Guest Columns

Perspective:
Dairy Markets

Lackluster volume here to stay for the dairy complex?

Andrew Faulman

Andrew Faulman is a research/broker assistant at Rice Dairy* in Chicago. He is a guest columnist for this week’s Cheese Market News®.

For the better part of the year, volume in Class III hasn’t really been something to write home to mom about. Last year we saw days where our market managed to trade more than 2,000 contracts with the record nearly getting broken in late December (it was a lot of fun when the floor traded more than 3,000 contracts that day). Standing in the pit and watching the screen everyday, it’s safe to say volumes have come off a bit. Before we look at what happened, let’s first take a look at how 2010 has been shaping up so far compared to years past. Referring to the following chart, it’s pretty clear that volume in both options and futures have been trending lower since the beginning of this year when you compare it to the past couple of years. When looking at the futures we haven’t seen volumes this low since the end of 2006. Options on the other hand have seen a little bit better performance as we’ve managed to maintain monthly volumes at or near 10,000.

So what happened this year that sets us apart from the rest? While it feels like we’ve been in a bit of a roller coaster ride for cheese prices, this year has been lacking volatility. This month we’ve managed to put in new highs in the cheese market; however, we’ve been relatively range bound this year. Starting the year out our market was cooling off from the bid that took us to $1.7000 in the block market for the better part of December of 2009. While we saw a brief stint under $1.3000 during the month of March, for the most part we’ve seen cheese trade between $1.30 and the mid-$1.50s this year. On the one hand you can say that trading inside a 20-25 cent range is a volatile market; however I think our volume (or lack thereof) tells us otherwise.

This year things have been relatively slow. We came off a strong export market this past December that seemed to take the block market from $1.4100 to just north of $1.7000 in a pretty big hurry (call it about 2- 3 weeks time). For starters, a 30-cent break in the price of cheese over that short amount of time is definitely what I would call volatility. However since that significant break we’ve seen the cheese market hold pretty steady for the course of 2010; if you look at the average price of cheese from January-June we traded between $1.3150 and $1.5100. It’s safe to say this year has been a good example of how a lack of volatility lends itself to low volumes, but what happens when things really start to heat up in the cheese market? In 2007 the range for the average cheese price at the Chicago Mercantile Exchange (CME) was between $1.3350 and $2.010 (when I say average I am simply using the average price between blocks and barrels). That range is more than three times as wide in terms of price action when compared to what we saw out of the first half of 2010. With that in mind it’s pretty clear that volatility breeds volume, point being in 2007 we set the record for futures volume in a single month at 35,602 contracts (this comes from data that goes back to 2005).

When looking at any market you can break down the participants into two basic categories: commercials and speculators. This year we’ve seen the lack of strong upside in cheese prices put a damper on the long side of the commercial equation. The buy side of the commercial participation of our market greatly exceeds the number of positions put on by commercial sellers. According to the Commitment of Traders report when looking at the number of open positions at any given time this year, the long side has seen an average of about 10,000 more contracts than shorts. For the first half of the year it’s been no secret that heavy stocks of cheese in the coolers (now sitting at more than a billion pounds), a lack of a strong export market and milk production holding steady have kept high cheese prices at the CME in check. This lack of price action to the upside puts a strain on the amount of long hedging as there simply has not been a strong need to put on upside protection. While the argument can be made that we’ve seen a lack of buy side volume on the commercial side, what about the sell side of the commercial deck? The numbers tell the tale in terms of which side of the market dominates the commercial volume, but in my opinion there is plenty of room for improvement here. Using back of the envelope math, we would guess that only about 5-10 percent of the U.S. milk crop is hedged on the exchange. We’ve got a tremendous amount of untapped sell side liquidity that could be brought to our marketplace.

Ask a dairyman and I’m sure they will tell you they would rather just forget about 2009 and just move forward. That being said, though, it’s hard to forget about the average monthly settlement for Class III last year which stood at a meager $11.36. While it’s hard to draw some good from what we saw in 2009, I keep an eye out for more short hedgers to trickle into our marketplace as a result of folks looking for means to protect themselves from prices similar to what we saw last year (not only does this improve volumes but it also improves overall price discovery).

With the addition of the cheese contract this past June we’ve added an interesting element to the dairy complex that could prove to be a shining star in terms of volume. Before this contract was introduced, if a buyer of cheese wanted to lock in a price they needed to buy Class III and sell off the Dry Whey component (I chose to leave butter out because of the minimal impact). Don’t get me wrong — this got the job done, but it was a bit clunky. With this contract not only can a cheese hedger use this tool to establish a truer hedge, our complex now has an arbitrage trade known as the crush. Recall this kind of play is a trade that would require an active participation in multiple contracts, in this case cheese, Class III and dry whey. However if done right a speculator has the capacity to lock in a profit while taking on next to no risk as opposed to taking on a more directional position. Given that these contracts are cash-settled, a speculator can carry these positions to expiration and not have to worry about making a delivery which is one less barrier to entry. I’ll be the first to admit it that this isn’t the sexiest trade to be put on but if there is money to be made (especially at such low risk) the speculative volume will come.

So what’s next for the volume in the Class III market or, better put, the dairy complex in general? Have we already seen the highs get put in for volume in a given month? It’s nearly impossible to predict but volatility has a way of sneaking back into any marketplace, and I believe we’ve got more ups and downs to come. With the introduction of a crush into our market we’ve got more tools than ever to really get volume moving at the CME. While it’s had a few years at the top, I get the feeling the days are numbered for that record set back in 2007.

CMN

*These observations include information from sources believed to be reliable, but no independent verification has been made and therefore their accuracy and completeness cannot be guaranteed. Opinions and recommendations expressed are the opinion of the author and are subject to change without notice. The risk of loss in trading futures contracts or commodity options can be substantial, and investors should carefully consider the inherent risks of such an investment in light of their financial condition.

The views expressed by CMN’s guest columnists are their own opinions and do not necessarily reflect those of Cheese Market News®.

© 2025 Cheese Market News • Quarne Publishing, LLC • Legal Information • Online Privacy Policy • Terms and Conditions
Cheese Market News • Business/Advertising Office: P.O. Box 628254 • Middleton, WI 53562 • 608/831-6002
Cheese Market News • Editorial Office: 5315 Wall Street, Suite 100 • Madison, WI 53718 • 608/288-9090