March 21, 2022
There has long been a correlation between corn prices and milk prices. An overlay of May corn and May Class III milk futures shows clearly that this correlation is alive and well.
Even though they run on different basic fundamentals they are interrelated as corn is a large part of the diet of the dairy cow. Remember, milk prices do not have to increase just because corn prices do, and corn prices do not have to increase because milk does. They are not related in the sense that one automatically drives the other. Corn is the commodity that has the influence on milk prices and not the other way around. This has been seen repeatedly throughout history. Yes, there have been years is which there have been aberrations to this pattern. The most recent was in 2020 when July Class III price was announced at $24.54 and the second highest price in history while at the time corn price was around $3.50 per bushel. This aberration did not last long. Milk price at that time was fueled by the Farmers to Families Food Box program which was an influence outside the realm of the usual. This relationship between milk and corn is something to keep in mind when analyzing the market.
Therefore, it is important to both hedge feed prices as well as milk prices with the preference being to hedge them separately. The Dairy Margin Coverage program is a great program to protect an income over feed price for smaller to medium sized dairies. However, all dairies will receive benefit up to 5 million pounds no matter what size it is. It is a good program and one that needs to be implemented on all farms. However, it does not protect milk price and it does not protect feed price. It only protects the difference between the two which is the income over feed price.
That is why it is imperative to hedge milk prices by themselves and feed prices by themselves along with the Dairy Margin Coverage program. By using options and option strategies in a volatile and uncertain market, you are utilizing the best of both worlds. Put options or put option strategies establish a floor for your milk while call options or call option strategies establish a ceiling for your feed. This allows for flexibility and protection while at the same time leaving the potential to capture higher milk prices and lower feed prices if they develop.
The current state of the milk market looks strong which can lull us into complacency. There are many things influencing the commodity markets that we have never seen before. We do not know at what level there could be demand destruction. We do not know at what level consumers will slow their demand for dairy products due to inflation. We do not know if there will be some unforeseen outside influence that could impact the market.
Demand for dairy products have increased since Covid-19 as consumers became more conscious of healthy eating with dairy products becoming more important in the diet. Hopefully this trend will continue. However, the job of high prices is to cure high prices. This has been true in history and will always be true in the future.