managing risk and seizing opportunity in 2012 and beyond
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Managing Risk and Seizing Opportunity in 2012 and Beyond. Dr. Marin Bozic I-29 Dairy Conference│ February 8, 2012. Topics for today. Recent events in the dairy markets Risk factors in 2012 Hedging margin risk Long-run risk management. April 2012 Class III Futures. - PowerPoint PPT PresentationTRANSCRIPT
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Managing Risk and Seizing Opportunity in 2012 and
Beyond
Dr. Marin BozicI-29 Dairy Conference│ February 8, 2012
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1) Recent events in the dairy markets2) Risk factors in 20123) Hedging margin risk4) Long-run risk management
Topics for today
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April 2012 Class III Futures
12/8/2011
12/12/2011
12/16/2011
12/20/2011
12/24/2011
12/28/2011
1/1/2012
1/5/2012
1/9/2012
1/13/2012
1/17/2012
1/21/2012
1/25/2012
1/29/2012
2/2/2012
2/6/2012
$15.00$15.50$16.00$16.50$17.00$17.50$18.00
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April 2012 Class III FuturesComponents contribution to decline
-$1.20
-$1.00
-$0.80
-$0.60
-$0.40
-$0.20
$0.00
$0.20
Cheese Dry Whey Butter
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Term structure of futures prices
Based on options data, there is 20% chance Class III price will settle below the shaded area, and 20% it will settle higher.
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15$10.00
$12.00
$14.00
$16.00
$18.00
$20.00
$22.00
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Dow
nsid
e Ri
sk
13
13.2
13.4
13.6
13.8 14
14.2
14.4
14.6
14.8 15
15.2
15.4
15.6
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
35.00%
40.00%
45.00%
50.00%
April 2012Futures: $15.68 (as of 2/8/2012)
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Dow
nsid
e Ri
sk
12.4
12.6
12.8 13
13.2
13.4
13.6
13.8 14
14.2
14.4
14.6
14.8 15
15.2
15.4
15.6
15.8 16
16.2
16.4
16.6
16.8
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
35.00%
40.00%
45.00%
50.00%
55.00%
July 2012Futures: $16.75 (as of 2/8/2012)
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Dow
nsid
e Ri
sk
10.9
11.2
11.5
11.8
12.1
12.4
12.7 13
13.3
13.6
13.9
14.2
14.5
14.8
15.1
15.4
15.7 16
16.3
16.6
-5.00%
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
35.00%
40.00%
45.00%
50.00%
55.00%
Dec 2012Futures: $16.75 (as of 2/8/2012)
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Risk factors
• U.S. recovery to stop?• Eurozone collapse?• War with Iran?• Runaway inflation? • Three year cycles? (2009 + 3 = 2012)
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Implied Probabilities of Uncertain Events:1. U.S. Economic Recovery
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Implied Probabilities of Uncertain Events:2. Dropping out of Euro zone
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Implied Probabilities of Uncertain Events: 4. War with Iran
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Implied Probabilities of Uncertain Events: 4. War with Iran
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Implied Conditional Probabilities of Uncertain Events
If air strike is to happen this year, what are the odds it will happen in summer:
23.1% 69.5%33.2%
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Can we make use of prediction markets in dairy?
Information discovery:• E-verify to become mandatory before
12/31/2012• Farm bill to pass before 9/30/2012Risk transfer:• “The Secretary of Agriculture to announce
that the stabilization program is in effect for June 2012”
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Expected Inflation: Evidence from Treasury Securities
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Expected Inflation: Evidence from Treasury Securities
Jan-08
Apr-08Jul-08
Oct-08Jan-09
Apr-09Jul-09
Oct-09Jan-10
Apr-10Jul-10
Oct-10Jan-11
Apr-11Jul-11
Oct-11
-2.00-1.50-1.00-0.500.000.501.001.502.002.503.00
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Historical Milk-Feed Margin 2010-2011
$0$2$4$6$8
$10$12$14$16$18
$12.90
$5.72$7.57
$15.46
$7.54
$16.56
$3.55
$6.28
$13.10
Margin - Historical Top 50% Percentile
Source: Katie Krupa, Rice Dairy, LLC.
