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Commodities 102--a follow-up presentation regarding hedging corn, SBM and milk
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Background
• Feed Cost Webinar: “Strategies to Lock in Milk and Feed Prices”
• Archived: www.extension.org/dairy cattle• Presentation: www.slideshare.net
– Today’s presentation will also be available for viewing and/or downloading
– Commodity report upon request – no charge
PRELUDE
Got Lamborghini?
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are needed to see this picture.
Maria Bartiroma Interviews Jim Rogers for Business Week
Outline
• Market Analysis
• Market Trends
• Price Risk Management Strategies
MARKET ANALYSIS
What Lies Ahead?
• The big question in the financial markets is, ”What lies ahead?”
• People want a financial crystal ball
• What will the price of corn, SBM and milk be
– 3 months?– 6 months?– 12 months?
What Lies Ahead?
• “How would you like to have a copy of the WSJ one year in advance (i.e., May 27, 2010)?”
What Lies Ahead?
• Nevertheless, there are secular systems that attempt to predict future market action
• Two main schools in the financial markets:– Fundamental Analysis
– Technical Analysis
Fundamental Analysis
• Looks at economic factors, known as fundamentals– Dollar– Acres coming out of CRP– Number of ethanol plants coming into production
• In short, it examines the forces of supply and demand
Technical Analysis
• Looks at the price movement of a commodity and uses this data to predict its future movements
• Technical analysts make extensive use graphs of data in an effort to “make the invisible visible”
• Hence, they are often called chartists
Key to Technical Analysis
• Identifying a trend• In fact, technical analysis can be
summed up in the saying, “The trend is your friend.”
• TAs strongly adhere to the premise future price movement is MORE LIKELY to be in the same direction as the trend
MARKET TRENDS
Three Trends
• Primary
• Secondary
• Minor
Three Trends
• Primary--tide
Three Trends
• Primary--tide• Secondary--waves
Three Trends
• Primary--tide• Secondary--waves• Minor--ripples
Three Trends
For investors, it is most important to be aware of the direction of the primary trend
Three Trends
For investors, it is most important to be aware of the direction of the primary trend
Corrections within the primary trend (the secondary trends) can be disconcerting and often expensive interruptions to one's position
Three Trends For investors, it is most important to be aware of the
direction of the primary trend
Corrections within the primary trend (the secondary trends) can be disconcerting and often expensive interruptions to one's position
The minor trend is the one the public gives most attention to, yet the minor trend is least important to the serious investor.
Secondary Trend
??? $63.00
The Primary Trend: DJIA (2007 - 2009)
Primary Trend and MAsMoving averages often used to determine theprimary trend:
Grains• Long term MA = 65 week
- Above 65 week MA = Bullish Primary Trend
- Below 65 week MA = Bearish Primary Trend
Primary Trend and MAsGrains• Long term MA = 65 week
– Above 65 week MA = Bullish Primary Trend– Below 65 week MA = Bearish Primary Trend
Milk• Long term MA = 65 month• Short term MA = 15 month
– Above 15 month MA = Bullish Primary Trend– Below 15 month MA = Bearish Primary Trend
CLASS III MILK
6.00
8.00
10.00
12.00
14.00
16.00
18.00
20.00
22.00
01/0
1/00
05/0
1/00
09/0
1/00
01/0
1/01
05/0
1/01
09/0
1/01
01/0
1/02
05/0
1/02
09/0
1/02
01/0
1/03
05/0
1/03
09/0
1/03
01/0
1/04
05/0
1/04
09/0
1/04
01/0
1/05
05/0
1/05
09/0
1/05
01/0
1/06
05/0
1/06
09/0
1/06
01/0
1/07
05/0
1/07
09/0
1/07
01/0
1/08
05/0
1/08
09/0
1/08
01/0
1/09
TIME
$/CW
Monthly S-T MA L-T MA
$9.31
Basic Tenets of Primary Trend
• The extent and duration of the primary trend cannot be predicted beforehand
• The primary trend will overshoot (farther than almost anyone imagines) $9.31/CWT
• The primary trend cannot be manipulated
The Primary Trend: DJIA (2007 - 2009)
The Primary Trend: DJIA (2007 - 2009)
Comparison of 2009 March Corn and Milk Prices
Comparison of 2009 March Corn and Milk Prices
PRICE RISK MANAGEMENT
Dairy Profitability
• COP ($/cwt)• Production (cwt)• Farmgate price ($/cwt)
Farmgate price ($/cwt)
COP ($/cwt)
Difference ($/cwt) x cwt multiplier = profitability
Multiplier Effect
• Good--make lots of money• Bad--lose lots of money
Farmgate price ($/cwt)
COP ($/cwt)
Difference ($/cwt) x cwt multiplier = profitability
Jan 01 (9.99) Jul 03 (11.78)
Nov 06 (12.84)
DAIRY CYCLES:• Bad Year $11.89 (‘06)• Good Year $18.04 (‘07)• Good Year $17.44 (‘08)
Spilt Milk(the ugly side of the multiplier effect)
10000 cwt
$6.00 /cwt
$60,000 /day
365 days/yr
$21,900,000 /year
Profitability and Price for Product
Nothing affects profitability of a dairy operation like the price of milk
Profitability and Price for Product
Nothing affects profitability of a dairy
operation like the price of milk
“We can’t do anything about the price of milk.”
