Volatility road sign.
May 27, 2020

Risk Management Is Now Mandatory

 |  By: Dairy Talk

The old saying goes like this: “Fool me once, shame on you, but fool me twice, shame on me.” In the case of COVID-19, its “fool me three times, how dumb am I.”

This is now the third time since 2009 that we’ve seen dairy markets shaken to bedrock by world events. In 2009, it was the fallout from the Great Recession of 2008 where liquidity markets froze because of the housing bubble.

In 2015, dairy markets cratered because the European Union went off quotas that had been in place for more than 30 years. European dairy farmers increased production to bolster cash flow. And then world markets crashed because of the build-up of milk powder and an embargo of/by Russia as punishment over its invasion of Ukraine.

And now we have COVID-19.

I’m writing this the week after Memorial Day, and dairy markets have done a stunning rebound. In fact, as market analyst Robin Schmahl points out, the run-up in dairy commodity prices in May is record setting.

He writes: “The block price has increased $0.8150 in the past month. The price increase that we have seen from April 15th to May 18th sets a new record in duration of time and magnitude of gain. What make this really incredible, is that it has taken place during a pandemic, record unemployment, a sickness that yet has no cure, a decimated food service and hospitality industry and an uncertain future.”

But Schmahl also points out that what goes up often—and usually—comes down. He notes that of the past six such rallies, five evaporated just as quickly—or faster—than the price run-ups.

Mark Stephenson, a dairy economist with the University of Wisconsin, also points out that unemployment levels that exceed those of the Great Recession could well be with through all of 2021. Global markets remain at risk as well as waves of Coronavirus wash over third world countries that are even less prepared for the pandemic than we were (are).

The point is: No one knows where this market is headed. All of this points to the need for risk management. At the very least, if you have not done so, open a brokerage account with a reputable risk manager. Begin discussions now about setting up a sustainable risk management plan for milk and feed price protection.

At a minimum, enroll in the Dairy Margin Coverage program in October when sign-up for 2021 begins. You can protect up to 5 million pounds of your annual milk production history. At current feed prices, it essentially guarantees an $18 milk price. (Schmahl always points out DMC protects income-over-feed-cost margin. So if feed prices fall, the effective milk price protection declines as well. If you need milk price protection for cash flow reasons, additional risk management might be needed.)

Then, work with your financial advisor(s) to determine how much more risk protection your operation needs. How much you need is obviously dependent on your level of equity, working capital and other liquidity you have readily available.

But given the consternation of dairy farmers across the nation faced this spring, the biggest factor will be how much risk management you need to sleep at night. The stress of this continued wild volatility can put you out of business even faster than foreclosure. Don’t be fooled again.