Guest Columnist / Editorial
International demand may force cheese market to 2004 highs

Jon Spainhour is a broker for Rice Dairy, Chicago. He is a guest columnist for this week’s issue of Cheese Market News®.

On May 4, Chicago Mercantile Exchange block prices pushed through $1.7000 per pound for the first time since March 1, 2005. While prices have retreated from those levels slightly over the last few trading sessions, the ability of blocks to reach those levels may be a sign of things to come.

Many have written off the recent rally in cheese prices as anticipatory buying on thoughts that prices will be higher later in the year. Instead of waiting for prices to move higher during the fall, participants are building inventories now and pushing current spot prices higher. Traditionally this has resulted in a short-term increase in spot prices but lower prices as time moves on. This pattern is currently being reflected by the price curve of the Class III futures market, where almost every contract over a 24 month period is trading at a discount to current spot prices. In other words, the market does not expect the recent rally to sustain itself.

While cash prices may not immediately move higher than their current levels, there is a distinct possibility they will top $1.7000 again and could possibly test the highs which were reached during 2004. During the last six months, the market has seen both cash and futures prices increase before its eyes while at the same time watching the traditional economic indicators report more and more bearish news. Total cheese outputs are at all-time highs and cold storage numbers are extremely impressive as well. With all this seemingly bearish news coming to the market, how prices can continue to move higher? International demand.

Last July, the National Agricultural Statistics Service (NASS) dry whey price was reported at $0.28 per pound. Since that time, NASS whey prices have been reported at an all-time high of $0.79 per pound, almost two and half times higher than just nine months ago. Nonfat prices have rallied hard since last summer when they were trading at support levels and spot prices are currently being reported as high as $2.20 in both the domestic and international markets. While domestic supply and demand circumstances are partially responsible for this unprecedented price increase, most in the industry will point to international demand as the main culprit.

The Asian economies are red hot right now and China is leading the charge. With their newly found wealth, the Chinese are now able to afford classes of products that have traditionally been too expensive for them. One of those product classes is dairy products and they are reportedly developing both an ever-growing taste and ability to pay for those products.

With protein prices rising so much over the last nine months, many feel it is only logical that fat prices will make that ascension as well. This translates into possible increases for the both the cheese and butter markets. Already cheese manufactures are complaining that it is uneconomical to fortify $1.65 cheese with $2.20 nonfat, meaning that cheese and fat inputs for process cheeses will increase. Others feel that it is just a matter of time before the world begins knocking on our door for cheese products in general, including standard grade blocks and barrels.

Another important element to the demand equation comes from ongoing decline in value of the dollar as compared to other currencies. Since the middle of October, the dollar has declined almost 5 percent in value. With each decline, American dairy products become more and more competitive with world prices and can increase in lockstep with decreases in the value of the dollar.

With so much focus on the demand element of the price equation, it is important to turn our attention to the supply side of the equation. From a fat/butter perspective, many international traders are quick to cite the fact that the traditional huge inventory of “intervention stocks” that the European Union has traditionally had on hand is essentially gone. In other words, Europe has no extra butter to offer to the world market. Australia is apparently enduring what many refer to as a drought of “epic proportions” and will have a hard time servicing their own domestic demand much less that of the international arena. Both Argentina and India have placed high export tariffs on dairy products in an effort to keep their domestic prices lower.

From a domestic supply perspective, it is easy to point out that the herd size is still growing and overall milk output is running at levels higher than last year. If prices remain high, it is safe to assume that the herd size will continue to increase. However, many of the supply shock elements that were supposed to have gotten cash prices to current levels have still yet to happen. Last year’s heat wave still could cause huge disruptions to the current production levels. While corn prices have retreated from their highs of $4.60 per bushel, they still are relatively high and stand to move back to and through their recent highs as ethanol production ramps up. This has caused farmers in corn-deficit areas of the country to begin looking for ration alternatives, which can severely affect per cow production levels.

While recombinant bovine somatotropin is still being used heavily throughout the nation, its usage is declining every day as more and more retail outlets are switching to milk from cow untreated by artificial hormones. There is a debate over the effect that this reduction will have on overall production levels, but it seems safe to assume that it will not increase the milk supply in the near term. Couple all of these factors with the possibility of another hot summer throughout the country and our own domestic supply could come under pressure.

In conclusion, the recent rally in spot cheese prices may not be over. If 2004 showed us anything, it was that prices can move to $2.20. However, it seems unfair to compare this year to 2004 as much of that rally can be attributed to a supply shock. This year appears to be a different set of circumstances and so far the rally can be largely attributed to international demand. Demand rallies can be much more sustainable than supply shocks and as stated earlier, our own domestic supply can still be compromised by a number of different factors.

While high prices will eventually cure high prices, it may not be for some time and the premium still feels like it should be to the high side for both cheese and butter prices.

CMN

The views expressed by CMN’s guest columnists are their own opinions and do not necessarily reflect those of Cheese Market News®.