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Big questions, big revelations for peer group using dairy market trading simulator

Angie Molkentin Published on 05 August 2011
It’s a soggy day in late spring and four dairy producers from different parts of the U.S. check their positions in the trading simulator, then connect with each other via phone. As is typical, they begin the teleconference by discussing weather and crop progress – or frustrations – in their various locations. Then these dairy producers dive into something they feel even less control over than the weather – the markets.

Month after month since February, nine participants keep coming back to two trading peer groups. The groups are facilitated and coached by Mark Ludtke of Stewart-Peterson, and participants use a simulator from the University of Florida to experiment with trades.

The simulator is a safe place for trial and error, and the conference calls offer a chance to ask questions and share the learning.

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One particularly rainy spring day, the quietest member of Group 1, Bronco from Idaho, shared his “lightbulb moment” about marketing.

“Of all the things I do on my farm, I can have the most immediate impact with marketing decisions, where other things on my farm are less flexible. In farming, we have so many positions we’ve taken, and most of those positions we can’t get in and out of so easily.

“How did I come to realize this? I was holding onto a losing position in the simulator, hoping it would turn around. And one day it dawned on me that this was crazy. I could get out of it, evaluate it with fresh eyes, and if I still feel the same way, I could get back in and only be out the cost of the trade.

I have other positions that I can’t get out of that easily on my farm – land, cows, feed. With these tools I can, and it seems to me I should, be using these tools on my farm for added flexibility.

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“So I got out of the position on the simulator, and I found that I didn’t have the emotion tied to the decision. It looked different to me when I didn’t want to be right. I could stand back and evaluate it more clearly.

“Big picture, if I do nothing in the market, I am taking a position. I am always long in the market. This realization has been as valuable to me as anything I’ve ever done. The reason for learning to use the markets makes sense to me now.”

Comments from Coach Mark Ludtke: “Once that desire to be right is set aside, it needs to be replaced with something: a more strategic approach. Use a process that makes your decisions as unemotional and objective as you can.”

Ludtke’s tutorials during May’s teleconferences focused on chart reading, and in June he walked through the thought process a strategic marketer uses:

• When is a good time to buy or sell?

• At what price should I buy or sell?

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• How/which tools do I use?

• Which strategy and tools perform best in various price scenarios?

Trader Joe had this to share in June, while the milk market climbed: “I still struggle with the fear of not capitalizing fully on opportunity. How often does a good marketer get it right?”

Coach Mark: “Think about ‘right’ in terms of your long-term average price, not in terms of any one position. For example, right now a good strategic marketer might be building an average price that is, say, 60 cents behind the market. We’re in an upward-trending market right now, and in an upward-trending market you’re going to give up a little in exchange for the protection against the price going down.”

Ludtke points to historical examples of the milk price cycle rolling its course.

“What goes up must eventually come down. Let’s say the market drops $5 or $6 in the near future. Because of the positions you have on, you absorb only $3 to $4 of that instead of the full $5 to $6. That 60 cents doesn’t matter so much anymore. In the long run, you are ahead, and you are ahead significantly compared to the person who simply took the market price. That translates to significant advantage over time.”

Gordy from Washington joined a trading group because he believes it is essential to learn how to use marketing tools to protect his dairy in the future, despite being burned in the past when milk went to $20 and he had forward contracted for $18. He describes his past marketing as “fits and starts,” taking the lows and locking himself out of the highs.

Gordy’s big question in May of this year was how to take advantage of the strong milk prices while still being able to capture opportunity.

Coach Mark: “If you sold milk using futures or a forward contract, by nature you have established a floor and a ceiling for your milk. Let’s say you sold at $17. You won’t go below $17, and you won’t go above it either. So, if you want to protect your upside, you’ll consider buying a call option, which gives you the right to buy that milk back at a given strike price, minus the cost of the option.

“Let’s say you forward contract at $17 and you are afraid the milk price will explode because of a tenuous corn crop situation. You buy an $18 call option and pay 20 cents for it. If milk goes to $20, you’ll be able to capture the rising price between $18 and $20, minus the 20-cent option premium. So in effect, you’ll be able to participate in any market that moves up above $18.20.”

Trent from Ohio wanted to know about time horizons. “How far out do I protect the milk prices I am seeing?”

Coach Mark: “The tools and the time horizon you use can be determined in part by where we are in the milk price cycle. When you are at a low point in the milk price cycle, you do not want to sell too far out because you generally expect the price to go up, based on historical cycles.

“We are about 12 months into an upward-moving price cycle for milk (at the time of this writing). July 2010 was the low point in the downward cycle. Historically, upward-moving markets last from nine to 18 or 20 months.

“We are now in the period of the cycle where, any time now, prices could start moving down, but, at the same time, an upward cycle could last for another eight months. So as we’re making our decisions right now, we want to have some sort of option strategies in place so that if we sell now to protect our price, we have the ability to capture a continued move up.

“If six months or more go by and milk prices stay strong, we will be 18 months into that upward cycle, and it is more likely prices will turn around. That’s when we’ll want to think about a longer time horizon for protecting prices and be more aggressive about locking in.

“We recognize that we might be early and sacrifice some on the topside, but in all likelihood it will not be much. We may experience some margin calls, but not for long. The upward trend is going to come to an end sometime, and we will likely be right longer than wrong.”

Having listened to his group’s discussion on decision-making, Joe from Idaho lamented with a laugh, “I just want to be right once!”

Then, he too shared a lightbulb moment.

“It has dawned on me that if I am consistent in what I do, I will be right in the long run. If I get in and out without a long-term view, I will not be consistent, and I will not be right.”

Coach Mark: “Well put!” PD

Angie Molkentin is a writer from Oconomowoc, Wisconsin. She has special access from Stewart-Peterson to observe the FACTSim dairy trading group and the interactions of producers in the program.

You can still join!
You can still join a team of Progressive Dairyman readers who want to learn how to make marketing decisions.

To join, e-mail Mark Ludtke at or call him at (800) 334-9779 .

Benefits of participating:
• Learn the language, concepts and typical positions in commodity trading.
• Learn how to move in and out of positions.
• Experience the impact of decisions made.
• Develop the discipline to execute decisions.
• Share experiences and ask questions of those in your peer group.

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