Guest Editorial
Class III futures market not waiting for news

by Dave Kurzawski

Dave Kurzawski is a senior broker with the Chicago-based Downes-O’Neill division of FCStone. He contributes this column exclusively for Cheese Market News®.

What happens when milk buyers worry about high prices while dairy producers feel entitled to those same high prices? The future price of milk goes up and how!

At times like these, it’s critical to step back and realize that it’s not the current price of milk — but the future price of milk — we’re all talking about. And a futures market, as its name suggests, is not prone to wait for news. By their very design, futures markets tend to shoot first and ask questions later. Recent commodity price volatility provides numerous examples of this shoot-first mentality. But there are many points throughout history that tell the same story. Take the price of gold in the mid-1970s, for example.

The U.S. government had actually banned Americans from owning gold bullion between April 5, 1933, and Dec. 31, 1974. But as usual when Washington operates outside the Constitution, most Americans ignored the confiscation order. In 1933, the only gold bullion Washington could seize was the gold kept in bank “safety deposit” boxes. Americans who held their gold bullion outside of banks almost universally ignored President Franklin Roosevelt’s appalling theft of private wealth. It goes without saying that when 1975 rolled around, a lot of this “underground” gold bullion hit the market.

Before the policy changed, gold prices had rallied to near $200 per ounce on the anticipation of the government allowing Americans to own gold. Once that decision was finalized, families who had held their gold bullion for four decades finalized their decision to sell. Gold lost 50 percent of its value in 1975. Yet, within five years, the price of gold skyrocketed to more than $800 per ounce. The precipitous drop in gold prices had been nothing more than a market correction within a long-term bull market.

So what does the price of gold in the 1970s have to do with the price of milk today? In addition to giving fodder to the old adage “Buy the rumor. Sell the fact,” it gives us a clear example of how futures market prices can get ahead of themselves. And during this dairy bull market, Class III prices are no exception. But as the gold bugs learned, corrections will come.

Right now, demand for block cheese remains strong. But the market has leaned on other reasons to buy milk, anticipating such events as a reduction in milk from cows treated with rbST going into cheese production, the next round of the Cooperatives Working Together herd retirement program, a two-tier pricing system in California that will cap milk production at 2007 levels, and general market inflationary concerns led by a $6.00 per bushel corn market. How many of these fundamental concerns have actually significantly hampered milk production to date? None.

Moreover, February was likely the best month in the past year to produce cheese. In fact, when we subtract February’s average Class III purchase price ($17.03) from the average Chicago Mercantile Exchange (CME) block sale price ($2.0023 x 10), we get a spread of $2.99. The last time there was a better spread between what a cheese maker paid for raw milk and the price he/she received for the finished product was in March 2004 at $3.71.

All the same, my expectation that more milk would make its way into cheese vats in February did not come to fruition. It takes time to turn around processing. But with nearby dry whey and CME spot cheese prices largely stable over the past six weeks, I suspect our long-awaited USDA Dairy Products Report will show March and April were even better for American cheese production.

So where does this leave you? As a hedger of milk for cheese, wait for a correction to forward price your needs. You will get one. The difference is recognizing it for what it is — a correction in a bull market — not a free fall to $10.00 per hundredweight milk. At least not yet.

CMN

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