Lower cheese prices may be around for a while

12:00AM Jun 23, 2008
( )
Robin Schmahl

It's been said that the market knows where the price is going one to two weeks before the traders do. This has certainly been true in the dairy market.

High grain prices and increasing costs of production had been providing continual support in cheese and Class III futures prices for quite some time. This bullishness permeated the market so it felt as if it were invincible. Every price break was bought into as prices were bound to move higher.

This became very evident when the CWT committee announced another herd retirement program. Cheese prices dropped significantly after the announcement with cash prices dropping as 28 1/2 cents. During this time, futures contracts through 2009 made new highs. The ideas of cows being slaughtered under the Herd Retirement program as well as heavier culling due to high feed prices were sure to tighten milk supplies and push price still higher.

The only problem with this idea was the evidence of international demand slowing when cheese reached higher than $2.25. International demand had been strong with buyers coming to the cash market to purchase loads to meet this demand. When export demand began slowing, cheese started backing up on the exchange. As price weakened, plants began to unload uncommitted cheese as quickly as possible before price declined too much. The result has been a loss in cheese price of 28.5 cents in three weeks.

For a period of time, Class III futures contracts continued to increase because traders were in disbelief that cheese price would remain lower for very long. However, last week, it seemed traders were facing reality and began liquidating some positions.  The July contract has lost $2.47 since cheese prices began declining. Many continued to question why cheese prices were declining until the May milk production report and slaughter report was released.

The May milk production report showed a production increase of 3% for all 50 states. Production per cow increased 25 lbs. with another 11,000 cows added across the country. Cow numbers are now 143,000 head more than a year ago. Production for all 50 states (on a 30-day comparison) has increased 2.2% for the first five months of the year. So, even with high grain prices, farmers have been adding more cows to take advantage of the high milk price. Many had anticipated cow numbers and production to begin to decline by now.

Dairy cattle slaughter for May showed a surprising decline with 24,000 less dairy cows culled than the previous month. However, this was 4,000 higher than the previous year. The fact that fewer cows were slaughtered as grain prices increased indicates the resolve of farmers to push production to pay bills.

I have indicated for some time that culling was the barometer to watch. Culling would reflect the profitability on the farm, not just feed prices. Now that these reports have been released, one can see why cheese prices have been declining. Prices reached a level that slowed demand causing cheese to back up and manufacturing plants to step up and sell. Buyers, sensing the weakness, are purchasing on the way down, but are not being aggressive about it. So, this gives us another classic example of the cash market declining two weeks before traders acknowledged the fact that contract prices should be lower.

The recent downturn in dairy prices may be temporary if culling becomes severe enough to tighten milk supply while demand continues to remain strong. However, demand is also in question. The economy continues to show signs of slowing as consumers adjust to high food and fuel prices. Wages have not increased to make up the difference. Less purchasing power will decrease sales for durable goods, resulting in less profitability to manufacturers and hinder any possibility of wage increases to the workforce. Consumers begin to limit the purchase of luxury items and instead purchase necessities. Many food items that use dairy ingredients are considered luxuries. One example is pizza. Pizza has been a very popular item over the years, but if push comes to shove, consumers will limit purchases or cut it out of the diet. Other snacks using dairy products as ingredients may follow suit resulting in lower demand. So, the economy is the key to dairy demand and cow culling the barometer of farm profitability.

Upcoming reports to watch for are the Quarterly Stocks and Acreage Report on June 30; the Agricultural Prices report on June 30; and the May Dairy Products report on July 3.

Robin Schmahl is a commodity broker and owner of AgDairy LLC, a full-service commodity brokerage firm located in Elkhart Lake, Wisconsin. He can be reached at 877-256-3253 or through their Web site 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 may not be suitable for everyone. Those acting on this information are responsible for their own actions.