Friday, September 24, 2010

Volatility Analysis

(click on image to enlarge)

I must confess I hesitate to deal with the recent paper "Analysis of Proposed Programs to Mitigate Price Volatility in the U.S. Dairy Industry" by Charles F. Nicholson and Mark W. Stephenson which was just released.


My problem begins in the first paragraph:

Volatility of prices and incomes has been an issue of importance for the U.S. dairy industry since the early 1990s. Much of this volatility appears to arise in the dairy supply chain, particularly the production sector, consistent with observed patterns of behavior for other commodities (both agricultural and non-­‐agricultural).

If you look at the above graph (fig 5 from the report)there is no evidence of volatility in the production sector. The report states, "It is apparent that the major segment of growth in U.S. milk supply is coming from dairy herds who are moving into a larger herd size category and the 740 herds in the largest herd size category (2000+ Head in year 2009) now account for more than 31 percent of the total milk supply." Then the authors state, "The cost structure of farms in the different herd size categories is quite different as is the responsiveness to price signals." which is to say large operations cannot respond to price signals.

If 31% of the milk supply cannot put on the brakes, why send the "price signal"?

Occam's razor ('s_razor) says, ""the simplest explanation is usually the correct one". When competing hypotheses are equal in other respects, the principle recommends selection of the hypothesis that introduces the fewest assumptions and postulates the fewest entities while still sufficiently answering the question." The rational thing to do is to eliminate those who cannot respond - to wit those over 1999 head.

They do not suggest this solution nor am I suggesting keeping all operations below 1999 head. Obviously, though, the idea should be on the table for discussion.

The paper concludes:

Milk price volatility has clearly become a significant problem for the dairy industry since the 1990s, although the underlying causes of volatility continue to be debated. Some observers have hypothesized that without an active Dairy Product Price Support Program dairy manufacturers will simply not hold enough commercial stocks of product to buffer supply and demand imbalances. Others have suggested that it is our emergence into world trade in dairy products that has been a cause of the price swings. Still others have suggested that it is simply a faulty price discovery mechanism in the Federal Milk Marketing Order system. But some dairy producers have also suggested that volatility results from rational responses to profitability incentives in the absence of coordinated expansion decisions.

Pretty much a "tea leaf" reading.

The is no mention of the CME relative to volatility. At the very least there should be some mention of the correlation of price and production - none. In California where most of the production gains originated, the correlation between price and production for the last 20 years is minus .13.


  1. I have been personally involved in the dairy industry all of my life, this issue did not start in the 1990's but has been out there since I would guess the good price period around the days of WWII. My father always said things went to pot with Eisenhower's Secretary of Agriculture, since 1974 I have watched this same senario, the cure was always something producers need to change, the fix when applied has yet to solve the problem, which perhaps escalated in the Reagan years and with the advent of globalization (which gave another excuse for not paying the producer) One has to wonder where all the milk is supposedly coming from right now with the short supply of butter fat and the increases in the cheese production. In the past more could be passed by the producer, because the internet did not exist and more or less an information vacuum in rural areas. Unfortunately what I see happening is just like the rest of the economy, the really poor get taken care of and the really rich get taken care of and if you look at government policy it attends to the vary small producer and the very large, those in the middle get the thin slice of American cheese in the middle of the huge sandwich.

  2. john I guess I don't follow your thoughts on the graph. It merely shows the change in distribution of farm size and resulting %milk produced. Doesn't address volitility per se

  3. Exactly, but, it is the only thing in the "study" which deals with production in any way. If the program is to limit production for some reason, you would think a case would be made relative to production.