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1 cwt of milk - 0.80575 bu of corn - 0.0087 ton of SBM
Rice Dairy Milk-Feed Margin Formula
Source: Katie Krupa, Rice Dairy, LLC.
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Three year cycles? Evidence from forward margins
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
$0.00
$2.00
$4.00
$6.00
$8.00
$10.00
$12.00
$14.00
$16.00
$18.00
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Three year cycles? Evidence from forward margins
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
$0.00
$2.00
$4.00
$6.00
$8.00
$10.00
$12.00
$14.00
$16.00
$18.00
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Historical Perspective
$7$8$9
$10$11$12$13$14$15 $14.15
Dec '07 Margin Trade Data
Source: Katie Krupa, Rice Dairy, LLC.
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Historical Perspective
$2$3$4$5$6$7$8$9
$10$11$12 $10.63
$3.62
Feb '09 Margin Trade Data
Source: Katie Krupa, Rice Dairy, LLC.
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Forward Dairy Profit Margins 1998-2011
17 16 15 14 13 12 11 10 9 8 7 6 5 4 3 2 1$0.00
$2.00
$4.00
$6.00
$8.00
$10.00
$12.00
$14.00
$16.00
$18.00
Margin = Class III Milk -0.80575*Corn -
0.0087*Soymeal
9-12 Months:Consistently Stable and
Sustainable Margins
Months to maturity
Inco
me
Ove
r Fe
ed M
argi
n
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Hedging by any other name…There are (at least) three very different way dairymen can manage risk:• Contracting – i.e. futures and options, forward pricing
through the coop, cash contracts for feed
• Strong equity/fast growth – increasing efficiency to keep costs below national average, possibly by attracting investors to keep debt/equity ratio low in face of fast expansion
• Dairying as a hedge – low cash-flow costs, but high opportunity costs of feed. Dairying as a hedge against lower future value of land/crops
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S
D
D′
Quantity
Price
Short run (wish there was a fifth udder)
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S
D
D′
Quantity
Price
Long run (eight udders are better than four)
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What does the long run U.S. milk supply look like?
130 140 150 160 170 180 190$0.00$2.00$4.00$6.00$8.00
$10.00$12.00$14.00$16.00$18.00
Annual U.S. Milk Production (3 year moving average) - Billion Pounds
U.S
. All
Milk
Pri
ce, 3
-yea
r M
ovin
g A
vera
ge
Data period: 1980-2010
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Change in Dairy Farm Technology
1993
1995
1997
1999
2001
2003
2005
2007
2009
10
12
14
16
18
20
22 100-200: Peak in 1997 @
20%
200-500: Peak in 2000 @
18%
500-1000: Peak in 2005
@ 14.3%
1000-2000: Peak in 2007
@ 16.1%
100-200 200-500 500-1000 1000-2000
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Percent of U.S. Milk Production by Large Dairy Farms
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
0
10
20
30
40
50
60
2000+ 1000-2000
Percent of US milk production by farms with 2000+ cows grows on average by 2.2% a year.
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Flat supply curve – what are the implications?
In the long run…• Dairy Darwinism: dairyman to businessman, or out of
business.• Demand-enhancing activities boost quantity, not price
(think exports, check-off, product research & development)
• Increase in price of one milk fraction decreases the price of another (think whey vs. cheese) until returns to dairying revert to average
• Uncertainty = higher average returns• Vertical integration as the 21st century version of
“cooperative revolution”
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Support from these companies is greatly appreciated
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Managing Risk and Seizing Opportunity in 2012 and Beyond
presented at the I-29 Dairy ConferenceSioux Falls, February 8, 2011
Dr. Marin [email protected] of Applied EconomicsUniversity of Minnesota-Twin Cities317c Ruttan Hall1994 Buford AvenueSt Paul, MN 55108
You may download this presentation at http://marinbozic.info/