Robin Schmahl
November 30, 2020
There has been some frustration over the use of hedging this year. Assuredly, it has been difficult due to the extreme volatility and the large negative Producer Price Differentials (PPD’s) that we have experienced and will continue to experience for another month or two. Hedge positions were implemented at levels that should have been above cost of production and even with a decent return on investment given a normal market. However, negative PPD’s changed the average basis that was anticipated severely reducing pay prices. This resulted in some hedging strategies that did not work at times.
What I mean by “at times” is just that. If futures or forward contracts were implemented just before prices fell early in the year and then during the high prices of mid-year for the September contract, it worked well. The large negative PPD’s still were a part of the pay price, but any gain realized from the market due to significant large declines helped to offset the losses from negative PPD’s. The problem came when forward contracts or futures were implemented and then milk prices went higher. It the case of forward contracts with the milk plant, one could not take advantage of the higher milk prices, but suffered further losses due to the negative PPD’s. Those who used futures were required to pay margin on their positions as milk futures move higher and then had the negative PPD’s removed from their milk prices as well.
Those who panic forward contracted in March or early April due to the fear of low milk prices due to COVID-19, had a very difficult year deepening on the length of time these forward contracts were extended. Those who jumped in and sold futures had to pay substantial margin calls if done at the same time and for the same duration.
Those who used options and option strategies or Dairy Revenue Protection insurance fared better. Yes, these did not eliminate the negative PPD’s, but they did provide protection while at the same time leaving the upside open providing a one and done payment despite the wild price fluctuations. If milk prices fell, there was a payment that was received depending on the strategy and the levels chosen. If prices did not decline or moved substantially higher, only the premium was paid and the higher prices taken advantage of.
The Dairy Margin Coverage (DMC) program was also a huge benefit this year to a marketing strategy as payments were received five of the nine months so far this year.
There is a strong possibility we may see at least another month of a DMC payment before the year is finished. It is recommended that you sign up for the DMC program for next year if you are not already in the program. The end of the sign-up period is December 11th. The outlook for grain prices and the milk prices does not bode well for a positive income over feed for 2021. That can change substantially, but this program has been very beneficial.
Even though this year has been a real challenge for marketing, the last thing you want to do is decide to not do anything for risk management going forward. The large impact of PPD’s should be reduced and move back to a more normal pricing next year. There will always be opportunities to protect milk prices using various strategies. Instead of looking at this year with frustration, we need to look at it as a time of learning. Use it to assess your marketing program and decide if there are strategies that might work better or even a combination of strategies. The goal of a marketing program in to protect prices and farm equity and not to speculate to make money.
Robin Schmahl is a commodity broker and owner of AgDairy LLC, a full-service commodity brokerage firm located in Elkhart Lake, Wisconsin. He can be reached at 877-256-3253 or through their website at www.agdairy.com.
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