Farming the Cycles
• Good year, good year, bad year
• Put money away during the good times
• Ride out the down market
Dairy Cycle (2006-2008)Year Av Price ($/cwt)
2006 11.89
2007 18.04
2008 17.44
3-year average 15.79
Standard deviation +/- $3.34
Price for Product
• “We can’t do anything about the price of milk?”
• We can capture more $$$, but “we need to get our ducks in a row.”
PRECISION HEDGING MILK
10,000 cwt
$6.00 /cwt
$60,000 $/day
365 days/yr
$21,900,000 $/year
$10,950,000 half
$3,650,000 cost
$7,300,000 net
Precision Hedging
Market Timing• Strategically sell milk at its peak
Market Timing• Strategically sell milk at its peak
• Know exact points to sell
Market Timing• Strategically sell milk at its peak
• Know exact points to sell
• “TIME THE TOPS!”
Market Timing• Strategically sell milk at its peak
• Know exact points to sell
• “TIME THE TOPS!”
• The graveyards are full of people who knew where the top was
Market Timing• Strategically sell milk at its peak
• Know exact points to sell
• “TIME THE TOPS!”
• The graveyards are full of people who knew where the top was
• Nobody can do it
Two Critical Objectives1. We should Never-Ever miss the
best prices
Two Critical Objectives1. We should Never-Ever miss the
best prices
2. Avoid the worst prices
M-I-L-K P-R-I-C-E F-L-O-O-R
50.00% <$16.28/cwt
M-I-L-K P-R-I-C-E F-L-O-O-R
66.67% <$18.00/cwt
Precision Hedging
• Never-ever miss the best prices• Avoid the worst prices• “milk insurance”• Futures/options commodity instruments• Self-directed, online account• Technical analysis to enhance profits
(Improve timing)
PRECISION HEDGING SBM
Soybean Meal Options Jul '09 - Mar '10
Apr 17, '09
Option Option Cost
330c 15.55
320c 17.15
310c 16.90
290c 18.10
280c 23.25
280c 23.25
320c 18.55
Soybean Meal Options Jul '09 - Mar '10
Apr 17, '09 May 26, '09
Option Option Cost Current Cost
330c 15.55 61.20
320c 17.15 59.20
310c 16.90 53.75
290c 18.10 53.90
280c 23.25 57.60
280c 23.25 57.60
320c 18.55 32.50
320c 18.55 32.50
320c 18.55 32.50
Table 1a. Soybean Meal Recommendations Report Card
Contract Action Price Profit/Loss
May '09 Bought 313.50 on 040309 $361.20 $4,770.00
Jun '09 Bought 361.20 on 050109 $377.20 $1,600.00
Jul '09 Long hedge 041709 $318.70 $4,565.00
Aug '09 Long hedge 041709 $306.50 $4,205.00
Sep '09 Long hedge 041709 $290.50 $3,685.00
Oct '09 Long hedge 041709 $271.10 $3,580.00
Nov '09 Long hedge 041709 $268.20 $3,435.00
Dec '09 Long hedge 041709 $268.20 $3,435.00
Jan '10 Long hedge 041709 $268.70 $1,395.00
Feb '10 Long hedge 041709 $270.50 $1,395.00
Mar '10 Long hedge 041709 $270.50 $1,395.00
TOTAL $33,460.00
Table 1b. Soybean Meal Recommendations and Scorecard
Contract Action Price Profit/Loss
May '09 Bought 313.50 on 040309 $361.20 $71,550.00
Jun '09 Bought 361.20 on 050109 $381.30 $30,150.00
Jul '09 Long hedge 041709 $318.70 $68,475.00
Aug '09 Long hedge 041709 $306.50 $63,075.00
Sep '09 Long hedge 041709 $290.50 $55,275.00
Oct '09 Long hedge 041709 $271.10 $53,700.00
Nov '09 Long hedge 041709 $268.20 $51,525.00
Dec '09 Long hedge 041709 $268.20 $51,525.00
Jan '10 Long hedge 041709 $268.70 $20,925.00
Feb '10 Long hedge 041709 $270.50 $20,925.00
Mar '10 Long hedge 041709 $270.50 $20,925.00
TOTAL $508,050.00
Summary
1. Stay aligned with the primary trend
Summary
1. Stay aligned with the primary trend
2. Avoid the big loss– Remember, you can be wrong!
– Know the risk:reward ratio
– Don’t take naked positions
– Reduce risk by using protective futures/options
Summary
1. Stay aligned with the primary trend
2. Avoid the big loss– Remember, you can be wrong!
– Know the risk:reward ratio
– Don’t take naked positions
– Reduce risk by using protective futures/options
3. Adopt a commodity strategy that allows you to sleep at night
Strategy Comparison
System
Never-Ever Miss the Best Prices
Avoid the
Worst Prices Cost
Fractional Buying
+ + + + + - - - - -
MarginalBuying
- - - - - + + + + + - - -
PrecisionHedging
+ + + + + + + + + + - -
Synopsis
• SBM -- Bullish
• Corn -- Bearish
• Milk -- Hopeless
Primary Trend
• Corn• Soybeans• Milk• Cattle• Stocks• Aluminum• Copper• Oil• Steel• Cocoa• Coffee• Cotton• Sugar• Lumber
• Gold• Guns