Doing Nothing Will Have a Devastating Impact
The past two weeks have not been friendly to the market. Class III contracts fell more than 80 cents as weakness in cheese prices caused futures to eliminate price premiums and moved closely in line with the underlying cash. The hope for prices to be supported as the calendar moved through a new year were just that – a hope. Dairy farms continue to go out of business as milk prices have been too low for too long. Some are being forced out of business while some are liquidating before all of the equity is gone.
There are signs that milk supply may be tightening, but not enough to result in a shortage. This could happen during the second half of the year when milk production generally slows during the summer and demand begins to ramp up for later in the year. However, there are two things that need to happen. Milk production needs to decline until overall demand is not being met. Then inventory needs to decline resulting in buyers becoming more aggressive as they purchase supply to meet demand.
This sounds simple and logical, but there are a lot of factors involved in these two things taking place. We are in the first phase of these events--at least that's what appears to be taking place. The issue here is that not all dairy operations have the same cost of production and while some dairy farms are exiting the business, others are either adding cows or planning to expand and add cows once milk prices trend higher.
There are varying ideas as to price potential this year. The January World Agricultural Supply and Demand report was not released providing no estimates as to what UDSA is expecting. But, as usual, there are many other analyst projections. I have heard an expectation for $18.00 Class III milk by the end of the first quarter all the way to another year of subdued milk prices due to domestic and global supply. No matter what is being said, we must not rely on the idea that milk prices will move significantly higher during the first half of the year and possibly even the whole year.
You must be proactive with marketing. I know many of you reading this are already reacting to that statement as you have maybe heard or read it numerous times with myself urging to be proactive and not become complacent. Establishing and executing a marketing plan has paid off immensely over the past years. My approach has been using options and option strategies to protect downside while leaving upside open. This should be the continued goal for all as we know we are closer to stronger milk prices than we were last year.
Dairy Revenue Protection (Dairy-RP) insurance is a good tool for establishing a floor while allowing for the capture of higher prices. Those who took advantage of this program prior to the government shutdown have protected some higher milk prices based on the current market situation. The problem here is that with the government shutdown over the past month, there has not been the ability to write endorsements to protect eroding milk futures prices. Thus, there was a good program, but we were not able to use it. However, put options were available and were used to protect milk prices.
Dairy-RP should be available again now that the government is running. The focus should be on the third and fourth quarters. Yes, it is possible milk supply will tighten by the second half of the year, but we do not know that. The cost of protection either with an option strategy or Dairy-RP will be minor if milk prices increase during the year and higher milk prices unfold. At least you will have peace of mind that your milk price will not go any lower.
You also need to be aware that using options provides more flexibility than Dairy-RP. The program takes the average of three months of milk prices to determine if there is an indemnity. It cannot be liquidated at any time. Options are established on a monthly basis and can be liquidated at any time if market fundamentals change and you desire to get out of the position. You do not need to verify the amount of milk produced and if you sell your cows or reduce your herd, there are no reports that need to be filed or penalty if there is an indemnity payment.
These differences need to be considered and then a choice needs to be made. Doing nothing is a choice and one that has had a devastating impact over the past years.