The USDA Risk Management Agency’s Livestock Gross Margin for Dairy (LGM-Dairy) program remains one of the better tools to protect dairy incomes, according to Alan Zepp, risk management program manager at Pennsylvania's Center for Dairy Excellence.
Zepp provided a dairy market update and discussed risk management options during his monthly “Protecting Your Profits” conference call, July 27.
Risk management options
The monthly call summarizes three income-protection options: the Margin Protection Program for Dairy (MPP-Dairy), LGM-Dairy and puts and options on the Chicago Mercantile Exchange (CME) futures market.
A reminder: By law, producers already enrolled in USDA’s Margin Protection Program for Dairy (MPP-Dairy) can’t participate in LGM-Dairy.
MPP-Dairy
The May MPP-Dairy margin was announced last month at $5.77 per hundredweight (cwt). Based on current futures prices, Zepp anticipates the June margin, to be announced July 29, will be similar, resulting in a May-June pay period margin of $5.77 per cwt. That would provide an indemnity payment of about 73 cents per cwt for any producer insuring a margin at $6.50 per cwt.
Using an example herd of 100 cows with a production base averaging 22,222 pounds of milk per cow per year, Zepp said a herd protecting a $6.50 per cwt margin on 90 percent of milk production would see a May-June indemnity payment of about $2,433. MPP-Dairy payments for the May-June period are expected sometime around mid-August.
Stronger milk futures prices have improved forecasted MPP-Dairy margins for coming months. Current pay-period projections are: July-August – $8.19 and September-October – $ 9.93. The outlook for the November-December margin is more than $10.00, and the first half of 2017 is in a range of $9.50-$9.80 per cwt.
LGM-Dairy
Under LGM-Dairy, producers can insure milk income over feed cost margins for a 10-month period. The July 29-30 sales period offers coverage for September 2016 through June 2017, with policies available through certified crop insurance companies.
The current 10-month (September 2016-June 2017) LGM-Dairy margin is expected to average $8.22 per cwt. As of July 27, the cost of a zero deductible policy for the 10-month period was 64 cents per cwt, with a $1 deductible policy costing about 19 cents per cwt.
“LGM-Dairy can provide a safety net against a catastrophic price fall without taking away the upside,” Zepp said.
CME Class III puts/options
In comparison, as of July 26, a November 2016 Class III $16.50 per cwt “put” was trading at 71 cents per cwt, with a $15.50 “put” (similar to a $1 deductible LGM-Dairy policy) costing 39 cents per cwt.
The cost for Class III puts/options and LGM-Dairy premium payments have both decreased in recent weeks due to a decline in CME milk futures price volatility, Zepp said.
Market fundamentals
Based on USDA estimates, June U.S. cow numbers, at 9.328 million, remain near the previous peak set in December 2008 of 9.334 million.
U.S. butter stocks are the highest since 1993, and cheese inventories are the highest on record. However, Zepp said U.S. population, combined with higher per capita consumption of both butter and cheese must be applied to put those numbers in context.
“The stocks-to-use ratios are high, but they aren’t record high,” Zepp said.
Current U.S. Class III and Class IV prices are still trading about 25 percent under the three-year average. The good news regards improving cheese and butter prices. Powder prices are still very low around the world, and the value of the U.S. dollar remains strong, weakening U.S. dairy exports.
While average Class III milk futures prices remains $2 under the five-year average, margins are averaging $1 above the five-year average, reflecting lower feed costs. Historically, margins typically improve during the second half of the year, Zepp said.
A recent report from the U.S. Dairy Export Council showed the top five dairy exporting countries—Argentina, Australia, the European Union (EU), New Zealand and the United States—produced less combined milk than they did 12 months earlier. That suggests global dairy supply and demand is becoming more in balance, and may be supporting the recent bump in Class III futures prices
“Class III milk followed corn, soybean and oil up in early June, but it hasn’t followed them down yet. That may be due to the stronger dairy demand both here and abroad. I think that’s sustaining the current Class III price.”
However, citing the U.S. fundamentals of high cow numbers and large product inventories, Zepp warns price risks remain.
Marketing plans
Historically, Zepp notes the current milk price cycle is extremely long, suggesting milk prices have bottomed out and are headed for improvement.
“When farmers call me, I’m reluctant to encourage them to fix the contract price for next fall or winter, because we are getting toward the end of this cycle, and nobody wants to miss the upside,” Zepp said. “We have seen a bump, and now is a good time to use puts/options or LGM-Dairy, something that can put in a price floor to protect the bump we’ve seen in case it doesn’t last, but leaving open the opportunity to take advantage of the upside.”
Find Zepp’s archived Protecting Your Profits podcast on the Center for Dairy Excellence website. Due to scheduling conflicts, next month’s call is scheduled for August 31, after the next LGM-Dairy policy sales period set for August 26-27. PD
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Dave Natzke
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