Prepare and Be More in Control, Less Vulnerable
Dec 06, 2010
Explore strategies that add flexibility while still removing price risk. If you do nothing, all you can do is watch and hope. If you prepare, you can retain some control over your milk and feed pricing.
By Steven Schalla, Stewart-Peterson
It’s the time of year when, as the temperature drops, many dairymen are coming inside to catch up on the “office” jobs that likely were pushed to the back-burner during harvest. That includes penciling out and putting together 2011 budgets.
Many folks are telling me that while the past several months of higher prices have been beneficial, there has been little progress made from a financial recovery standpoint. Looking ahead to next year, we’ve heard a wide range of projected breakevens coming from different operations throughout the country. Figures have ranged from a base Class III price as low as $14.00/cwt. to as high as $17.00/cwt.
Nearly all producers continue to struggle with high input costs, with corn, meal and even various by-product feeds continuing to hold at historically high levels.
Adding to the challenge, many bankers continue to tighten their lending standards, and current prices on the CME board for the first six month of 2011 look lackluster at best.
As we study the current milk market fundamentals, there are still some positive indicators heading into next year. For example, year-to-date export figures for 2010 have been very strong, highlighted by a 63% increase in cheese and a 38% increase in whey shipped abroad compared to last year. National cow numbers have also remained basically steady through October despite much stronger milk prices.
On the other hand, cheese inventories continue to grow, and, over the past two USDA Cold Storage reports, have begun to grow at an increasingly fast rate. Cow productivity (milk per cow) has also shown sizeable increases throughout 2010, resulting in national milk production edging higher.
So, while there is some potential in next year’s outlook, the better strategy is to be prepared for both scenarios-- much lower or much higher prices than what is trading on the CME futures today.
What to do now?
At this time, marketers are in a most difficult situation. Any time milk prices are below breakeven and the risk appears to be for even lower prices, marketing decisions are more difficult to execute.
Referring back to our breakeven discussion, many of my clients acknowledge the risk of lower prices but are hesitant to make forward sales that would almost certainly lock in a loss. While this is a perfectly reasonable feeling, remember this:
· While knowing our cost of production or goal price to achieve is very important for numerous reasons, focusing only on these figures when considering marketing decisions can be very dangerous. At times the market may never offer your desired price, and unfortunately, sometimes limiting a loss is a necessary thing to do.
· There are also times when the market price far exceeds your desired price, providing unanticipated opportunity.
We believe that the current milk price situation is the ideal time to reach for some of the other marketing tools available to manage further downside risk, and also leave room to capture higher, more desirable prices.
A simple example: By using a Put option strategy you can place a floor price to avoid a fall to back to lowest end milk prices, but only committing a fixed cost or premium that can easily be recovered if prices rally higher. A more advanced marketer may use a Short Fence (sometimes called a Min/Max) position to decrease the upfront premium cost by creating a window of prices they will receive for those pounds of milk. Both of these strategies will provide a minimum price while giving room to secure a higher price.
I encourage you to explore some of these strategies to add flexibility while still removing price risk. If you do nothing, all you can do is watch and hope. If you prepare, you can retain some control over your milk and feed pricing.
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