Guest Editorial
We didn't start the fire

Phil Plourd is vice president of research at Blimling and Associates, Cottage Grove, Wis., and is a guest columnist for this week’s Cheese Market News®.

More than once recently, I have thought that the current dairy market situation would provide good fodder for another stanza in We Didn’t Start the Fire, Billy Joel’s rollicking anthem about the swirl of events in a world gone mad. Something like this:

Powder sale, Western heat,
NASS revisions, stocks deplete
Australia’s bleak, dollar’s weak,
no Posilac, markets freak
Milk production getting small,
pigs in China eating whey
All the corn is in ethanol,
I can’t take it anymore!

Things have been, in a word, crazy. There are so many variables to the current equation, and many of them are new. It is easy to get caught up in the storm.

In quieter moments, however, I find myself reflecting on how well the Class III market has performed amid the turmoil. Thinking about how it offers a valuable opinion about the current state of affairs in the cheese market (and offers it 23 hours a day). And, lamenting the lack of similar information about the powder/Class IV markets.

* * *

While the cheese/Class III/whey complex may not be perfect, at the very least we can look at a screen and get the lay of the land. One can love the numbers or hate the numbers. One can debate the assessment or embrace the assessment. One can buy the board or sell the board. No matter: It is all right there in front of us. Things may be different tomorrow, next week or next month. Today’s market may not be “right” when all is said and done. But it is today’s market, and from it a lot of information can be gleaned.

And the value extends beyond any single, discrete slice of time. There is a discernible rhythm, a perceptible flow to the market. We can get a sense of when the beat has changed — even if we don’t immediately know why.

The fledgling whey futures market presents an interesting study in the immediate value of an openly traded environment. The market does not yet qualify as liquid. But it is off to a good start. Over the first 60 sessions of the contract’s existence, volume has totaled 2,208 contracts (37 per day) with open interest at 1,354 as of Tuesday. In its first 60 sessions, the cash-settled butter futures contract saw 1,729 contracts trade (29 per day) with open interest at 881.

More importantly, I believe the whey futures market already “tells” market participants something. I have a higher degree of confidence in making whey market assessments now than was the case before the futures contract was launched.

Walk through the process. Today, I think the whey screen is saying that we have topped out for now, but there is a measure of uncertainty about where things go from here, with only modest price variability over the next few months. That assessment can be taken and weighed against various supply/demand data, conversations with market participants and my own frame of reference. Currently, anecdotal reports and various data suggest that the cash market is at something of a stalemate. Product is generally more available in the Midwest, but export demand remains a prominent factor in the West. Neither force has yet revealed itself to be strong enough to tip the balance one way or the other. That essentially squares with the futures market. Were I to have a bias (or pronounced exposure) to one force or the other, I can buy or sell accordingly. Or I can do nothing and wait for the situation to sort itself out more clearly. If the data and anecdotal reports at hand don’t align with what the market might be saying, it’s probably time to reassess conditions in the country. Or, think harder about the message conveyed by the futures market.

In sum, one can assemble an opinion from futures market prices/behavior, balance that opinion against other information and act (or not act).

The best traders I know sometimes boil things down to a simpler equation: If told by a contact that prices are going up, the trader asks “What’s your bid?” or “How many do you want to buy?” Or, if presented with a bearish scenario: “What’s your offer?” or “How many do you want to sell?” There is elegance in this simplicity. Translated to the futures market, it is reasonable to ask why no one is buying if things look “way too cheap.” Or, if things look “too expensive” why is no one selling?

There is power in those questions ­— power in the ability to see a bid and see an offer.

How much better would the industry be today if it had well-developed futures markets for nonfat dry milk (NDM) or Class IV milk? The market situation might be no different — prices could well be the same or higher — but market participants would at least have a shot at seeing more of the forces at work. Certainly a better shot than we have today waiting for the AMS Dairy Market News reports on Thursday morning or the NASS survey numbers on Friday morning. Market participants could make more frequent assessments … and presumably do something with the assessments.

I understand that we have NDM and Class IV futures markets today. Moreover, I well understand that there are structural issues in the NDM market that will hamper any immediate development of the powder futures market. The point of this discussion should not be construed as merely a wish for a more viable NDM market. Rather, it is mostly a compare and contrast exercise. The dairy industry is much better off for having reasonably healthy futures markets for Class III milk, butter and whey. The industry would be better off yet if we could get there with NDM.

Which brings me to a larger point, one we have made consistently over the past few years: Shouldn’t the dairy industry be looking to become more futures-centric? Have we not seen up close how the transparency and liquidity of futures markets outperform the opacity and narrowness of spot markets or surveys? Isn’t it clear that as the markets domestically and globally become increasingly driven by supply/demand forces instead of policy dictates, we need to deploy more modern, market-based tools? Can we reasonably expect what worked in a heavily-regulated, domestically-centered industry 20, 30 or 40 years ago to work well today?

As the dairy industry contemplates where it wants to go with market structure generally and the next Farm Bill specifically, we remain adamant in our belief that there ought to be a place in the discussion concerning an increased role for futures markets. The current situation, in our estimation, provides an exclamation point to an already compelling case.

CMN

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