When is the Right Time to Hedge Milk?
The futures market is an anticipatory market as traders are buying and selling based on what they think each contract will settle at the time of expiration. As fundamentals and technicals change, price movement will change. For every buyer there is a seller. Futures will trend higher due to buyers being more aggressive and will trend lower due to sellers being more aggressive. Quick changes of information create more volatility. Any news from around the world has a bearing on market movement. It is not just what takes place in your backyard or even in the U.S. anymore.
This brings us to the discussion of the anticipation of Class IV futures that unfolded during the second half of last year. Class IV prices have been quite a bit higher than Class III prices since December 2021 setting a record for the duration of that difference. Obviously, the reason for this was the strength of butter and nonfat dry milk prices on the daily spot market. Nonfat dry milk price began to trend sharply higher in August 2021 and moved higher and remained strong into early June. Butter began moving higher in August 2021 and remained in an uptrend eventually reaching a record higher in October 2022. The impact of these strong markets pushed Class IV price to a record high of $25.31 in April. Class IV prices remained strong for much of the rest of 2022 as demand for butter was very strong both domestically and internationally.
However, being it a futures market traders began pondering the likelihood of prices being able to maintain the lofty levels for a duration of time. A change in thought eventually permeated through deferred contracts resulting in traders being more cautious over a seasonal price premium than the market generally carries. This became very evident in Class IV futures for the spring of this year. Futures have declined nearly steadily since mid-September with prices down about $3.00 per cwt. With butter still moving higher toward the highest level it has ever been, futures were already on their way down (see chart).
One reason traders began selling later Class IV contacts was due to the weakness of nonfat dry milk. While most were focused on the rise of butter and the concern over supply, nonfat dry milk was falling with supply overwhelming the market. Nonfat dry milk price began falling in early June 2022 and had very limited price bounces on the way down. To put the impact of this in perspective, each one-cent price movement of nonfat dry milk impacts the Class IV price by 9 cents. So even though butter price was still increasing, a greater impact was being felt by the decline of nonfat dry milk. We also need to keep in mind that a one cent move in butter equates to a 4 cent move in Class IV. Thus, nonfat dry milk price carries more weight than butter. When butter price began declining after reaching its record high in early October, Class IV futures were already around $1.00 per cwt lower as traders were both seeing and anticipating future weakness.
This is the reason why a marketing plan is so important. Once price weakness is seen in the cash market, the futures market in deferred contracts many times has it already anticipated and factored in. We all hope for higher prices for our milk, but we need to realize the market does not care whether a farm remains in business or not. The market will move according to supply and demand with price aberrations in between. That is what creates volatility. Volatility needs to be taken advantage of and that is the purpose of marketing and risk management. Many who read this column likely know they need to do a better job at marketing or even need to be involved in it but are hesitant because you may not know enough about it or how to get started. We can help you with understanding and getting started with risk management. Feel free to contact us.
By ROBIN SCHMAHL
January 10, 2023