Now is the time to capitalize on high milk prices and make up for the low milk prices of 2006. By developing a marketing strategy to lock in long-term cash flows, producers can offset low milk prices that are certain to return following the effects of high prices, which include improved profitability, herd expansion and milk supply growth.
Running a profitable dairy farm, much less generating necessary cash flow to expand an operation, is no small challenge. In the last decade, government program modifications, changing world markets and international competition have made the task even more complex.
Producers everywhere are looking for the confidence that comes from knowing they’re making the right marketing moves at the right time. The key is to establish a systematic marketing strategy unique to the particular farm that is built with the flexibility to allow for continuous adjustments based on changing conditions. A customized approach gives you confidence like never before when seeking out opportunities to generate cash flow in a volatile dairy market.
When you consider a marketing strategy to help create cash flow for expansion, make sure you study the big picture trends. This will help determine how far out hedges are needed. If the milk market is trending upward, keep hedges to only the nearby months. As time progresses, deferred months typically rally up to the price levels of the nearby months.
When the big picture cycle begins to slow, however, then – and only then – shift gears and hedge as far out as possible. This locks in long-term cash flow and provides more certainty for producers. The idea here is to always create enough room in your strategy to hold hedges through high volatility periods.
Many producers think they can fund hedge positions with operating cash, but the milk market is far too volatile for this approach. When producers depend on operating cash, marketing decisions tend to be made based on the availability of dollars rather than on current market conditions. By working with a financial institution to fund the hedge lines for marketing, you put yourself in a better position to make sound decisions over the long-term.
By the way, outguessing the market through an outlook approach does not work over the long-term. Strategic approaches weigh both opportunities and risks that the market may offer including price trends, seasonality, price direction probabilities, options volatility and more. This becomes even more important when volatility becomes the market norm. The rising cost of inputs and the sheer number of other factors affecting milk markets assure volatility is here to stay, as I have said before, for years and decades to come.
It is equally important that producers get proactive in hedging feed costs to guarantee a profit margin. Milk producers can lock in feed costs by forward buying their needs through their local feed supplier, or through the use of futures and options contracts. It is extremely important that a producer does not go overboard selling their milk production, while leaving their feed cost risk unprotected. There is tremendous feed cost risk for the foreseeable future. Locking in $16 milk, but then having to pay $5 per bushel for corn and other costly feed expenses, could eliminate the producer’s entire profit margin.
In developing and implementing an effective marketing strategy, producers must remember that long-term commitment is important. An economic return on marketing will never be seen if a producer is only concerned about marketing at $11 milk and not concerned at $18 milk. Producers can manage their milk price risk through forward contracts, futures and options. A combination of all three would be ideal to diversify risks and opportunities.
Another way to take a more strategic approach to marketing is by applying “stops,” which has produced positive results for dairy farmers. When a commodity like milk is rallying, opportunities can be lost by blindly selling just anywhere in an upward-trending market. A “stops” approach is a trend-following strategy that allows a producer to get hedges in place when the market appears to be potentially running out of gas and topping out.
This year’s milk markets illustrated why the “stops” marketing approach is effective. Knowing milk future’s contracts historically only have a $3 to $4 per hundredweight (cwt) trading range, most producers could sell into a rally of $3 to $4 and rest comfortably that when the dust settled, they would have done pretty well. But this year, some milk contracts have rallied over $8 per cwt, meaning if you sold at $3 or $4 you left 50 percent of the market gain on the trading floor.
Another reason a “stops” approach is an effective marketing strategy is because it creates trigger points for hedge entries, if prices decline. Regardless of what direction the milk market moves, a one-sided approach creates a scenario for opportunity to be lost.
To create a strategic marketing plan that complements today’s high milk prices and creates cash flow for expansion, producers must dedicate the time to review and evaluate it. If you cannot sell what you produce at a profit, can you really afford to produce it? Or, conversely, if you put all the time and effort into producing something, don’t you deserve as much for it as the market will allow? The answers to these questions provide the basis for committing the time and effort to developing and reviewing a sound marketing strategy. PD