Q&A Series: Market Analysts Share Risk Management Strategies
October 1, 2020
Milk futures were off to a roaring start at the beginning of 2020. As COVID-19 made its way to the United States, prices took a major hit. Will that price hit continue into 2021? We sat down with market analysts Alyssa Bagder and Ryan Yonkman to gather their thoughts.
Director of Global Operations
HighGround Trading LLC
Dairy Risk Manager
Rice Dairy LLC
Q. What do you think milk prices will do next year?
Badger - Though I may not be a market veteran (yet), but I would like to start out by mentioning with confidence that over the past 13 years working with farmers, and having been introduced to commodities and hedging throughout the Great Financial Crisis, 2020 has been the toughest year for forecasting prices and analyzing markets. At the beginning of the pandemic, there was an overwhelming sense of bearishness in the marketplace as consumers were told to stay home, restaurants shut their doors, and uncertainty spread throughout the globe. However, a combination of milk production cuts in the US, the Farmers to Families Food Box Program and record-breaking cheese exports sent milk prices to the moon. Now the calendar is six months into Covid-19 restrictions and a number of fundamentals have changed.
First, US milk production has come back at a strong pace and will remain that way through the end of the year. American farmers are so good at what they do that there are now concerns that milk will return to strength too quickly, which has the potential to outpace demand, which brings me to the second point. Outdoor dining has saved many restaurants in big, northern cities during the warm summer months. A large amount of US dairy is consumed through foodservice outlets and as outdoor dining options fade away into winter, paired with limited indoor capacity, the path of least resistance on milk prices is to the downside. Strong retail demand has been a saving grace for the dairy aisle but it does not have the potential to offset losses from foodservice (think conferences, stadium foods and catered events as well). Another big factor in deciding milk price is the November election – will farm support remain or come to a close once the winner is announced? All these factors highlight the important of risk management with HighGround’s current forecast pricing in an average Class III milk price of $15.33 per hundredweight throughout 2021, and a $14.93 average on Class IV milk prices.
Yonkman - Rice Dairies current forecast has 2021 Class III at an avg price of $14.44 and Class IV at $15.37 assuming no new government intervention. General bias here is that U.S cheese stocks have been building as gov't purchasing into the food box program has helped keep us well above world prices hurting exports and at the same time there a couple new large cheese plants firing up over the next few months that without the government buy programs could weigh heavily on U.S Class III prices. On the Class IV front we have seen very little government help allowing nonfat and butter to trade a much more fundamental curve. Our Class IV products have been competitive in the world market all year, keeping stocks in check and with some new plants coming online not focused on making powders we could see milk move out of the dryer's and into the new plants firing up.
Q. Share two risk management strategies that are working for your customers?
Badger - Given the volatility in today’s world, it is important for producers to remain cautious yet consistent and buying Dairy Revenue Protection (DRP) has been a great tool for our customers. It has been a favorable option for first-time hedgers, as well as experienced risk managers. Using this strategy is essentially a subsidized put option by quarters, deferring payment of premiums and allows for the ability to lock in a price not only based on Class III and IV prices, but components as well for producers that have stronger fat and protein output from their cows, instead of tying up cash. You will want to work with an insurance company that knows dairy markets the way HighGround does and what better way than for our insurance division being lead by a dairy farmer.
Contact us today to discuss this advantageous way to help protect your farm risk.
For longer term hedgers looking to get coverage further out to 2021, our team has found success with the use of minimum/maximum strategies (collars) where the farmer buys downside protection (put) but subsidizing that expensive premium by selling a call option (ceiling price). For first half 2021 (Class III milk futures average settled at 16.35 on Mon, Sep 14), something like a $15.00-$17.75 collar at even money provides protection against poor prices in 2021 but you’re technically locking in a ceiling price of $17.50 as well in case the market runs higher than that. Our producers make money at the ceiling level and would need to be willing to forego prices higher than that in order to get that kind of protection.
Yonkman - Since the inception of DRP (dairy revenue protection insurance) it has become the cornerstone for most our dairies going up to 5 quarters out. DRP allows you to set a subsidized floor underneath Class III and IV prices going up to 5 quarters forward.
With DRP being the base of most hedge structures (especially at these prices), we often then look to use the CME to compliment the DRP by either using futures and/or options to better their coverage or protect DRP gains.