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Perspective:
Dairy Markets

Conflicting fundamentals at play through year end will drive prices

Lucas Fuess

Lucas Fuess is the director of dairy market intelligence at HighGround Dairy*, Chicago, a firm specializing in dairy hedging, risk management and market analysis services. He contributes this column exclusively for Cheese Market News®.

“What a week, huh?”

“Lemon, it’s Wednesday.”

So goes the classic “30 Rock” quote: When Liz Lemon seemingly indicates a stressful week is wrapping up, she is reminded that she and her coworkers are only halfway to the weekend, with who knows what else to come on the horizon. It seems to be a quite apt metaphor for the year to date as dairy markets have navigated the worst pandemic in a century and adjusted to rapidly shifting supply and demand fundamentals that have driven cheese markets from close to record lows to a new record high in just a few short weeks. The upset normalcy has driven record volatility over the past five months, and what a year it has been! But, as Jack might reply to remind that the adventure is not yet over, “Lemon, it’s July.”

Looking ahead to the remaining five months of the year, there are a variety of market fundamentals at play that will drive price behavior from now through the New Year. Some factors could provide some bullish support to cheese prices over the next five months, but HighGround is increasingly concerned about bearish factors that could drive sentiment and prices through the year-end holidays.

From a supply perspective, milk production will be higher versus prior-year levels in each month for the foreseeable future. The total U.S. herd size likely bottomed out in June and will climb slowly throughout the rest of the year as farmers add cows. Weekly cow slaughter numbers that are well below prior year and the three-year average trend throughout June and into July are also supportive of herd size growth. Farmers will also likely implement herd management changes to push milk per cow higher to drive milk volume and total farm profitability to make up for several low milk checks. Anecdotal evidence suggests heifer inventories are increasing, with plenty of animals poised to enter milking in the coming months. HighGround anticipates total 2020 U.S. milk production will be up 1.3% versus the prior year, while globally, milk production gains in the EU and New Zealand into the remainder of the year will drive total production higher and lean bearish toward global dairy prices if demand does not keep pace.

One factor that could hold milk production gains slightly lower versus expectations is if the current extraordinarily wide Class III/IV milk price spread persists into the fall months and keeps producer price differential (PPD) values at sharply negative rates. Typically, the current high Class III price would draw milk into cheese production as milk attempts to flow to its highest price manufacturing use. However, the Class III price rose so quickly and to such lofty levels that some cheese manufacturers are limiting production to match immediate, confirmed orders, fearful of producing extra loads in concern that they will be holding high-priced inventory and taking a loss when the cheese price tumbles.

In turn, milk was pushed into Class IV channels instead, keeping butter and nonfat dry milk values lower and exacerbating the problematic wide spread. The wide III/IV spread and subsequent cheese plant depooling created negative PPDs that approached $9 per hundredweight, shaving significant value off milk checks and possibly limiting farmer appetites to drive milk higher. However, balancing milk prices that were sharply lower versus CME futures market values and what some farmers were likely expecting to see in their June milk checks, USDA began issuing direct support payments recently through the Coronavirus Food Assistance Program, and as of July 27 had sent dairy farmers almost $1.3 billion in payments. While negative PPDs are difficult to see, direct payments will help smaller to medium sized dairies’ cash flow, and farmers will still likely drive milk output regardless of less than desirable milk checks.

In addition to higher expected milk supply, total stocks among most products are strong as well and will be a fundamentally bearish factor in the coming months. While stocks have been less of a factor lately due to immediate supply and demand concerns driving prices, at some point stocks will matter and the industry will have to work through stronger supplies. In cheese specifically, the May and June drawdowns were impressive, but total cheese in storage remains higher versus prior year as orders continue to work through the massive stocks in movement in April when foodservice demand collapsed. Butter, nonfat dry milk and dry whey stocks are all stronger versus prior year as well with plenty of product in storage to fulfill anticipated demand.

Also contributing to bearishness is the questionable (dismal?) state of the economy. Typically, a recession and high unemployment would mean lower dairy consumption, similar to the 2008/2009 recession when total cheese consumption per capita fell lower versus prior year for the only year-over-year decline in at least the past two decades. So far, stimulus measures this year have included a $1,200 payment to most Americans plus an extra $600 per week in unemployment to those who lost their jobs. However, as of late July, Congress allowed the benefits to expire with the two parties debating another potential $1 trillion stimulus package. If high unemployment coupled with a recession persist into the fall and winter months with less government benefits, dairy demand could decline.

While stronger milk production, higher product stocks and a weak economic outlook all point to low dairy prices into the end of the year, the key wild card in recent months, and one that will persist in the near term, is government support and intervention in dairy markets. The Farmers to Families Food Box program has been extended for a third round, with deliveries extending past the prior Aug. 31 end to the program. At least 5 pounds of dairy products plus 1 gallon of milk are required to be included in each delivered box. Of the $500 million to $700 million remaining in the food box program budget, at least one-third of that ($167 million to $233 million) will likely be spent to procure dairy. While the spend will keep markets supported, higher dairy prices that vendors will use to bid for contracts mean less volume will move in round three of the program. However, money continues to flow through the Section 32 commodity purchasing program as well, with cheese, butter and other products secured for August-November deliveries.

While bearish factors loom large for the next several months, HighGround expects that price volatility and market surprises will persist throughout the end of the year. USDA has not been shy or frugal in supporting markets so far this year, and further purchases or additional funding into existing programs would not be surprising. Currently, the cheese market has declined nearly 70 cents from the record block high, with further declines likely until buyers perceive significant value and start to purchase. Bearish factors will limit the upside in most markets, but any fresh, CME-spot eligible cheese shortages into the holiday season could give markets a bump, especially if competing with government procurement. $2.50+ per pound cheese is likely over, but expect significant volatility to endure throughout the year’s end.

CMN

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

*These observations include information from sources believed to be reliable, but no independent verification has been made and therefore their accuracy and completeness cannot be guaranteed. Opinions and recommendations expressed are the opinion of the authors and are subject to change without notice. The risk of loss in trading futures contracts or commodity options can be substantial, and investors should carefully consider the inherent risks of such an investment in light of their financial condition.

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