Dairy Market Update, December 2011

Dairy fundamentals point to a weaker market with downside price risk.

Prices: On Monday, Dec. 19, 2011, spot prices for cheddar cheese blocks and barrels at the Chicago Mercantile Exchange (CME) were $1.5625/lb and $1.5350/lb, respectively. CME block and barrel cheese prices are down since late October (10/21/11), -$0.1575/lb and -$0.1550/lb, respectively. During the same time period, butter is down (-$0.2575/lb) to $1.6025. CME Class III futures averages (12/19/11) for 2011, next 12 months, and 2012 were up (+$0.2692/cwt, +$0.3792/cwt, +$0.5759/cwt, respectively) to $18.36/cwt, $17.25/cwt and $17.10/cwt, respectively. These Class III futures averages correspond to potential USDA Michigan mailbox prices for 2011, next 12 months, and 2012 of $19.35/cwt, $18.24/cwt and $18.09/cwt, respectively. Figure 1 shows the current (12/19/11) CME Class III futures averages for 2011, next 12 months, and 2012 are at the 92nd, 88th, and 88th percentiles, respectively.


Supply: In November U.S. milk production increased above trend (+1.6 percent, 1995-2010) at +2.1 percent compared to November 2010 (+2.5 percent in Top 23 dairy states). November was the fourth consecutive month milk production grew above trend increase. November production in Michigan increased 3.0 percent compared to November 2010. The size of the U.S. dairy herd shrunk by 1,000 head from October to November but is up 96,000 head versus November 2010. Dairy cow slaughter numbers in 2011 continue to run well ahead of last year, up 109,800 head through 11/26/11. Average U.S. cull cow prices are softening, but remain historically very high in November at $65.70/cwt (+27.6 percent compared to November 2010). Milk production per cow for January through November was below trend increase (+0.8 percent) however, it has rebounded nicely from the July heat-induced decline. USDA reported an increase in dairy feed prices in November of +37.8 percent compared with November 2010. November’s income over feed cost was down 2.8 percent (-$0.22/cwt) as compared with November 2010. 

Demand: USDA reports total commercial disappearance in 2010 increased over 2009 (+3.3 percent), well-above the 1995-2009 average increase (+1.6 percent). All categories of wholesale dairy products showed above trend increases for 2010 except fluid products. Total commercial disappearance for 2011 started the year strong, but has weakened over the past five months and is now below trend increase (+1.1 percent) through September. All-time monthly records were set for January, February, March and April, but May through September was down 0.8 percent compared to May through August 2010 despite September setting another all-time September record. January through September disappearance of individual product categories was: American cheese, +0.7 percent; other cheese, +4.5 percent; nonfat dry milk, -3.6 percent; butter, +10.0 percent; and fluid milk, -1.5 percent.

U.S. dairy exports were strong in fiscal year 2011 (Oct-Sep) with exports valued at a record $4.611 billion with a dairy trade surplus of nearly $1.8 billion. Calendar year 2011 (Jan-Sep) exports were equivalent to 13.3 percent of total U.S. milk solids production as compared to 12.4 percent for the same period in 2010. Imports for calendar year 2011 were equivalent to 2.8 percent of total U.S. milk solids production (lowest since 1996). September dairy exports equaled 13.3 percent of total U.S. milk solids production down from 14.7 percent in September 2010. In the first nine months of calendar year 2011 (Jan-Sep) exports accounted for 49 percent of NFDM/SMP produced in the U.S., 4.7 percent of cheese, and 8.7 percent of butter.

Dairy Product Inventories: The latest USDA Cold Storage Report showed inventory decreases in October for American cheese (-3.8 percent at 614.7 million lbs.) and total cheese (-4.3 percent at 1,012.6 million lbs.) compared to October 2010. American cheese inventories set all-time monthly highs for each of the months from January through May, and July and August. October butter inventory was 19.3 percent above October 2010, marking the third consecutive month butter inventory was above the same month last year. 

Outlook: The normal fall holiday dairy product sales season (Thanksgiving and Christmas) is coming to a close. The recent decline in cheese prices is normal as this all-important sales season winds down. The CME block/barrel cheese price peaked this fall at $2.0250/lb on 11/15/11 and has dropped $0.6250/lb to $1.5488/lb on 12/19/11. However, the CME Class III futures average for 2012 peaked on 12/05/11 at $17.1483/cwt and has only fell $0.0491/cwt to settle at $17.0992 on 12/19/11. Look for cheese prices to continue their decline as we move into the first of the year. Some are forecasting cheese prices in the low $1.40 range. If this occurs, look for Class III futures to decline also. The old adage of Class III prices equaling about ten times the cheese price is not very accurate currently due to high dry whey prices. The current (Dec) dry whey futures price of $0.6575/lb is adding about $1.60/cwt to the Class III price as compared to 2010. The CME dry whey futures prices in early 2012 are even higher ($0.6950/lb for March). In fact, the dry whey futures market is forecasting strong dry whey prices above $0.60/lb for the entire first half of 2012. In the second half of 2012 dry whey futures drop below $0.60/lb to as low as $0.5250/lb (Nov) which would drop Class III prices ~$0.80/cwt. Thus, I look for Class III prices to drop to $16.00/cwt after the first of the year due to lower cheese prices and then to potentially drop close to $15.00/cwt by mid 2012 as dry whey prices fall. This forecast assumes there are no major changes in market fundamentals.

The export market remains very strong, and there is some indication of improvement in domestic consumer confidence. Hopefully this will translate into stronger domestic consumption in 2012. However, a great deal of risk remains in the market. The U.S. economy remains fragile. Economic problems continue to overshadow economies in the European Union and economic growth in China and other Asian countries remains below earlier expectations. We must remember that the U.S. dairy industry in very dependent upon the fact that over 13 percent of our total milk solids production is going into the export market. Any shock to that market that would even shave a couple of percentage points off our exports could have a very negative effect upon domestic milk prices. Presently the USDA is forecasting a 13.3 percent decline in fiscal year 2012 U.S. dairy exports as compared to fiscal year 2011. However, many dairy export industry exports are predicting an increase in U.S. dairy exports for 2012.

As expected the Livestock Gross Margin-Dairy insurance funds were depleted very quickly. Right now the reports are only $30.91 remains for fiscal year 2012 (October 2011 through September 2012). Thus, without an unexpected move from Congress this risk management tool will not be available again until late October 2013.

Given these price forecasts and risk factors in the market, dairy producers would be well advised to consider pricing 25-40 percent of their first half 2012 milk production. Corn and soybean meal prices have dropped dramatically since late August. Therefore, if you are a producer forward pricing milk be sure to simultaneously lock in some feed. It is possible that feed prices might drop a little more, but I believe there is much more upside than downside risk for feed prices.

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