3) Be aware of price “anchoring.” Price “anchoring” is quite common among people who follow any market. Whether prices are low, high, or somewhere in the middle; people usually become psychologically anchored to the level of current prices. If prices are high, producers often wait to forward price milk and then when prices begin dropping they are still psychologically anchored to the higher prices and wait too long to forward price their milk. The same is true on the other end of the scale. When prices are low and begin rising, producers are psychologically anchored to the lower prices and wait too long before forward pricing milk and miss out on the higher prices. The result is that many producers become so wary they can never make a pricing decision. Make your first criteria be the relationship between what the current futures market is offering in comparison with your cost of production. Don’t be afraid of forward pricing a portion of your milk if it is profitable even if you believe the market is going higher. Remember, the goal is to control risk, remain profitable, and keep your business operating.
4) Know your historical milk prices. Current futures prices need to be put in the context of historical prices. The best way to accomplish this is by using a cumulative probability chart of historical Class III prices since most milk pricing tools (futures, options, forward contracts) are based on Class III prices. For the current 2012 Chicago Mercantile Exchange Class III futures price average (12/19/11) of $17.10/cwt, we find that $17.10 falls at the 88th percentile. This means that from 1995-present only 12% of the monthly settled Class III prices were above $17.10/cwt. Thus, from a historical perspective $17.10/cwt is an excellent price. Some have questioned including prices going all the way back to 1995. However, of the 17 annual average Class III prices from 1995-2011, of the ten lowest annual averages, six of those have occurred since 2000, and the second lowest was as recent as 2009.
5) Know your dairy market fundamentals. Dairy market fundamentals refer to knowing what is currently happening in the dairy industry as it concerns national milk production, cow numbers, cull rate, dairy product consumption and inventories, dairy product export and import markets, consumer confidence, feed costs, overall economic environment, etc. Every month, I compile a Dairy Market Update that discusses these factors and ties them together to give a coherent outlook of the current market. Basically you are trying to make two simple assessments: 1) Do the current market fundamentals support stronger, weaker, or the same milk prices in the future? And, 2) How strong is this support? It is an imperfect science since it is impossible to predict the future. But it remains an important tool to give producers some level of confidence in making futures pricing decisions.