Market Watch Diary Recovery will take time

April 5, 2009 07:00 PM
Alan Levitt
A burst of short-covering in the futures market in March drove Class III futures to levels not seen since last fall, providing dairy producers an opportunity to hedge some of their 2009 milk. In the fourth quarter, contracts topped $16/cwt.—a level that should be attractive to producers, given where things are at this writing.

And yet, many will hold out hope that maybe, just maybe, the market will go higher. Indeed, fundamental indicators are slowly starting to turn. Slaughter rates are at a 12-year high, running about 26% higher than the five-year average. U.S. cow numbers dropped 36,000 head in January and February alone, the largest two-month contraction since the fall of 2003. This is already shaping up to be the weakest spring flush in years.

We are also seeing the beginnings of firming in the global dairy ingredients market. In New Zealand, Fon-terra says the huge inventories it built up during the first half of its production season are clearing. Low milk prices are curbing growth in milk output in Oceania and Europe, just as they are here in the U.S.

EU government programs to remove excess from the market have also helped. In the first three weeks of March, manufacturers sold more than 200 million pounds of butter and skim milk powder into intervention. That's on top of the 120 million pounds of butter already in private storage aid stocks.

A large Cooperatives Working Together herd retirement round looms on the horizon as well. So it's easy to see how U.S. milk production could continue declining throughout the year until supplies are suddenly so short that buyers have to bid up the market aggressively.

Bide your time. I urge caution here. The U.S. dairy market is volatile, but it doesn't turn on a dime. We still have relatively large inventories to work through. Commercial American cheese stocks were up 13% on Feb. 28 (see chart), commercial powder stocks were up 22% on Jan. 31 and government powder inventories are nearly 200 million pounds.

We also have a large supply of replacement heifers in the pipeline (nearly as many as last year, when we had a 22-year high), so for every cow we send to slaughter there's another one (or two) waiting in the wings.

Meanwhile, we still haven't seen that all-important demand recovery in the foodservice channel, where such a large share of U.S. dairy products are sold.

Will we see $16 milk later this year? That will require cheese prices to get to about $1.80. It's still too early to call that a foregone conclusion.

Bonus content:

USDA Cold Storage Reports

USDA Livestock Slaughter Reports

CWT: Cooperatives Working Together

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