A Difficult Year Lies Ahead for the Dairy Industry

Published on: 12:28PM Jul 23, 2012

What can the market bear as near-record drought conditions and low corn stocks bolster both corn and milk prices?

We are moving into uncharted waters and interesting times as very dry weather covers nearly 55% of the nation.

Yes, we saw this back in 1988, but corn stocks going into that year were at 4.259 billion bushels, much higher than this year. The drought of 1988 pulled carryout down to 1.930 billion bushels. Ethanol was not being produced or mandated at that time and the use of corn for manufacturing was not as great as it currently is.

Current drought conditions are nearly the same as 1936, which again was a bit different than they currently are. If you can believe it, there are four other years during which the percent of the nation in drought was greater than the present. A cause for great concern is carryover of stocks, which are estimated to only be 903 million bushels for the end of the current marketing year, according to the latest World Agricultural Supply and Demand report. This spells real difficulty for the dairy industry.

Class III milk futures have been increasing, with contracts this fall exceeding $19.00. Prices are certainly higher than was expected this spring, but that provides little consolation as feed prices continue to rise. Since mid-June, December corn futures have increased nearly $3.00. Over the same period of time, December milk futures have increased nearly $2.60. This does not improve the milk/feed ratio and may actually decrease it further, depending on the price of soybeans and alfalfa hay, both of which also are increasing substantially.

As of June, we have not seen the evidence of the effects caused by the current situation. Dairy cattle slaughter in June totaled 229,000 head, up just 10,000 head from a year earlier and down 22,000 head from May. This was the lowest monthly slaughter since July 2011.

However, the latest USDA Milk Production report did indicate a slowing of milk production from the previous year. Production in all 50 states was up 0.9%, with cow numbers still up 54,000 head from a year earlier, but down 19,000 head from May. July is expected to see a significant decline as culling increases and the effects of hot weather are seen. July milk production is expected to show negative year-over-year growth for the first time in 29 consecutive months.

Lower milk production should tighten the market and push prices higher. The question is, “What can the market bear?” and “Will U.S. dairy prices lead world prices higher?” A recent estimate indicated cheese prices could reach $1.92 later this year. If that is achieved, then milk futures really do not need to increase any further. A block cheese price of $1.92 with barrels at $1.90 and butter at $1.80, as an example, would indicate a Class III price of $19.34 -- nearly the price current futures are. However, variation will be based on actual AMS weekly prices. Traders are already anticipating this price by putting a premium in the futures contracts.

My current recommendation is to hold off on any further milk price protection strategies but to keep a vigil on weather and grain prices. If crop conditions begin to stabilize and grain futures cease moving higher, fence strategies need to be implemented to cover a greater portion of your milk production. Those who currently hold previously recommended fence strategies consisting of the purchase of $16.00 and $17.00 puts and the sale of $18.00 and $19.00 calls should hold those positions. That’s due to the price premium in the market and the fact that the end result will be a significantly better milk prices than what was initially protected.

Let’s all hope it rains soon and the drought ends.

Upcoming reports:

- Global Dairy Trade auction on July 31
- Agricultural Price report on July 31
- Dairy Product Production report on August 1
- July Federal Order class prices on August 1

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.

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.