It’s a great time to be a dairy farmer. Tight U.S. cheese inventories and light milk production are pushing Class III and IV milk futures to over $23.00 per hundredweight (cwt). Butter, whey, powder, and cheese futures are currently all in an uptrend and new yearly highs are being hit almost weekly. The selling price for cull cows is near record levels while the cost of feed and fuel are sitting at multi-year lows. In fact, October is currently forecast to be the best month of income-over-feed-cost margins since 2014 with nearly a $16.00 per cwt margin!

 

The blue line is income over feed cost totals using settled prices. The orange line displays the forecast totals through the end of the year based on the current market (https://dmc.dairymarkets.org/#/price-forecasts).

 

Furthermore, the milk trade has been riding on some of the best fundamentals seen in the dairy industry in years. U.S. milk production has declined year over year in twelve out of the past 13 months. It was just reported that production has recently contracted in May, June, and July, with year-over-year declines of 1.00%, 1.70%, and 0.40%, respectively. As of July 2024, the U.S. dairy cow herd was 43,000 head less than a year ago. Additionally, strong export demand at the start of the year has wiped out U.S. cheese inventories, now down about 7% from a year ago. The market knows cheese inventories are light and the milk production and capacity needed to replace that cheese is going to take some time. For now, buyers are adding premium to milk prices almost weekly as more data comes out as bullish.

 

All in all, with the wind so fully in your sails, you wouldn’t be alone in just wanting to enjoy the boon and letting it ride. However, is this a wise course of action? Let’s explore why this is exactly the time to consider hedging with actions you can take for production AND inputs.

 

 

Feeling Good? Then It’s the Perfect Time to Get Nervous

 

While you might be feeling excited about prices, it’s time to take action now against the inevitable decline. Producers who actively play defense to protect wide margins like we see today are also the ones who extend their personal periods of profitability longer than what the market offers. To put it simply, the risk to you rises as price euphoria rises, and long-term winners are those who manage that risk.

 

Are you skeptical of this argument, given how good prices are looking right now? Let’s take a look at how your emotions and euphoria in particular can influence and undermine your marketing decisions by reviewing the market cycle of emotions chart below:

 

• When the market is hot (in phase A and where we argue the market is today), dairy sellers get excited and hold off on future sales, certain that prices surely will continue to rise and concerned about selling too far from the high. This is also the time when producers expand production or new entrants enter the market to take advantage of profit, with the impact of increased supply.
• Sellers keep betting the market will rise, until suddenly it stalls and begins to fall (phase B) as demand falls or supply broadens. Some sellers begin selling future production to garner still advantageous prices while they can, as many others wait for prices to return closer to the high.
• With a continued falling or stalled market (phase C), more and more sellers are feeling anxious (or actual fear) as bills come due in the face of low prices. The market becomes saturated with product at prices far from the peak seen in phase A/B.
• It’s at this point (phase D) where many current and future sales are made in desperation from worries that prices will continue to decline. After the last of the desperation sales, prices start rising again, as demand returns set off by low prices and the market returns to phase A.

 

 

The Market Cycle of Emotions

 

 

 

 

The Case for Hedging Your Bets

 

Clearly, now is not the time to be complacent with the prices you’re being offered. Instead, think about what often follows a strong rally – a sharp decline in price. The two most recent bull markets in milk bears this out:

 

• In 2014, second month milk futures traded up to a high of $25.30 in September before crashing to a low of $14.25 the following January. That’s nearly a 44% decline in only four months!
• Even more recently, in 2022 second month milk hit $25.79 in April before eventually falling to $14.21 the following July from a steady selloff. This would equate to a nearly 45% decline in a little over a year.

Given the high prices we’re enjoying now, we need to be on alert for potential changes in sentiment – and the case for hedging. For instance, we’re thinking about three potentially disruptive fundamentals:

 

1. The U.S. economy appears to be slowing as the Fed takes action to pull back on inflation. The Fed funds rate remains high, putting upward pressure on an unemployment rate of 4.2% that is outpacing expectations. Although the Fed is expected to pull back from the high rate over the next several months to alleviate the chance for a recession, the Fed funds rate is not a precise tool, and a soft landing isn’t guaranteed. Furthermore, higher inflation could put commodities under greater price pressure in tandem with lower demand.
2. The U.S. cheese price is roughly $0.30 per pound above the global market, putting downward pressure on the demand for U.S. cheese.
3. U.S. butter inventories are up 7% from last year, potentially lowering the demand for U.S. butter.

