Current Progressive Dairy digital edition
Advertisement

1408 PD: Price risk management in today’s electrified world

Mike North Published on 29 September 2008

In a time when adjustments to feed rations can be compared and made at the drop of a hat using well- developed spreadsheets, when dairies can be monitored at remote distances by camera systems with online viewing capacity and when people communicate through a diverse offering of technologies, producers can also view, analyze, research and access the very prices that predicate the profitability of their livelihood.

With that access comes a lot of questions: How does this system work? How do I get involved? Is this something I want to do on my own or should I seek help? Where do I go for help? What systems/tools/programs do I use to make quality decisions about price activity? How do I manage these decisions? The answers to these questions can often be as broad as the questions themselves. So let’s take a poke at answering some of them.

advertisement

advertisement

How does online market access work?
Quite simply, it is a means by which buyers and sellers come together to “talk” with one another. Traders, brokers, speculators and hedgers all have the ability to enter orders through online trading platforms to access the marketplace. Such platforms are available at brokerage houses nationwide.

Each person, at the time of order entry, determines whether they are buying or selling, the quantity that they are buying or selling, their commodity of choice and whatever price move at which they choose to take action. They may choose to enter orders that are executed in the pit (a place where traders gather at an exchange to trade a specific commodity) or they may choose to post their order in an electronic matching system where orders to buy are paired up with orders to sell at prices that are agreeable to both in an environment of price movement. Choice abounds.

How do I get involved?
The commodity market structure is very simple. Market activity takes place under the authority of an exchange (i.e., the CME Group). Those who wish to participate in the marketplace must be a member of the exchange or have access to a member. This access is accomplished by opening a brokerage account with that member or any firm that has a brokerage relationship with that member.

Can I go this alone or should I enlist help?
The creation of electronic markets was inspired by a desire to create transparent access to prices and market information. However, as access to information has grown, so has the amount of information that is being made available. The volume of information available can be rather cumbersome to filter through. Couple that with the tasks of developing a plan of action to capitalize on price opportunity, monitoring price activity for that opportunity, taking action in accordance with a predetermined plan and managing those actions thereafter and you have just created a tall order of confusion, frustration and disinterest.

For some, it is a challenge that they enjoy pursuing. But these are a rare breed. My observation has been that as technology has granted a greater access to the marketplace, more people need someone to help guide them through the mountains of information available to make quality decisions and plans.

advertisement

In managing our farm, my father always instructed me to “Do what you do best, and get help for the rest.” Each person must take a personal inventory of their skills, strengths, knowledge and emotional capacity for market fluctuation in order to determine if they are suited for the task.

There is no shame in enlisting the help of a professional marketing adviser. Some advice here – seek help from a company or adviser that matches your intentions. If you desire a low-risk means to managing the price of milk, don’t align yourself with a broker who is in the business of actively trading a slew of markets. Before you know it, you could be trading orange juice, palladium, S&Ps and more. Select someone that matches up with your specific needs, not the first broker you stumble upon in your backyard.

What systems can/should I use to make quality decisions about price?
The door has certainly been flung open for the world to walk through in terms of market access. However, many view the open door not as something to walk through but rather something to stand in front of as they wait for information to rush out. Gone are the days of finding out about price in the newspaper or using the noon radio show as your sole monitoring device. People have migrated toward a need for instant notification. They have text message quote services, phones with web access and instant messaging (IM) services that update them without searching.

Though incredibly helpful in keeping a pulse on the market, instant access can have some devastating consequences. Rather than taking action on scripted plans, many have been caught making decisions on small windows of price action that may not ultimately represent the broader movements of the marketplace. When considering that those decisions will be played out over an extended period of time (a month, a quarter or years), making them based on five minutes of market activity may not be the best thing. Actions like these are a constant reminder of the need for a filter, strategy or system by which to process price and make quality decisions.

We will not be able in this short article to exhaust the list of approaches by which marketers judge the opportunity in a price and come to the market. However, let’s explore some of the more common methods by which price opportunities can be measured. Probably the most common tool used by producers to direct their marketing efforts is a cost-of-production analysis. A simple spreadsheet can help you identify your break-even price. From it, you can quickly discern whether the price is within your return-on-investment (ROI) parameters. When using this system, it is important to recognize that the market may not always honor your hope for profitability. However, in a climate of rapid price movement, both on the milk and input fronts, defining an agreeable profit and then capturing and defending it is a wise measure of self-preservation and advancement.

Another means by which one can sort through market volatility is price analysis. When establishing market objectives or discerning what to do with price, the use of technical and fundamental analysis can be very helpful. Several websites provide such information. The Chicago Mercantile Exchange (www.cme.com) is a great resource for both fundamental information and technical analysis tools. Quote providers and brokerages (i.e. www.hedgebroker.com) also offer tools for such analysis.

advertisement

Though highly useful, these types of analysis can be quite involved (an example of technical analysis tools can be viewed in Figure 1) and require a great deal of study and understanding before they can be successfully applied. However, it is not a lost cause. Several resources exist to help you understand the elements of fundamental and technical analysis. One of my personal favorites is a set of books authored by Jack Schwager titled Schwager on Futures: Technical Analysis and Schwager on Futures: Fundamental Analysis. It is a comprehensive breakdown of the tools used by professionals in both areas of study.

Though technology has made available an almost limitless choice of tools for analyzing the marketplace, it is most important to identify which tools suit you, your schedule, your management style and your level of interest in participating in the marketplace. Methodology varies from person to person. Everyone has his or her own way of analyzing the marketplace. What is important is that each person identifies something that meets their needs and can be implemented in a manageable plan of action. It will require some study and homework to move forward with choosing an adviser, developing a marketing plan and taking action. However, the stability offered by sound price management practices is what will help dairymen weather the storms of market volatility and fluctuating operating margins. PD

UPDATE: Since the publication of this article, Mike North has left First Capitol Ag and is now the president of Commodity Risk Management Group. Contact him by email.

Mike North
Milk Marketing Specialist
First Capitol Ag

LATEST BLOG

LATEST NEWS