Rabobank Foresees Continued Market Tightness Through Q2 2011

March 25, 2011 08:07 AM

Dairy prices may rise, but until Japan's situation becomes clearer, expect enhanced market volatility.

Despite the sudden mid-March contraction that cut milk-price gains by about half, Rabobank economists expect market fundamentals to return close to levels seen earlier this year.

In its “Rabobank Dairy Quarterly” released last week, the international bank says the dairy price rally was halted when market sentiments were rocked by Japan’s recent earthquake-tsunami disaster and grains futures dropped.

If the Japanese nuclear crisis is brought under control, Rabobank expects the net impact of the earthquake and tsunami to prove relatively limited for dairy.

The bank’s economists foresee continued market tightness through the second quarter of 2011, backed by improving consumption, ongoing shortages in key import regions and expectations of a rebound in grain costs.

“Thus, while sentiment may play a dominant role in setting market direction in coming weeks, Rabobank expects market fundamentals will reassert themselves and continue to sustain international prices at close to the levels evident in mid-March as we progress through Q2,” notes the report. 

The early-year price rally spurred greater milk production in the U.S. and the European Union, but “demand proved more than sufficient to soak up this strong wave of milk,” Rabobank says. 

The global market delivered a “get out of jail free” card to U.S. dairy producers in the new year as international prices leapt and the gap between domestic and offshore pricing closed. By mid-March, near-position Class III milk futures had risen by 40% on year-opening levels, outrunning even the grains price rally.

While domestic sales have improved, U.S. dairy exports have been the real star. In 2010’s fourth quarter, net exports rose 300% over year-earlier levels. Export growth remained strong through at least January 2011, Rabobank says.

An improving U.S. economy and particularly inroads into unemployment are expected to bring a further improvement in local sales of dairy, though retail inflation will be a headwind. A strong international market, and demand for U.S. products to plug global market shortages, will likely combine to sustain high pricing on the domestic commodity markets, though heavy cheese stocks remain a risk for negative basis.

“This should, in turn, sustain high milk prices for farmers, bringing the prospect of solid profitability for those growing feed, and above break-even conditions for many buying it in,” says the report. “Nonetheless, milk production growth is expected to continue to moderate through Q2, reflecting poor earlier returns to milk production and a desire by producers and their financiers to rebuild equity, rather than expand.”

Export volumes, which are thought to have remained well above prior year levels through Q1, are likely to fall in year-over-year terms in Q2, reflecting low stock levels and a more balanced domestic market.

Looking into the second quarter, Rabobank says much will depend on how the Japanese crisis plays out. 

The bank believes international dairy fundamentals point to continued market tightness through June 2011. Its optimistic forecast is backed by improving consumption, with rising incomes and employment outweighing rising retail prices. The bank also expects ongoing shortages in key import regions, and expectations of another rise in global grain costs.

“But until the Japan story becomes clearer, enhanced market volatility is all but guaranteed,” the report says.

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