The tectonic shift in the financial, equity and commodity markets has created the most uncertain milk market outlook since the onset of the 2002–03 bear market. Business survival and margin preservation are critical given the market themes:
spreads are trading at the highest levels since fourth-quarter 2007. Mostly because milk never was caught up in the precrash commodity frenzy of 2008, all feed commodities have fallen precipitously as funds liquidate, large harvests loom and demand ticks lower. The spreads are so wide that on spot pricing, margin relief across most of the 2009 milk board presents the best opportunity for margin preservation in more than a year—but only if most of your feed is not already purchased and dairy demand does not evaporate in the worldwide financial crisis.
If you have substantial
feed purchases contracted or hedged in uncovered positions, look hard at matching percentages in the milk market in order to preserve margins. Remember to include high-cost, new-crop-raised forages in that percentage. While some upward correction may be coming to the feed markets in the longer term, your business' liquidity trumps trends and that should be your priority. Either cover feed price positions (if you take a bearish view on feed prices) or sell sufficient covered positions in milk.
If you are not highly
booked in feed, longer-term trends do not show major pullbacks in milk disappearance. In fact, disappearance in the last major milk price downturn (2002–04) had 0.86%, 2.05% and 1.08% growth in disappearance. The challenge will be how much inventory is sacked away for how long until herd numbers come down to obtain negative balance. Exports (which were running 6% to 7% of production) will fall off dramatically, and the Commodity Credit Corporation is already buying powder. I'm expecting a pricing downturn on a lift in cheese inventory with continuing CCC powder purchases.
How long a downturn
lasts depends on how quickly supply comes back to balance milk. With an all but certain pause to exports looming, there will be a 2% to 3% overbalance to which domestic milk sales must rally to close the gap, which usually takes at least 12 to 18 months.
If you can do it, covering a long-term margin may be a good plan given so much fundamental uncertainty trending toward an intermediate-term bearish outlook. Ensuring a working capital margin with more flexible spread strategies may be the best investment to make ahead of what appears to be a dip in margins.
- November 2008