Dairy Market Update, February 2012

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

Prices: On Wednesday, Feb. 22, 2012, spot prices for cheddar cheese blocks and barrels at the Chicago Mercantile Exchange (CME) were $1.4800/lb and $1.4750/lb, respectively. CME block and barrel cheese prices are down since mid-January (1/23/12), -$0.0250/lb and -$0.0100/lb, respectively. The block/barrel average has been below $1.50/lb for 15 consecutive trading days. During the same time period, butter is down (-$0.1500/lb) to $1.4150. The CME Class III futures average (2/23/12) for 2012 was down (-$0.9692/cwt) to $15.95/cwt, the next 12-months was down (-$0.8842/cwt) to $16.03/cwt, and 2013 was down (-$0.1375/cwt) to $16.05/cwt. These Class III futures averages correspond to potential USDA Michigan mailbox prices for 2012, the next 12-months, and 2013 of $17.02/cwt, $16.94/cwt and $17.04/cwt, respectively. Figure 1 shows the current (2/23/12) CME Class III futures averages for 2012, the next 12-months and 2013 are at the 79th, 80th and 80th percentiles, respectively.

Cumulative probability distribution chart 

Supply: In January U.S. milk production increased above trend (+1.6%, 1995-2011) at +3.4% compared to January 2011 (+3.7% in Top 23 dairy states). January was the sixth consecutive month milk production grew above trend increase. January production in Michigan increased 2.8% compared to January 2011. The size of the U.S. dairy herd grew by 13,000 head from December to January and is up 76,000 head compared with January 2011. Dairy cow slaughter numbers in 2011 ran well ahead of 2010, up 106,600 head, but are down 13,300 head so far in 2012 (as of 1/28/12). Average U.S. cull cow prices are softening, but remain historically very high in January at $65.00/cwt (+13.5% compared to January 2011). Milk production per cow in 2011 was below trend increase (+0.9%), however, it has rebounded nicely since summer and in January grew above trend rate for the second consecutive month. USDA reported an increase in dairy feed prices in January of +27.5% compared with January 2011. January’s income over feed cost was up 6.9% (+$0.45/cwt) as compared with January 2011.

Demand: USDA reported all categories of wholesale dairy products showed above trend increases for 2010 commercial disappearance except fluid products. Total commercial disappearance for 2011 started the year strong with January through April up 3.7% as compared with last year. However, it averaged only -0.8% May through September as compared with May through September 2010. However, October and November were excellent months at +3.9% and +2.8% as compared with October and November 2010. Through November total commercial disappearance is very near trend increase (+1.6%) at +1.5%. All-time monthly records were set for each month this year except July and August. January through November disappearance of individual product categories was: American cheese +1.3%, other cheese +3.9%, nonfat dry milk -4.1%, butter +11.1% and fluid milk -1.7% (through December).

U.S. dairy exports were strong in calendar year 2011 with exports valued at a record $4.88 billion (+29% as compared with 2010) with a dairy trade surplus of almost $1.95 billion. Calendar year 2011 exports were equivalent to 13.3% of total U.S. milk solids production as compared to 12.8% for 2010. Imports for calendar year 2011 were equivalent to 2.8% of total U.S. milk solids production (lowest since 1996). December dairy exports equaled 13.0% of total U.S. milk solids production and marked the 21st consecutive month dairy exports equaled 12-15% of total U.S. milk solids production. In calendar year 2011, exports accounted for 49% of NFDM/SMP produced in the U.S., 4.7% of cheese and 7.6% of butter. In 2011, one of every eight tanker loads of raw milk ended up as an exported dairy product.

Dairy Product Inventories: The latest USDA Cold Storage Report showed inventory decreases in January for American cheese (-4.0% at 612.5 million lbs.) and total cheese (-7.1% at 977.8 million lbs.) compared to January 2010. American cheese inventories set all-time monthly highs for each of the months from January through May, and July and August. Total cheese inventory set all-time monthly highs for every month January through August. January butter inventory was 44.1% above January 2010 at 171.2 million pounds, marking the sixth consecutive month butter inventory was above the same month last year.

Outlook: Dairy fundamentals are mixed as mild winter weather helps fuel high milk production. In fact, the increase (+3.4%) in January as compared to January 2011 was the largest increase since November 2007. Also, the U.S. dairy herd continues to grow in size (+13,000 head in January as compared with December). However, commercial disappearance figures for October and November were quite strong (+3.3%) and American cheese and total cheese inventories are well behind last year. The block/barrel average price has been below $1.5000/lb for 15 consecutive trading days and was almost $0.50/lb higher this time last year ($1.9638/lb). CME Class III futures average for 2012 peaked on 1/11/11 at $17.45/cwt and has fallen $1.4225/cwt to settle at $16.03/cwt on 2/22/12. Look for cheese prices to slide to the mid $1.40 range in the coming weeks. There may be some possible rally points as wholesalers refill pipeline stocks at the lower prices. But, don’t look for cheese prices to rally more than $0.15/lb. Dry whey prices continue to fall. They had been as high as the low $0.70/lb range, but the futures market is now forecasting prices as low as $0.44/lb by mid-2012. This holds the potential to erode over $1.60/cwt off current Class III prices. I don’t know how much of this is factored into the current Class III futures market, but dairy producers need to think about this as they evaluate current Class III prices and contemplate forward pricing their milk production.

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 as U.S. milk production has grown at or above trend for the past six consecutive months. Also, the U.S. economy remains fragile and 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% of our total milk solids production is going into the export market. Any shock to our export market that would even shave just a couple of percentage points off our exports could have a very negative effect upon domestic milk prices. The fiscal year 2012 export outlook is mixed with the USDA is forecasting a slight decline while other dairy export industry experts are predicting a modest increase. As expected the Livestock Gross Margin-Dairy insurance funds were depleted very quickly in October and November and without an unexpected move from Congress LGM-Dairy will not be available again until late October 2012.

Even though Class III futures prices have declined over the past month, there is still significant downside risk. Producers need to recalculate their cost of production and consider marketing milk. I expect milk production and cow numbers to continue increasing above trend. Hopefully commercial disappearance will continue to grow at or above trend rate. However, look for near term Class III prices to possibly drop another dollar in the coming 6-8 weeks. Feed prices continue to be quite strong, especially if you are looking to buy hay. Thus, if you are a dairy producer forward pricing milk be sure to simultaneously lock in some feed. It is possible that feed prices might drop, but I believe there is much more upside than downside risk for feed prices.

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