Dairy Price Outlook Declines As Milk Production, Exports Improve

Published on: 11:09AM Aug 23, 2010

Cheese and butter prices have exceeded many market analysts’ expectations, and that is a good thing. 

The August Class III milk price will exceed $15.00/cwt. for the first time since December 2008. Traders are currently predicting the August price will be near $15.12/cwt. as, for all practical purposes, the price is set. Traders calculate the daily and weekly spot trading and get a good idea of where the weekly NASS prices will be.
The strength in cheese and butter prices almost assures a September Class III price higher than August, improving cash flow and making dairy farming a bit more enjoyable.
Lest we get too complacent with the idea that milk prices are on their way up and will continue to do so, we need to keep a few things in mind. I do not want to sound bearish here, but sometimes market strength of the moment can cloud our judgment and make us complacent. There are a few things to keep in perspective.
First, exports are increasing over last year, with June exports of cheese up 85% over a year ago. Exports of butterfat increased 244%, skim milk powder increased 78%, and exports of whey proteins increased 44% over a year earlier. This is certainly good news, and tighter milk supply in other countries has allowed the U.S. to be a greater world supplier.
Second, the July milk production report showed production increasing 2.9% in the U.S. This is the highest year-over-year percentage increase since June 2008 -- and this during a hot, humid month of the year. Cow numbers have increased 63,000 head since the end of 2009. In July alone, cow numbers jumped 20,000 head from the previous month. Heifers are coming into the herds and production per cow is rising.
This continuing growth prompted the USDA to raise its estimate of milk production for both this year and next. In the latest World Agricultural Supply and Demand report, USDA projected 2010 milk production to reach 192.0 billion pounds., an increase of 800 million pounds from its July estimate. Milk production for 2011 was increased 1.1 billion pounds to a new estimate of 194.6 billion pounds.
My hope is that the economy will improve, unemployment will decline, and more disposable income will be available to consumers, which would improve demand and use this extra production rather than increase inventory.
Third, cheese stocks continue to grow. July cold storage showed increases of 11.9 million pounds of American cheese, 1.0 million pounds, of Swiss cheese and 10.8 million pounds of other cheese, pushing total cheese inventory to 1.049 billion pounds. Although fresh cheese is traded on the CME Group’s daily spot market, these stocks will need to be reckoned with. This growth shows demand in July was met and cheese still moved to inventory despite rising prices.
July butter stocks surprisingly increased after decreasing in June. Butter supply is tight, with churning activity lower due to tight cream supply and the desire of some manufacturers to sell cream rather than churn it due to price advantage. Last week, price surged above $2.00 to settle last week at $2.04 and the highest price since Dec. 3, 2004.
The market is taking all of this into consideration, resulting in closer month Class III futures trading near the underlying cash, while later contracts continue to show a discount. In fact, most contracts in the first half of 2011 have been slowly eroding, with prices now struggling to hold above $14.00. Traders anticipate a surge in milk production as well as improving components when weather cools and feed intakes improve.
There has been some panic that has emerged, causing some farmers to step up and forward contract a portion of their milk. This is well and good if this will meet your objectives. I prefer using either put options or a fence position for the first half of next year as it allows one to take a higher price. With the fence strategy, look to sell a call option $2.00 above the strike price of the put option you purchase. Worst case scenario with a fence is that you would be selling Class III milk at $16.00.
We need to abandon the prevailing idea that milk prices just “have to go up.” They currently are going up, but along with it is the desire to push production as hard as possible to make up for lost income. This may keep upside price potential under wraps for a while longer.
Upcoming reports: 
-          The Agricultural Price report on Aug. 31
-          Fonterra auction on Sept. 1
-          California 4/4b prices on Sept. 1
-          August federal order class prices on Sept. 3
Robin Schmahl can be reached at 877-256-3253 or through their website at www.agdairy.com.
The thoughts expressed and the data from which they are drawn are believed to be reliable but cannot be guaranteed. Any opinions expressed are subject to change without notice. There is risk of loss in trading and my not be suitable for everyone. Those acting on this information are responsible for their own actions.