Market Watch Diary The new global benchmark

February 23, 2010 09:31 AM
 
Alan Levitt

Scarred from the volatility that has trampled the world dairy markets in the last three-and-a-half years, traders have grabbed onto Fonterra's monthly commodity auction as a new global benchmark.

The auction trades on the first Tuesday of every month. After a couple hours of online bidding and counterbidding, a weighted-average price is published. It started as somewhat of a curiosity in July 2008 with whole milk powder (WMP) and has since added anhydrous milk fat (AMF). But with the absence of transparency in world dairy pricing, the Fonterra auction is evolving into a de facto reference point for all dairy commodity selling prices.

The U.S. doesn't produce much WMP or AMF, but the auction has an indirect impact on U.S. commodity prices. In the last 19 months, world skim milk powder (SMP) prices have closely paralleled the movements of the WMP auction price (see chart), so each announcement provides a valuable indicator on where the markets are going.

For instance, in the February round, the price of the front-month lot dropped just 2.5% from the January auction. This told traders that milk powder markets were nearly balanced. In addition, prices for deferred-month lots were slightly higher than the front month, suggesting potentially stable prices in the months ahead.

The monthly auction will become more significant going forward. Beginning in March, SMP will be added to the lineup. Expect that price to quickly become a benchmark for global SMP and nonfat dry milk trade.

As further testament to the credibility the trading platform has garnered, NZX, the New Zealand stock exchange, plans to debut a WMP futures contract by June. Futures will be cash-settled to the front-month auction price.

NZX officials hope farmers and others will regard the WMP futures price as a daily pricing indicator.

"The data would be helpful to farmers. It would give them an idea where demand levels are,” explains NZX derivatives manager Katherine Jaggard. "We are looking at [other] dairy derivatives; it won't just be whole milk powder. New Zealand is the logical hub for derivative trades in dairy futures.”

Price volatility has been identified as the biggest challenge facing the global dairy industry in the new decade. Platforms like the Fonterra monthly auction and New Zealand's new milk powder futures seem to be the tools the industry is choosing to add transparency to the dairy price discovery process.

Bonus content:

Fonterra monthly auction

 

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