On the latest World Agricultural Supply and Demand report, USDA estimated milk production this year to reach 208.9 billion pounds. This was an increase of 100 million pounds from the previous estimate. The estimate for 2016 milk production remained unchanged at 213.0 billion pounds. USDA had reduced their estimate for 2016 milk production a few times, but seems to be content with their current estimate. Despite substantially lower milk prices than last year, milk production continues to exceed last year. Profitability is a lot less or in some cases non-existent, but cows are being pushed to produce in order to make up for the loss of income by increasing volume of milk sold off the farm.
Current milk supply is sufficient for demand from both bottlers and manufacturers. Strong demand has been able to keep milk prices supported better than expected earlier in the year. However, there is growing concern over what will take place once end of the year demand subsides. Will slowing demand and slow exports collide resulting in a back up of supply? I would guess the answer is “yes”. This is what the current trend would indicate. Butter and cheese inventory drawdown has not followed the usual pattern. Butter stocks have declined, but not as much as usual. Cheese stocks increased in July when they generally would show some decline. The August cold storage report will be released next week which will be very important for determining trend. Good underlying support from buyers has held cheese and butter prices from not following the weakness of other world markets. If inventory has not declined very much, if at all, during the month of August, then I believe there is real concern over end of the year and 2016 prices.
If milk production continues to gain and supply begins to increase, the reaction will be to lower prices in order to stimulate demand and/or slow milk production. This is being seen to some extent in New Zealand and Europe due to farm gate milk prices running below cost of production. Fonterra Dairy Cooperative Ltd. so far has maintained their expectation for milk output for New Zealand, but has indicated their forecast may be lowered due to farmers reducing the feeding of supplements and are also reducing herd sizes in order to better utilize available pasture areas. If this becomes more widespread, it may slowly reduce milk supply and begin to balance supply and demand in the international markets. This would improve milk prices over time, but may take longer than 2016 in order for this to be accomplished.
The U.S. is not very competitive in the exports market at this time, but the market does not care due to good demand. Even if world prices continue to improve, it will take time for export interest to move back to where it has been a year ago. Export contracts have been and are being made for 2016 and I fear the U.S. is not going to be a large part of those contracts with the current price spread between domestic and international prices. So, just like U.S. prices were able to perform very well last year despite plummeting world prices, the reverse may be true when international prices improve and U.S export demand remains slow until prices become competitive and new export contracts are initiated. I am not indicating export business will be non-existent, but may be depressed for a while.
Hedging opportunities for 2016 have not been very great with lower prices than 2015 prices and very limited volatility. Yet, with the concern over prices next year, I continue to recommend fence positions that consist of purchasing put options and selling call options $1.75-$2.00 higher. To reduce overall cost for a position, consider adding the sale of puts to this strategy. It will provide downside protection to the sold put option and leave upside potential open to the sold call option. I recommend putting these on by selling puts $2.00 below the purchased put options and selling the call options $2.00 above the purchased put options.
-August Milk Production report on September 18
-August Cold Storage report on September 22
-August Livestock Slaughter report on September 24
-August Agricultural Prices report on September 29
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 www.agdairy.com.
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