By Matt Mattke
As milk prices roller coaster higher and lower, so do the emotions of dairy producers. The more extreme prices rally the more bullish the emotions; and the more extreme prices drop, the more bearish the emotions.
There is a tendency for the majority of producers to become victims of what is known as the recency bias: the bias that whatever has worked lately is the thing to do now and in the future.
After a price collapse, the mentality sets in that forward selling milk worked lately so that is the mindset adopted going forward. As soon as the market starts to rally, many producers are quick to sell because they recall the pain of the lows and do not want to experience that ever again.
That approach can work for maybe a year or two, and if so, that establishes a habit of continually selling on minor bounces with no regard for the bigger picture cycle. Then all of a sudden, prices explode, the bull run is on, and sales that initially looked good become further and further behind the market. The producer regrets ever making the sales and then the new bias takes over and a new mindset is established: forward selling milk hasn’t worked lately, it cost me money, so I am not forward selling anymore milk ever again.
Then prices hit their peak and collapse and the pain of low prices is felt all over again. At this point the emotional bull/bear cycle is complete and starts anew with the producer again looking to what worked recently, forward selling milk, and decides that is the approach to take going forward. Then again on the first rally the producer sells quickly and it works for a while.
As a comfort in selling is developed and the total bearish mindset takes hold the market explodes higher and once again milk sales that initially looked good are now behind the market and the producer stops selling and adopts a take-the-market price stance just in time for another price collapse.
Fortunately, not every producer does this, or does it on all of their milk, but far too much milk is marketed as described above. Emotions take hold and override logic, discipline and strategy.
Due to the historic drop, and the below average milk prices currently being experienced, it is well worth taking the time to review how marketing decisions are made. A $10.00/cwt. drop and $9.00/cwt. milk has a lot of producers that sold no milk for 2009 feeling tremendous emotional and real monetary pain. This pain makes many producers susceptible to making huge marketing mistakes in the months and years ahead, but the good news is that these major marketing mistakes can be avoided. Perfection in marketing is an unrealistic expectation, but doing a good job of marketing is not.
You’ve all likely heard the term “the trend is your friend.” When a market is rallying let it rally and don’t stand in front of it, but when a market is dropping sell and keeping selling. Two strategies that can empower producers and let them gain control of their marketing are put options, and “following the market with stops.”
If milk prices rally a little and a producer really feels the need for price protection, buy put options. These will provide a floor for your milk, but leave your upside wide open.
In addition to, or in lieu of put options, a producer can use a “follow the market with stops” strategy that establishes trigger points at levels of price support. If that price support (stop point) is broken then start forward selling milk. Otherwise, let the up trending prices run higher and wait to sell.
As the price rallies, establish another higher stop point and if that is broken forward sell more milk. If the stops are never broken and prices keep rallying you will not need to make any sales. In such an instance you let the trend be your friend, while still being strategic and having a strategy in place to start forward selling milk in the event prices started falling. You protected your downside risk while keeping your upside opportunities open.
After a period of unprofitability, that extra profit margin will be welcome and much appreciated.