A Look at the Pricing Opportunity on the Chicago Mercantile Exchange (CME)

Dr. Cameron Thraen, Milk Marketing Specialist, Ohio State University, Additional milk marketing information by Dr. Thraen

In the last issue of my article for the Buckeye Dairy News, I discussed my "Premiums and Discounts" chart which can be viewed on my Ohio Dairy Website (http://aede.osu.edu/programs/ohiodairy/) under the heading 'Mideast Price Watch @ a Click.' In this article, I will introduce another chart posted on the website and accessible under the heading "A Look at the Pricing Opportunity on the CME". On this chart, I show the current Class III futures price for the next 12 months, along with Median Class III prices and the upper and lower 25 percentile price lines. What is the point of posting this chart daily? What information do I wish to convey to you - the dairy farmer or milk processor?

The information on the Website chart shows you the relative position of the CME futures prices and the Median Class III price by month, calculated from the time period 1996 through the latest information in 2005. Why use the Median Class III price rather than the average Class III price for comparison? The reason is that the average price gives you a distorted impression from historical data. Because dairy prices are limited on the downside and not limited on the high side, reported prices are bunched-up on the lower side and spread-out on the upper side. The average price will suggest that the high side prices occur too often over time. The average price will suggest a 'typical' price that is too high. Without getting into the statistics of this, the median price shows you the Class III price for each month at which 50% of the Class III prices were either above or below this median price. For example, in the chart reproduced in this article, you can see that the median price for the month of July is $13.59/cwt. This tells you that over the 1996 to 2004 period, 50% of the Class III prices were announced below $13.59/cwt and 50% were above this price. Also shown on the chart are the current Class III futures prices. For our example, you can see that the July CME Class III futures price is trading in the neighborhood of $14.88/cwt. How 'good' a price is this futures price? Viewing the chart, we can see that it is substantially above the median price and therefore looks like a 'good' price. But, how good is the next question to address.

On this chart, you can see two additional price lines shown as an upper line and a lower line. These lines show you the boundary for 75 and 25% of the announced Class III prices. Again, working with the July month you can see that the upper or 75% price line is $14.77/cwt and the lower or 25% price line is $10.86/cwt. This is quite a spread for July prices. That is the first piece of information. This 'spread' between the upper and lower price lines gives you a visual clue as to the possible variation you can expect for any selected month. Between the upper and lower price lines, 50% of all reported July Class III prices have occurred during the 1996 to 2004 time frame. Now to answer the question, the current CME futures price of $14.88/cwt appears to be a very good price for the July month. Only 1 out of four years has the July month price been above the $14.77/cwt level. Does this mean that when announced, the July 2005 Class III price will be at $14.77/cwt or better? No, but using the past as a guide, there is only a 1 in 4 chance that will happen.

Taking an overview of the entire chart, you can see that the CME futures prices for the next 12 months (July 2005 through June 2006) are looking very good. This tells us two things. First, those buying and selling Class III futures contracts, factoring in their own forecasts for milk supply and consumer demand, are anticipating a good year price-wise. With only a couple of exceptions, the CME Class III futures price is above the historical median price and near or above the upper 75% line. Using the CME futures prices as a guide, this puts the average CME price over the next 12 months at $13.58/cwt and this is $1.16/cwt higher than the average of the median prices. In Federal Order 33, the mailbox price adds another $1.25/cwt to the Class III price.

Second, the futures market prices suggest that over the next 12 months that the market will give up about a $1.00/cwt on the Class III milk price. This is consistent with the month-to-month Class III price changes over the last 6 months. Coming off of the high price in May 2004, the Class III price has drifted down to the $14.00/cwt level, and the market is telling you that it expects this to continue down to the $12.80 - $13.00/cwt level before leveling out by June 2006.

If you like to stay up-to-date as to the opportunities for getting better than average prices for your milk, be sure to bookmark my Ohio Dairy Website (http://aede.osu.edu/programs/ohiodairy/) and visit daily. My current milk price outlook can be viewed on the web. I update this outlook each month. Check it out at http://aede.osu.edu/programs/ohiodairy/ProActivePricing/priceforecast.htm.

For a complete update on current market conditions, futures, and options markets, and policy issues of importance to Ohio and Federal Order 33 producers go to my web site, Ohio Dairy Web 2004, and click on Cam's Price Outlook.