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RSS By: Jim Dickrell, Dairy Today

Jim Dickrell is the editor of Dairy Today and is based in Monticello, Minn.

Waves of Dairy’s Future

Aug 27, 2010

Economists know that dairy prices ride on seasonality and other cause-and-effect waves. They can even roughly predict upcoming peaks and crashes. Shouldn’t dairy policy also look ahead and not just react to 2009?

In 1905, Albert Einstein published his theory that light was actually composed of tiny particles pulsating in waves traveling at, well, the speed of light.

A century later, we learn that the dairy industry also travels at the whim of waves. These waves, like light, are relatively (pun intended) predictable. In fact, economists at Wisconsin and Cal Poly universities were fairly certain in 2007 that milk prices would bottom in February or March of 2009. Boy, did they ever.
The economists, Mark Stephenson, director for the Center for Dairy Profitability at the University of Wisconsin, and Chuck Nicholson, with the Department of AgriBusiness at Cal Poly, estimated the trough of the wave to bottom at about $13/cwt. U.S. all-milk price, give or take $2.
What they didn’t know in 2007 was that the industry was facing two of the largest supply and demand shocks since Ronald Wilson Reagan cut support prices in the early 1980s. Feed costs went through the roof in 2008, driven by ethanol-fueled demand for corn. And in December of 2008, global demand fell through the floor as the Great Recession took an almost death grip on credit and cash flows. The end result: The U.S. all-milk price plunged to $11 in early 2009, and has been struggling to recover ever since.
So, can these wave riders predict the next peak and the next crash? Well, we’ll get to that.
First, you need to understand what’s causing the waves. As it turns out, there are actually four different waves, pulsating at different frequencies and amplitudes.
Wave 1 is a seasonal wave. “We still have seasonality in the dairy industry because we tend to have more calvings in the spring and more productivity,” says Stephenson. “We also have seasonality in demand in the fall, with schools opening and holiday inventory building.”
Wave 2 is a 36-month wave. This wave has the greatest amplitude and it’s increasing over time. Stephenson and Nicholson are not totally sure what causes this wave, but they suspect it’s a supply response to good milk prices. It takes nine months to get a heifer calf on the ground, and another two years to get her in milk. Pretty soon you’re out three years. “It seems reasonable this second wave is a supply response,” Stephenson says.
Wave 3 is a nine-month wave. Again, the economists aren’t sure of causality. “But it would be related to cow numbers and gestation length,” says Stephenson. In other words, when prices are good, producers keep and breed more heifers (that’s what the cowboys do). Nine months later you have more cows milking.
Wave 4 is a 26-month wave. This one’s a puzzler, because it’s not really tied to biology or normal demand cycles like schools opening or Super Bowl pizza parties. “It’s still a mystery, but if you think outside the box a little bit, it might be related to new cheese plant openings,” says Stephenson.
Every few years, some large cheese manufacturer announces it is building a 3-million pound per-day plant as Phase I of a plant expansion. Two years later, the plant is complete and dairy producers start filling it. Think Idaho; think Texas. “These plants are big, and they’re really lumpy on the demand curve,” says Stephenson. “They create huge new demand for milk, and you get an almost immediate supply response.” And then a year later, the cheese manufacturers announce Phase II—and the cycle starts over.
So what does this all mean for future prices? If all things were normal, Stephenson and Nicholson would expect the next trough to occur in 2013. “But it is not at all clear that will be case,” says Stephenson.
The feed cost and demand shocks of 2009 were so severe that they could have reset three of the four waves that determine prices. Producers, processors and their lenders are all running scared. Many lenders now require 50% equity levels on new expansions—after the expansions are complete. That alone will hit the reset button, and could well dampen the amplitudes of the 36-, 9- and 26-month wave cycles.
The bigger point is that future dairy policy should be future oriented, and not totally reactionary to 2009. The depth of 2009 prices occurred when all four waves troughed simultaneously with the feed cost and global dairy demand shocks. The probability of that happening again is low, extremely low.
Yes, some safeguards should be put in place to prevent future catastrophes. But the policies should not be so restrictive that they don’t allow the U.S. to compete for new and growing global markets. Constrictive supply management programs and sky-high dairy support prices just won’t get us there.
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COMMENTS (8 Comments)

And NE, why do you call them Mexicans and not illegals? They are illegal Mexicans. Although I guess you're technically correct, because they are foreign nationals, but why is this country OK with hiring illegals?
2:26 PM Sep 8th
And Small Guy, I agree. Due to the illegals working mostly for the BTO's, providing much product, and getting more for their milk than the small guy and getting big discounts on supplies. It's coming sooner rather than later, the small guy's number is almost up.
2:21 PM Sep 8th
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