Milk Prices Exceed Expectations – For Now

Published on: 11:21AM Sep 03, 2010

Prices are higher now, but the long-term picture is more bearish. The potential for production increase is great, and farmers are intent on making up for lost income. Traders can sense this, resulting in lower futures prices next year.


The August Class III and Class IV milk prices are the highest since late 2008. Class III was announced last Friday at $15.18cwt., with Class IV at $15.61/cwt. Continued strength in cheese and butter prices is certainly improving cash flow. September Class III futures are indicating a price above $16.00 for the first time since October 2008. Cheese and butter prices have now exceeded most everyone’s expectations.

Cheese stocks are large and continue to build, despite the fact the economy has not improved as much as anticipated. Milk production is increasing and milk prices continue to climb -- well, at least in the near-term. Traders are not optimistic these prices will hold as milk futures contracts for next year have been moving steady to lower. Seasonally, prices will decline after the end-of-year buying is complete. Inventory again builds during the first half of the year as production exceeds demand.
Current tightness in the market has brought in buyers to purchase cheese and butter, but they were met with limited selling interest over the past three months. This aggressive buying interest has pushed cheese price to the highest it has been since Dec. 3, 2009, as of Sept. 2. If the block cheese price exceeds $1.72, it will be the highest price since December 2008. Again, this is somewhat of a welcomed surprise, given the outside factors prevalent in the market. But we will take what we can get.
The inability of futures contracts for 2011 to increase is a real concern. The market will need to prove itself before any support comes into futures contracts next year. Class III futures are already factoring in a cheese price of around $1.50 for the first half of the year. Futures would not need to change if cheese prices decline, but this will likely not be the case. A decline in cheese or butter would result in selling pressure in all contracts. This was evident on Thursday when barrels lost 0.50 cents declining for the first time since July 30, bringing futures down as well.
Have cheese and butter prices reached a level that will not be sustainable? There is always the risk that higher prices will limit demand, resulting in prices declining in order to stimulate that demand. The industry is currently watching butter very closely to see if the higher prices will impact demand at the retail level. It will be an interesting next few months.
The high butter price is resulting in some manufacturers selling some cream rather than manufacturing high-priced butter. This continues the current tight supply, with less being produced, and less production results in higher prices, and so on. USDA’s July “Dairy Products” report indicated butter production was down 2.9% from July 2009. Inventory for the same month is the lowest it has been since 2004.
This has prompted Cooperatives Working Together to suspend the acceptance of bids to provide export bonuses for butterfat. Over the past six weeks, bids had been accepted to subsidize exports for butter and anhydrous milkfat, despite a significant increase in butter price. This has pushed price above the Oceania price for the first time in nearly a year, according to the CME Groups’ Daily Dairy Report published by Alan Levitt.
Cheese production during July was opposite that of butter. Production increased significantly with total cheese production increasing 4.7% over July 2009 to 882.3 million lbs. and the first time in history that July cheese output exceeded May. American cheese production increased 4.0%, Italian-type cheese was 5.3% higher, and Swiss cheese production increased 4.3%. Higher cheese production during a hot, humid month, along with low components, was somewhat of a surprise, especially when compared to last year when it was unusually cool.
The bottom line is the potential for production increase is great and farmers are intent on making up for lost income. Traders can sense this and hence the lower futures prices next year.
My recommended fence positions are still viable, with downside price potential very real. However, Class III futures have already factored in a discount. Fence positions will set a floor and allow some upside potential to the strike price of the call option you sell. It will be difficult if prices fall significantly from current levels. This strategy allows for some upside potential if price strengthen. The goal is to remain out of the hole and not sit back and do nothing, hoping prices will move higher and other farmers go out of business.
Upcoming reports:
-          The World Agricultural Supply and Demand on Sept. 10.
-          Fluid milk sales on Sept. 10.
-          California Class I price on Sept. 10.
-          Fonterra auction on Sept. 15.
-          October advanced Class I price on Sept. 17.
-          August Milk Production report on Sept. 17.
Robin Schmahl is a commodity broker and owner of AgDairy LLC, a full-service commodity brokerage firm located in Elkhart Lake, Wisconsin. He can be reached at 877-256-3253 or through their website at