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1108 PD: Growth despite record input costs? It’s possible if you manage volatility

Scott Stewart Published on 24 July 2008

One year ago in the May 2007 issue of Progressive Dairyman, I was asked to write an article on feed price direction. By using basic fundamental analysis, a dose of futuristic forward thinking and some technical analysis on historical price patterns in commodity markets, I forecasted that the next bull market would likely give us upper $6 to lower $7 corn prices.

Well, $7 corn is here, and everyone is now wondering, “What’s next?”

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I can say with certainty that volatility is the forecast. Anyone can predict high prices or collapsing prices and be wrong, wrong, wrong. But no one is going to be wrong by predicting volatility. It’s a given!

Market analysis is just one small part of revenue management on a dairy operation. Strategic use of risk management tools and a disciplined approach is the real answer to “now what?” And that has never been more true than now, with volatility ahead.

Volatility means that prices for your feed inputs, and for your milk, will move fast. The moves are going to be dramatic. If you are on the right side of these moves, you are going to see record profit margins. One producer told me just last week that even in these markets he has seen “profit margins he absolutely never dreamed of.” With careful revenue management, you can be in the position to pay down debt dramatically, grow your operation and achieve your profit margin goals … even with unprecedented input costs.

Corn beyond $7?
So what is the forecast for inputs? I’ve been saying for a few years now that, once corn hit $7, the next major bull market would likely take it to $12. There are some technical and mathematical forecasts that might point to it stopping in the $9 range. However, $12 is a more likely scenario.

That’s not all: With disruptions such as massive margin call liquidation, fast-moving markets and other extremes that typically happen when prices are making historical highs, I believe $18 corn is not out of reach. It’s not going to happen tomorrow, and it’s not going to stay there for long, but it is a possibility if we were to have a substantial short crop. I am using corn as the main crop example, but you can translate these numbers into extreme silage prices, meal prices and other feed inputs.

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These kinds of extraordinary price projections are exciting for crop producers but frightening for dairy producers. When talking about price rallies to all-time high levels, it is just as important to think about what kind of downward price swings we’ll see once highs are made. This is where the volatility comes in.

Hedge your feed inventory
More than likely, when corn prices peak, we will see them drop at least $3 per bushel. (Remember, we saw the wheat market drop from $13.50 to $7.50 in three months.) If you’ve just bought an inventory of corn, meal or any other feed input, and you see 40 percent of its value disappear in a matter of three to six months, that is heartbreaking and financially devastating.

If you are buying high-priced feed, you need to think about actually hedging your feed inventory, because you own an expensive inventory that could substantially cripple you, should prices fall and milk prices follow the input prices downward.

This brings me back to what I talked about in the article one year ago: You have to be strategic in both your milk pricing and your input pricing. What do I mean by “strategic”? Being strategic involves having a set of strategies and trigger points prepared, so that you can act with confidence no matter what the market does. For example:

• Be prepared and know what you’re going to do if milk prices go up a little or if they go up a lot. Conversely, be prepared and know what you’re going to do if prices go down a little or if they go down a lot.

• Prepare this strategic approach for milk that you are selling this month, next month and 18 months out.

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• Have a set of strategies in place for feed now, the next quarter, next year and even two years out.

• Extend these strategies for feed that you have in inventory, feed you’ve committed to purchase and feed you’ve hardly thought about needing yet.

This type of strategizing is the only solution to manage these volatile times. Producers who are not on top of this volatility may see crippling losses and cash flow problems as input costs go up faster than milk prices and margins are squeezed. You have to face the challenge and make a conscious decision that you are going to capture the opportunities and manage the risks these markets present.

As we move forward, those producers who do manage their input costs and capture milk pricing opportunities are going to see extraordinary profit margins. These producers will also be in a position to weather the bad that will come, sleep well at night and enjoy the fruits of their labor. Volatility does not have to be a substantial threat to your operation, if you are strategic and disciplined in your marketing. PD

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