September 25, 2017

Can Historical Patterns Predict Prices?

 |  By: Robin Schmahl

Markets are different from year to year as fundamentals are never the same. It is either too hot or too cold. Feed quality is excellent, average, or not very good. There is too much rain or not enough. Culling is more aggressive or cow numbers are increasing. Milk supply is burdensome or supply is tight. Inventory is heavy and growing or declining at a rapid pace. Exports are very good or not so good, etc. You get the point.

There are so many variables in the dairy industry that impact the market each year. This makes it difficult to forecast prices, yet that is something we continue to do. The reason this is done is because historical patterns are followed. The saying is; “History always repeats itself.” Now, it may not repeat itself in exactly the same way or at the same price levels, but patterns can be seen. This is why technical analysis works many times as traders predict price movement based on technical studies. Technical analysis provides chart points or formations that have been seen many times in the past prompting traders to trade those chart points or formations believing those patterns will again be correct. Many traders follow the same studies and place buy or sell orders at those levels. If no one would trade a specific chart point or technical study, it would be meaningless. I believe there is great value in looking historically at markets and to compare history to the present. After all, that is what weather forecasters do to some extent.

This brings us to the forecast for milk prices through the rest of this year. Seasonality has not played much of a role so far with the highest Class III milk price taking place in February. October, November, and December contracts are not too far below the price of $16.88 seen in  February and could reach and achieve that easily with strength of the underlying cash markets. What has been similar has been recent price movement compared to last year. Futures prices declined steadily last year from early September to mid-October at which time futures price rallied back up to the level they were at the beginning of the decline which established the highest Class III price of 2016 in December.

The market is current following a similar pattern as last year only with the steep price decline taking place from mid-August through mid-September. Last futures prices trended higher for the November and December contracts eventually reaching back to the level they were before the price declines. There is a good chance a similar pattern could be seen again as demand is increasing and U.S. cheese and butter prices are more competitive on the world market now than they were a year ago.

We do need to exercise caution in that patterns do not always move the same and the recent price strength in cheese and futures may again be temporary. But it does give us something to watch for and be prepared to act on if milk futures are able to regain a good portion of what has been lost.

There are some positive fundamentals shaping up in dairy providing hope for some better milk prices, but the extent of higher prices may be limited depending on demand strength through the end of the year. My recommendation is to establish put option or put option spreads if any futures contracts reach $16.50. This will provide downside price protection while leaving the upside open to take advantage of a higher price. Futures prices moving back to $17.00 may be difficult to achieve, but certainly welcomed if it were to develop.  Option strategies will provide protection as well a flexibility. Do not guess your way to profitability.