Dairy Market’s Psychology Turns Bearish

Published on: 12:06PM Jan 23, 2012

Lackluster supply and demand are restraining the market, although dry whey adds significantly to milk price levels.

A lot can change in two weeks. My previous article indicated Class III prices in nearby contracts were reaching for $18.00, with traders exhibiting a bullish attitude. Cheese prices appeared to have bottomed, adding some fuel to the fire. However, that changed rather abruptly since my last article.
The change seemed to correspond with the release of the January “World Agricultural Supply and Demand Estimates” (WASDE) report. Now, I don’t think that was the main reason, and maybe it had little influence on the change in attitude, but there was a definite change in the market at that time. Underlying cheese and butter prices began weakening, taking milk futures down with them. Price premium that had been put into futures quickly began eroding and magnified the decline relative to the underlying cash prices.
Over the past two weeks, cheese prices have declined to a level not seen since January 2011, and the butter price fell to the lowest since December 2010. This caused milk futures to fall from nearly $18.00 in nearby months to the current level of roughly $16.50.
So, a correlation can be made that bearish impact on grain prices resulting from the WASDE report could have changed the outlook of dairy traders. After all, there is a correlation between feed prices and milk prices. In 2011, milk prices and grain prices trended fairly close with each other as they have many times in the past.
However, I don’t think cheese and butter buyers have this in their mind at the present time. Supply and demand is driving the market. Weakness has caused buyers to be less aggressive as product continues to be offered at lower prices. Buying is being done to replenish depleted inventories, but is being done without panic.
USDA released its December “Cold Storage” report last week which indicated inventories are increasing seasonally. American cheese stocks increased 16.7 million pounds to 600.7 million pounds. This remains 30.0 million pounds below a year ago. Swiss cheese stocks declined 2.5 million pounds to 27.6 million, with other cheese stocks at 353.0 million pounds, down 2.0 million pounds for a year earlier. This put total cheese stocks at 981.3 million pounds, up 12.3 million lbs. from November, but down 66.7 million pounds from a year earlier. Butter stocks increased 11.7 million pounds to 105.2 million pounds, which is 23.5 million pounds higher than a year earlier. Stocks should continue to increase throughout the first half of the year.
We must remember that increasing stocks do not necessarily mean lower prices. That will always be dictated by supply and demand. We have experienced some very high prices even when inventory was increasing. Last year, Class III milk price increased from $13.48 in January to $19.40, but we experienced declining inventory during February and March, which helped support prices. Exports did and will continue to play an important role in milk prices. Cheese inventory will be watched closely.
Another factor playing a large role in higher milk prices has been the steadily increasing dry whey price. One year ago, whey price was 39.53 cents per pound, while the current weekly NASS price is 70.20 cents per pound. This in itself adds $1.8402 to the milk price. Whey has been the real strength to milk price. There is some concern that price moving over 70 cents may impact demand as it did in 2007. Manufacturers began using alternative products resulting in price decline. Dry whey futures are anticipating a decline with contracts indicating a declining price to 48 cents by the end of the year.
My current recommendation is to implement fence strategies by purchasing the $17.00 put and selling the $19.00 call for 25% of your milk production through the third quarter of this year. First half of the year contracts should already have some coverage of a similar strategy and price level.
Upcoming reports:
-          Bi-annul cattle inventory report on Jan. 27
-          January Agricultural Price report on Jan. 31
-          Commercial disappearance on Jan. 31
-          Dairy Products report on Feb. 1
-          California 4a/4b prices on Feb. 1
-          Fonterra auction on Feb. 1
-          January Federal Order class price on Feb. 3