Just like a rollercoaster, milk prices have been moving up and down within very short periods. Consider that in January 2022, the All-Milk price started at $24.20 per hundredweight (cwt.). It then climbed to $27.30 in May 2022, slipped to $24.30 per cwt. in August 2022, and rose back up again to $25.90 per cwt. in October 2022. The release of the All-Milk price for December is still pending, but the number for November 2022 showed a declining tendency.
Although uncertainty exists for the short- and mid-terms, everybody should be prepared to manage this price volatility. Dairy Margin Coverage (DMC) is an option to navigate times of high volatility, especially if high commodity prices and low milk prices are anticipated. If you missed the recent DMC sign-up deadline, there are alternative financial risk management tools you can explore.
Hedging or securing prices in the futures market is one tool useful to navigate these high-volatility times. When milk prices are relatively high, farmers can hedge or secure their milk prices when convenient. Hedging prices in the futures market might be unfamiliar to some farmers, and the best advice is to seek help from a broker operating in the futures market.
For farmers who need a broad idea about hedging prices in the futures market, here are a few tips that might be useful to know ahead of time when considering this option. First, a single contract for Class III milk covers 200,000 pounds or 2,000 cwt. For some perspective, a 200-cow dairy shipping 75 pounds of milk per cow per day would market about 456,000 pounds of milk in one month, which means that two contracts would be needed to hedge most of this monthly production.
Second, a deposit is needed only for a fraction of the contract and not for the totality of the contract. This means that a 2,000-cwt. contract at $19.50 per cwt. implies a total value of $39,000. However, the farmer would only need to deposit approximately 5% to 10% of the total value.
Third, a commission should be paid to a broker, and this commission is likely a flat fee for each of the two trading transactions (one for selling and one for buying the contract). As an example, if a commission is $45 per trading transaction, then the farmer would be paying a broker fee of approximately $90 per contract, which is less than 0.5% of the total contract.
As a closing thought, if a farmer hedges a Class III milk price in the futures market and nothing changes in the market (which would mean low volatility), then the farmer would recover the deposit back and would have lost only the $90 in broker fees. This is not too bad in comparison to the rollercoaster of high volatility.
February 2, 2023
hoards.com
