Riding this Market RollercoasterWritten by Dallas Mount
By Dallas Mount, UW Livestock Extension Educator
What a year 2015 markets have been! If you contracted calves on the video last year, I hope you didn’t abandon a ship and cash market strategy this fall. If you cash marketed in 2014, I bet you didn’t switch to video for 2015. Maybe you were lucky enough to hit the highs in both 2014 and 2015, but I’d be careful about congratulating yourself too much.
I often wonder, if we paired up a market forecaster and the magic eight ball, how much advantage would the forecaster have over the eight ball? My guess is not much.
I custom grazed some high quality Red Angus cattle these past two summers. In 2014 the calves sold for around $1,600 per head. In 2015 that number was about $1,150 per head – quite a swing in one year’s time.
In the Ranch Practicum School, we use an example ranch built to represent a typical Wyoming cow/calf operation that runs about 300 cows, develops heifers and puts up hay. In July the ranch was projected to make an $86,000 economic profit after salary to owner/operators. When the class came back together in October, we updated our projections, and the ranch is now losing $19,000. That is a swing of about $100,000 in 90 days.
These market swings should challenge us as ranch managers to re-examine our risk management strategy and be sure our actions match our desires. I don’t need to tell you that there are lots of forms of risk in the ranching business. For this conversation let’s focus on market risk.
Some of you have ranches operating on a large owned-asset base that use very little leverage and maybe even have cash reserves to operate though down years. Others are operating on leased land or making land payments, must also cover an operating note and/or a cow note and have few liquid reserves to cover living expenses.
Operation-specific risk management
The risk management strategy of these two operations needs to be very different. The strange thing I’ve observed is that often the strategy doesn’t match the need.
For example, the second operation often will not use any market price protection strategies and just take their chances on the market on whatever day they sell. The $100,000 swing experienced by the example ranch I mentioned may be the difference between still being in business next year.
This ranch needs to take some actions to protect it from market swings. These actions may include some of the more typical price-protection strategies like forward contracting, put options, Livestock Risk Protection (LRP) or others.
Maybe there are some non-typical strategies, such as market diversification or others, that would work as well. This ranch will likely have to give up some income potential to protect against the downside. In other words the profit-maximizing strategy is often not the same as the more risk adverse strategy that a ranch like this should implement.
If you happen to fall into the camp of the first ranch that can withstand a few down years and continue operating, I don’t think you get a free pass on considering your risk management strategy.
This needs to be a discussion for the ownership level of the ranch that gets clear intentions and expectations from ownership. Perhaps ownership understands that a strategy to maximize profit will also increase risk exposure and increases the likelihood of years with lots of red ink. Maybe ownership would be willing to give up some profit if the likelihood of loss years was reduced. Either way you need to discuss this and be clear.
I’m a big fan of setting profit targets and implementing a strategy that protects a minimum profit and leaves the upside open.
For example, what if you projected your 2016 calf production costs to be $900 per calf weaned? When markets offer us the opportunity to put a floor price on our calves that covers our economic costs, then we may commit to doing 50 percent of the steer calves as soon as possible and the remaining 50 percent of the steer calves 60 days prior to market. We might leave the heifer calves to follow the cash market.
I’m not recommending this is the right strategy for you. I’m recommending you develop your own strategy. Development of your strategy would be even better if it were discussed and in place prior to the season. Then the emotion and our own self-deception is taken out of the decision making.
Understanding price protection tools can be a daunting task, but it can also be worth the work. It sure would have been in 2015. Please contact me or any other Extension educator if we can help.