Is the Commodity Future Market suitable for Hedging the Price Risk in Dairy Markets?

Background and Objective

Commodity future markets could be a instrument of risk management. These markets get most importmant, if price risks should be hedged. Prices of commodity future markets are a powerful instrument in detecting future market developments. But do prices of commodity future marktes satisfy this requirement, if participation is low? The research project address this central question: Do prices significantly correlate on spot and future markets - even though participation (liquidity) is low? And therefore, do producer prices follow commodity futures prices movements?

Target Group

Decision markers in policy and economy.

Approach

Between the milk producer price and the prices for butter, skimmed milk powder and whey powder traded at the Commodity Futures Exchange (EEX) in Leipzig price correlation is analysed with econometric methods. If there exists a statistical significant correlation between these time series, then price movements at the EEX could be used as indicators for future market devlopments. Even though participation (liquidity) might be low. Thus, milk producers would be better able to dispose production decisions with more reliable informations.

Results

The participation at the future commodity exchange was low for the futures of butter, skimmed milk powder and whey powder. In spite of this early stage the three futures fulfil their function:

1. The futures for butter, skimmed milk powder and whey powder fulfil the characteristic of price leadership. Put simply, this means that market relevant information is taken up by the futures market and then is transferred to the spot market. At the spot market these information triggers the corresponding price movements.
2. The hedging effectivity is high. The three futures are suitable for an effective private price risk management.

However, liquidity is low compared to other agricultural futures. Therefore, efforts have to made to encourage an increase in the number of market participants and further investments.