After the last high-price cycle, many dairy producers learned to expect the very worst. Now the milk market has taken the lessons of the previous cycle and is trying to avoid the same costly mistakes.
By Steven Schalla, Stewart-Peterson
One of my favorite quotes is from Mark Twain: “A man who carries a cat by the tail learns something he can learn in no other way.”
Experience can be the best teacher and, since 1996, dairy producers and milk users have been learning quickly about using an open futures market to manage risk and opportunity for their milk. And there have been many lessons over the past 15 years.
The lessons that stick with us the most are often the most painful, such as carrying a cat by the tail! In our dairy world, you don’t have to look any farther than the price depression of 2009. Even today, more than two years after the low point of June 2009, the most common reason producers give when asked why they want to start marketing is to “avoid a year like 2009.”
As milk prices have reached historic highs (like they did in 2008), the talk of the impending next depression is rampant. The lesson many dairy producers learned was to expect the very worst. But the latest rally of milk prices has included some key differences from 2008, demonstrating that the milk market has learned from experience.
The most important difference between these respective high points in the milk price cycle is the prices offered in the forward curve. The “forward curve” is simply how the future prices map out compared to the front month contract. These are the prices the producers and milk users are analyzing when considering major decisions such as expansion or exiting the business.
As a milk producer, the forward curve can suggest three basic things about expectations of the future:
· the market needs more production,
· the market needs the same amount, or
· the market needs less production.
During times of peak demand (or absence of supply), the market will build a premium into the close-up prices to indicate that it needs your production now. This summer, July and August Class III prices have topped $21.00 as year-to-year milk production growth has slowed from 3.3% last September to a mere 0.7% in July. At the same time, both domestic and export demand has been solid through the first half of the year. The result is the market paying up for available supplies to meet this demand and encouraging a boost in near-term production.
However, after the third quarter months in 2011 the futures drop off dramatically. While 2012 prices have appreciated about $1.00 per cwt. this summer, these prices are only averaging about $17.00, or a dramatic $4.00 per cwt. less than the front months. Here, the market is signaling that it expects available supplies to increase (or demand to decrease) this fall and winter, resulting in a lower price. Rapid growth in cow numbers this year in the Northwest and Southwest regions helped lead to this expectation.
This discount in prices next year is a stark contrast from 2008. In February of that year, the forward curve carried a 12-month futures price average that broke over $17.00 and maintained above that level until mid-August. Moreover, during five weeks in May and June 2008, the next 12 months averaged over $20.00. The market signal was clear: The expectation was that the market needed a lot more milk for a prolonged period of time, and producers appropriately responded as such. Of course, as the supply pipeline filled, the global financial crisis stalled demand (particularly exports), compounding price declines. An invaluable lesson was learned by all about the power of the forward curve.
When we talk to producers, we’re glad to hear that many are detecting this critical difference. With high input costs, there is a considerably different signal when forward prices show $20.00 versus $17.00. While $17.00 for 2012 milk is often described as feasible, this more conservative price seems to be resulting in more conservative expansion goals on an aggregate level. The actual extent of production growth (or potentially lack thereof) will be seen this fall as milk-per-cow productivity improves in cooler weather.
This analysis is not to say that a sharply lower price scenario for 2012 is not possible, but, rather, that the milk market has taken the lessons of the previous cycle and is trying to avoid the same costly mistakes. In the case of U.S. dairymen, this starts with cow numbers and milk production.
Of course, there are numerous other factors that will also impact prices looking into next year. International supply and demand will be vital as New Zealand targets a robust production increase of 5% growth, and many global economies struggle with high debt levels and imbalanced budgets, leading consumers to tighten their own spending habits. Feed cost will also stay top of mind as expectations of a short crop drive prices higher. December corn has broken into new contract highs, and bean meal futures continue to test major resistance at $375 per ton.
These moving parts lead to a number of potential scenarios for 2012 prices, providing both opportunity and risk in the coming months. While it may not be necessary to implement specific positions today, discussing different strategies and how they will impact your price in either an up or down price trend will be very beneficial. Especially with the busy harvest season just around the corner, this preparation will be rewarded when you are able to easily implement the positions when the timing is right.
While we can’t say with certainty what will happen in 2012, we can say with certainty that proactive strategizing now will lead to more confidence in decision-making and stability in your price for the coming year.
The data contained herein is believed to be drawn from reliable sources but cannot be guaranteed. Neither the information presented, nor any opinions expressed constitute a solicitation of the purchase or sale of any commodity. Those individuals acting on this information are responsible for their own actions. 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. Any reproduction, republication or other use of the information and thoughts expressed herein, without the express written permission of Stewart-Peterson Inc., is strictly prohibited. Copyright 2011 Stewart-Peterson Inc. All rights reserved.