 

 

Strategies to Lock in Your Potential Now Before It Deflates

 

Producers now have an opportunity to lock in well over $20 milk over the next five to six months, which compares quite favorably to the January to August 2024 average Class III milk settlement price of $17.75 and the 2023 calendar year average of only $17.02. Look into using fixed-risk tools that will put a floor under the market to protect the downside risk, while keeping plenty of upside open. Producers won’t want to cap off too much upside here, given that the second month Class III milk contract could still have room to run. Even though market conditions are bullish now, sentiment could change in a hurry. The downside risk of a slowing economy should not be taken lightly, and current prices can be protected.

 

Another revenue stream that producers can protect right now is the near record-high cattle market. Front month live cattle futures traded as low as near $0.80 per pound during COVID on demand concerns. However, what has followed has been a nearly four-year rally in cattle prices on light cow numbers. The market has pulled back from the record highs near $1.90 in recent weeks – on concerns over a slowing economy – and currently sits at great levels near $1.75 per pound. Producers should consider using put options to put a floor under this market. Consider picking a price you are comfortable spending and get coverage in place well into 2025. Given the strong rally over the last four years, a pullback should be expected. Looking back, after setting all-time highs in 2014 and peaking at $1.7275 per pound, front month cattle fell for the next two years straight and hit a low of $0.9610 per pound in October 2016. That’s a 44% decline. Now is a great time to protect this additional source of revenue into the future.

 

Finally, remember to lock in prices of your inputs – fuel, corn, and soybean meal are all trading at multi-year lows. Fuel has been falling into the election, as summer demand wraps up and ending stocks are slowly building. Meanwhile, the feed markets have been under duress from record-yield expectations in the U.S. as well as large U.S. and global carryout figures. Producers should consider starting to lock these inputs in with local suppliers for months to come. Take an incremental approach and set targets below the market, should prices continue to fall further with harvest approaching. If basis levels aren’t attractive, there are brokerage tools that could be used to hedge the input cost now on paper until the local price improves.

 

 

Total Farm Marketing Can Help

 

Ultimately, the best thing to do in a period of high margins is to protect current levels and prepare for a change of trend. Using fixed-risk tools will ensure the topside remains open, should the milk market continue to rally into year’s end. Additionally, purchasing feed and fuel in increments will help ensure costs are managed for the foreseeable future. Additional purchases could be made at a later date to average down pending further market weakness. One of the best ways to build confidence in your marketing decisions is to work with an experienced, season team like the advisors at Total Farm Marketing.

 

Since the birth of the dairy futures markets, Total Farm Marketing has been a leader in helping producers like you develop strategies to protect price and maximize opportunity. Talk to us about how we can help you gain success and peace of mind.

 

 

Total Farm Marketing can help, as we’ve helped farmers for almost 40 years.

 

Have questions about how you can build a plan to help you in any market environment, or questions about your plan?

 

Call us at 800.334.9779.

 

©October 2024. Total Farm Marketing. Futures and options trading involve significant risk of loss and may not be suitable for everyone. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition. No representation is being made that strategy ideas mentioned in this article will guarantee success or profits. Examples of seasonal price moves or extreme market conditions are not meant to imply that such moves or conditions are common occurrences or likely to occur. Futures prices may have already factored in the seasonal aspects of supply and demand. The data contained herein is believed to be drawn from reliable sources but cannot be guaranteed. Reproduction of this information without prior written permission is prohibited. This material has been prepared by a sales or trading employee or agent of Total Farm Marketing and is, or is in the nature of, a solicitation. Any decisions you may make to buy, sell or hold a futures or options position on such research are entirely your own and not in any way deemed to be endorsed by or attributed to Total Farm Marketing. Total Farm Marketing refers to Stewart-Peterson Group Inc., Stewart-Peterson Inc., and SP Risk Services LLC. Stewart-Peterson Group Inc. is registered with the Commodity Futures Trading Commission (CFTC) as an introducing broker and is a member of National Futures Association. Stewart-Peterson Inc. is a publishing company. SP Risk Services LLC is an insurance agency and an equal opportunity provider. A customer may have relationships with any of the three companies.