By Matt Mattke
Milk prices have been trending lower for almost a year, and nearby contract months remain at historically low levels. Possibly five futures contract months will settle below the $11.00/cwt. price level (January to May contracts). The failure of Cooperatives Working Together (CWT) buyout announcements and high input costs to generate any sustainable rally in milk prices is causing a tremendous degree of pessimism toward the milk market. Some producer pessimism is, unfortunately, a necessary evil right now so that the necessary cow liquidation takes place to bring supply and demand back in balance. However, a high degree of producer pessimism is also incredibly dangerous, because it has the tendency to lead to major milk marketing mistakes.
These milk marketing mistakes originate from emotions that generate a “stop the pain” mentality. The current financial pain producers are experiencing is unfathomable. Milk checks aren’t coming anywhere near close to covering expenses and cash flow shortages are tremendous. Equity in the operation is being used up quickly and additional credit lines are being sought to bridge the shortfall. Emotions are high and rising, and the desire to “never have to go through this type of financial distress again” is becoming a foremost thought in many producers’ minds; understandably so. This desire to mitigate further financial distress has the potential to lead to massive amounts of forward contracting, especially when future contract months are offering historically decent value.
Milk futures contract months in August 2009 through December 2010 are offering $14.50/cwt. to almost $16.00/cwt. price levels at this time. These are $4.00 to almost $5.50 per cwt. more than the $10.00/cwt. prices producers have been experiencing on recent milk checks. This degree of premium in the market over the spot month has the potential to entice a substantial amount of forward contracting of future milk production. Producers need to pause and think about the potential consequences of any such forward contracting decision at this time.
• Is forward contracting here a good decision?
• Do the technicals and fundamentals support it?
• Is this an emotionally based decision?
These are important questions that need to be asked, due to the rollercoaster ride of emotion between extreme optimism and extreme pessimism that tends to occur at market extremes.
A cycle of emotion in a bear market
Let’s go through an example of this cycle of emotion.
At market tops, optimism is through the roof – everything is bullish so there is no way that prices can drop. Then prices start dropping. The first stage of the bear market is underway, but producers deny that the bull market is ending, and no milk is contracted. Prices continue to drop and, after a substantial slide, prices stabilize, but are not rallying strongly back. The belief still exists that prices will come back and lingering bullish fundamentals can still be touted, but “what ifs” start to pop into mind: “What if prices don’t come back?”
This creates nervousness, but doesn’t spur any action. Then, prices start to break again and capitulation finally sets in: “I need to sell something, these prices won’t stop dropping.”
So some sales occur, but they tend to be small in quantity and nothing substantial. Prices continue to fall and then, eventually, stabilize. Calls that a bottom is in begin. Some sharp short-covering rallies occur, further fueling the calls that a bottom is in. Any rallies quickly reverse, the market sells off hard and new lows are made again. Early bulls turn back bearish. Desperation sets in as things look tremendously bearish: “There is no way prices will ever come back,” and a “sell-it-all” mentality starts to set in. The bottom is now in.
That is the rollercoaster ride of emotions that completes the psychological cycle of a bear market. You can see this illustrated in the chart below using the past year’s trade in the milk market. The different stages of this emotional cycle are laid out in the chart.
Bottom line, producers need to be cognizant of the emotions that he or she is presently experiencing if thoughts of forward contracting right now are coming to mind. This is not to necessarily talk you out of forward contracting, but to make you aware of the pendulum of emotion that occurs from the beginning of a bear market to the end of a bear market.
The current degree of pessimism toward milk prices suggests this bear market is in its final stage. How long this final stage lasts we cannot tell you. We cannot tell you if it will be two more months, or six more months. We cannot tell you if the price will drop $1.00 or $3.00 more per cwt., but we can say with a great degree of confidence that this is the final bear market push lower.
Ultimately, what we want to accomplish with this article is to suggest that you have a “Plan B” if you do decide to forward contract any of your milk production now. In the event that the market bottoms shortly after you sell, you absolutely need to have a strategy to protect those sales, because when the market does turn from bearish to bullish, that initial surge has the potential to be very significant in magnitude.