How Important is Risk Management?
Dairy markets have been volatile over the past two months. Block cheese price declined 10 cents and then rallied 24 cents. Barrel cheese price increased 37 1/2 cents, then fell 32 1/2 cents and then increased 13 1/4 cents. Butter price fell 65 3/4 cents and then rallied 32 cents. December Class III futures fell $2.42 and has rallied $2.77. December Class IV futures fell $3.11 and has rallied $1.26. No one has been able to predict this type of market movement. Price generally trends higher through October and then softens into the end of the year. This year is one for the record books.
There has been a lot of volatility through all commodities and the financial markets all year and dairy has not been immune to it. This makes it very difficult for farmers to find a solid number for the cost of production. Many are looking ahead and trying to make a cost of production projection for next year. This may be a difficult number to nail down, but it needs to be done in order to make plans for the dairy for the upcoming year. Much of the cost of production numbers next year will likely be a range and not a specific number. Lenders will need to be satisfied with that.
Many farmers have been apprehensive to do any price protection due to the uncertainty of their cost of production. However, risk management is important and with the uncertainty over milk prices and input prices, it becomes necessary to establish price floors for milk and price ceilings for feed. Utilizing options or revenue protection is a must and will either provide damage control or protect profitability.
Price protection is a serious business and one not to be taken lightly. But it is something that all should be involved in. I do need to make it clear that if you do not know your cost of production, you should not use futures or forward contracting to protect your milk price. Those two strategies lock in a specific price and dictate what you will received for the amount of milk covered. If you do not know your cost of production, you may be hedging a price that is losing money. If milk prices increase, you are locked in and cannot take advantage of the upside. In this market environment, the use of options or revenue protection insurance is the best choice. These provide downside protection while allowing for upside gain.
Marketing is as important as any other aspect of the farm. Farmers are focused on improving breeding, herd health, nutrition, cow comfort, employee relationships, facilities, quality feed production, etc. All these things are necessary to run an efficient farm. You can be the best you can be in all these areas and still lose money due to lower milk prices. Not doing anything is making the decision to leave your whole farm and livelihood at risk.
There have been farms that have done well this year by using different strategies to hedge. This has been able to add significantly to their bottom line. The recent strong price increases in milk futures are providing opportunity to establish some floors again that were not possible just a week or two ago. The recent weakness of grain prices is providing opportunity to establish a ceiling for feed prices. I have talked with numerous farmers that admit that they should do marketing but are not doing it because they do not understand it. If that line of thinking is maintained, nothing will ever be done. We are here to help anyone to better understand the market and strategies that can be utilized to provide flexibility and the opportunity to protect the downside while leaving the ability to take advantage of higher prices if they develop. Feel free to contact us.
There is concern over milk price potential after the holiday season is over. High food prices as well as prices for all goods and services may have a negative impact on demand. Maybe the large price declines of a few weeks ago are an indicator what might take place after holiday demand is finished and regular consumer demand carries on early next year. We certainly hope not but we did not anticipate the volatile price swings of the past two months.
Robin Schmahl is a commodity broker with AgDairy, the dairy division of John Stewart & Associates Inc. (JSA). JSA is a full-service commodity brokerage firm based out of St. Joseph, MO. Robin’s office is located in Elkhart Lake, Wisconsin. Robin may be reached at 877-256-3253 or through the website www.agdairy.com.
The thoughts expressed and the basic data from which they are drawn are believed to be reliable but cannot be guaranteed. Any opinions expressed herein are subject to change without notice. Hypothetical or simulated performance results have certain inherent limitations. Simulated results do not represent actual trading. Simulated trading programs are subject to the benefit of hindsight. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. There is risk of loss in trading commodity futures and options on futures. It may not be suitable for everyone. This material has been prepared by an employee or agent of JSA and is in the nature of a solicitation. By accepting this communication, you acknowledge and agree that you are not, and will not rely solely on this communication for making trading decisions.
By ROBIN SCHMAHL
November 16, 2022