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Got Milk Contracts? Indeed!
Futures, Options Activity Climbs as Farmers, Food Firms Hedge Price Swings


The milk market is becoming more liquid.

Long a backwater of the commodities market, milk futures and options activity has soared. The number of outstanding contracts on the Chicago Mercantile Exchange averaged 110,197 in January, up 32% from a year ago, even as the aggregate number of trading positions among other raw materials fell, according to exchange data. Since 2007, it has more than doubled.

Piling into the market are farmers and food companies burned by the collapse in milk prices in 2009. They are looking to protect themselves after a recent drop in prices, following a surge last year. Their increasing numbers make it easier to buy and sell futures contracts, known as liquidity, typically a problem in smaller markets. And that is starting to arouse the interest of speculative investors.

Virtually all of the major restaurants, food companies and dairy processors are using the market, said Peter Turk, owner of Rice Dairy, a brokerage that counts many Fortune 500 companies among its clients. "If they're not doing it themselves, I guarantee their supplier is in one fashion or another," he said.

Futures for Class III milk, which is identical to milk used for drinking but is designated for use in dairy products such as cheese, outperformed all of the commodities on the S&P GSCI Index in 2011, rising 30%. Since the beginning of the year, futures prices, which roughly track retail prices in supermarkets, are down 7.8% and on Friday fell three cents, to $16.07 a hundred pounds. Much of the growth has come in options, where traders say liquidity is improving.

Milk prices have been fueled by many of the same trends that have sparked a boom in grain demand and meat production: expanding middle classes in developing nations, particularly China, that are seeking better diets higher in protein. Milk exports have soared, with 2011 exports totaling $4.82 billion, up 30% from the year before.

Still, commodities traders said milk futures remain a niche market, despite its ubiquity in America's refrigerators. Outstanding contracts in New York Mercantile Exchange crude-oil futures totaled 1.48 million as of Thursday; for corn futures, contracts stood at 1.3 million at the Chicago Board of Trade as of Thursday.

The increase in trading volumes hasn't kept up with the rise in the number of outstanding contracts. Companies that use futures and options contracts to hedge tend to trade less than short-term, speculative investors such as hedge funds. While the milk market has expanded, big speculators for now are staying on the sidelines because any large trade would move prices, said Shawn Hackett, a Florida investment manager whose clients are split evenly between investors and companies who hedge commodity-price risk. "Right now it's a cottage industry," he said.

Dairy futures were launched in 1996. Then, it was a handful of traders clustered around a dry-erase board. Now, they are jammed in a trading pit, with about 50 traders crowding in during peak periods, just off the main floor of the CME. Milk futures and options also are traded electronically as are other commodities. The Rogers International Commodity Index last month included for the first time Class III milk among its 38 commodities.

The size of the U.S. dairy industry, at about $100 billion, makes it prime for growth. Many in the dairy industry, known for its boom-and-boost cycles, are turning to futures and options for the first time.

Edward Gallagher, head of risk management for Dairy Farmers of America, the country's largest farm cooperative for milk by membership, viewed dairy futures as a hobby when they started. Now, about 1,000 of the cooperative's more than 10,000 members are signed up for the risk-management program, double that of a couple of years ago, and he has a staff of eight, which also has doubled in the past couple of years.

"We need more people on the phones to take calls from members who want to place forward contracts," he said.

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