Market Watch Diary Aligning the stars

May 3, 2010 11:19 AM
 


One morning in late April, a longtime dairy trader told me he was "perplexed.” Whereas the dairy markets usually are either long or short, on this particular day he couldn't quite pin things down with any certainty.

Prices had been trending up and there was a clear bullish sentiment in the market, yet he wasn't quite sure that all the stars were aligning.

In truth, the whole constellation is interconnected. Each part is tethered to another, and when one gets out of line, something has to give. Here are a few examples:

In the world of dairy ingredients, all things come back to protein. Therefore, the whey complex and nonfat dry milk/skim milk powder tend to travel together. This spring, the global milk powder market was firming but whey was facing some price resistance, particularly from the feed sector. If dry whey can't push past 40¢/lb., it'll be difficult for nonfat dry milk to move above $1.30.

Likewise, Class III and Class IV prices tend to move in sync. In the last seven years, there were only a few months—in the summer and fall of 2007—when the Class IV price got more than 50¢ above the Class III price. We're about to test this relationship again because the April prices, to be released after press time, will have Class IV about 75¢ higher than Class III. The May spread could be larger still.

When the relative values shift, more milk is channeled into butter/powder production and supplies increase. Then a little less goes into the cheese vat, and supplies decrease. It may take a few months, but eventually the balance is restored.

The relationship between U.S. prices and world prices also bears watching. In a global market, all prices strive for equilibrium. If world levels get too high relative to U.S. levels, overseas buyers start to buy from the U.S. and U.S. prices realign. If U.S. levels get too high, America's exports decline, its imports increase and prices come back down to earth.

As I write this in late April, the international prices for butter and milk powder are rallying on fears of supply shortages for the balance of the summer months.

Traders are trying to determine if these runups are strong enough to pull the entire U.S. dairy complex higher or if the relative softness of the U.S. cheese and whey markets will be an anchor on the entire thing.

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