategies, Ltd., a commodity trading advisor. Contact him at firstname.lastname@example.org or through www.dairygrossmargin.com.