The futures markets act like a sponge
Updated: Nov 28, 2022
Sign-ups for the Dairy Margin Coverage program are underway, with the December 9 deadline quickly approaching. Dairy Margin Coverage (DMC) is one of the price risk management tools available for dairy farmers today.
In a recent University of Wisconsin-Madison Division of Extension webinar, price risk management was the topic of discussion. According to Leonard Polzin, a dairy markets and policy outreach specialist at the university, theses price risk management strategies all relate to the commodity futures market in some way.
We often hear about the futures market, but not everyone may truly understand what it is. Polzin spent a few minutes explaining what futures markets mean for dairy and other commodities.
“The futures market sets the biggest backdrop for the market information that we have regarding prices for commodities,” said Polzin. “Futures market acts as a clearinghouse for all of kinds of relevant information.”
Factors such as weather, policies, the general economy, production reports, and more are soaked up by this “giant sponge,” Polzin explained. Using this information, the markets try to synthesize a value or price that people can find agreement on, for both sides of the transaction. This is done for multiple points of time, both for today and in the future.
Of course, there is no crystal ball when it comes to predicting prices. “Futures are going to be wrong, but we don’t have evidence that they are bias or wrong in one direction or the other,” Polzin noted.
“The closer we are to the expiration date, or today’s date, for the commodity we are trying to forecast, the more accurate a future’s price is going to be,” he continued. The further out we go, the more difficult it is to forecast or price something in the futures market.”
For people who are not actively taking positions in the market by buying or selling, Polzin said watching the price forecasts is a useful way to take a temperature of the market.
“Even though forecasts are not perfect and always changing, and the chance of them being exactly correct is quite minimal, they are still useful to gather the information that is available to collectively paint this larger picture of the marketplace,” Polzin summarized.
In addition to DMC, other price risk management tools available to farmers include futures and options cash contracts to dairy cooperatives or milk plants, Dairy-Revenue Protection (DRP) or Livestock Gross Margin for Dairy (LGM). To learn more about these options, the full webinar is available here.
November 21, 2022