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AgDairy Market Update

RSS By: Robin Schmahl, Dairy Today

Robin Schmahl is a commodity broker and owner of AgDairy LLC, a full-service commodity brokerage firm located in Elkhart Lake, Wis. He provides dairy market insight.

Slowing Demand Dims Milk Price Potential

Oct 03, 2011

Milk prices owe their recent decline to the downward movement of cheese and corn as well as increased milk production, diminishing exports and the faltering economy.

Class III milk futures have been following grain prices lower. A chart overlay of December corn and December milk shows nearly an identical pattern: December corn fell $1.75 per bu. during the month of September while December milk fell $1.66 per cwt.
 
Milk futures did not fall simply because corn fell, but that does have an influence. However, milk futures were directly influenced by the price movement of cheese, which is a reflection of demand. The July Commercial Disappearance report, released by USDA last week, showed disappearance of American cheese at 323.0 million pounds, down 9.8% from a year earlier and down 12.6% from the previous month. This is where much of the pressure stems from. Some varieties of cheese are experiencing better demand with supply a bit tighter. Disappearance of "Other" cheese was up 2.3% from a year earlier, but down 3.7% than the previous month.
 
Cheese buyers have been less aggressive lately as orders, although good, have not been good enough to tighten supply. It was thought the demand for milk to fill the school pipeline would have significant impact in light of this summer’s weather-related lower production. However, even though most areas experienced prolonged heat and humidity, milk production remained relatively strong. Production remained above year-ago levels, with the August milk production report showing 50-state milk production up 2.1%.
 
Along with increasing milk production and slowing commercial disappearance, exports have been slowing as well. July exports of American cheese were only 5% above the previous year, but down 19% from the previous month. The economic slowdown both domestically and internationally is certainly having an impact.
 
Butter is also seeing some interesting things happening. All year, butter stocks have been running below year-ago levels, with the industry very concerned over supply. Stocks at the beginning of the year totaled 81.7 million pounds, down 52.0 million pounds from a year earlier and the tightest since 2005. Demand was strong. However, over the course of the first eight months, stocks have increased to a level above a year earlier. August stocks were 10.3 million pounds higher than August 2010. Demand has been good, but not exceptional. Exports have been good, but not exceptional. Production has been strong enough to both meet demand and increase inventory.
 
There continues to be concern over a secondary recession, which would likely have a devastating impact on milk price. The last recession showed Class III milk prices drop below $10.00 for four months before prices began slowly moving to higher levels. The September price was announced at $19.07, already a decline of $2.60 from the previous month. October futures trading are around $17.30, down another $1.77.
 
The question is, How much could prices decline if a second recession takes place? Not the same as last time, I hope, but it certainly could mean significantly lower prices than we currently have.
It is critical that producers watch grain prices. A liquidation phase has been taking place, but this will not last forever. Prices will rebound, as stocks are still relatively tight. Purchasing call options and implementing call option spread strategies are necessary to protect future feed needs.
 
At the same time, any rebound in milk futures prices needs to be hedged. My recommendation is to use fence strategies consisting of the purchase of a put option and the sale of a higher strike call option. These need to be tailored to your cost of production. This strategy does give some price flexibility by allowing you to take a higher price up to the sale of the call option.
 
Along with the use of options to protect both feed and milk prices, RMA has provided funding for LGM-Dairy again. This margin insurance is another tool that can be used to protect your income over feed cost.
 
Upcoming reports:
- Fonterra auction on Oct. 4
- California Class I price on Oct. 10
- World Agricultural Supply and Demand on Oct. 12
- Fluid milk sales on Oct. 14
- Fonterra auction on Oct. 18
- September milk production on Oct. 19
 
Robin Schmahl is a commodity broker and owner of AgDairy LLC, a full-service commodity brokerage firm located in Elkhart Lake, Wis. He can be reached at 877-256-3253 or through his website at www.agdairy.com.
 
The thoughts expressed and the data from which they are drawn are believed to be reliable but cannot be guaranteed. Any opinions expressed are subject to change without notice. There is risk of loss in trading and it may not be suitable for everyone. Those acting on this information are responsible for their own actions.
 
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