Dairy Market Update, June 2012
Dairy fundamentals showing some strength, but plenty of downside risk remains in the markets.
Prices: On Wednesday, June 27, 2012, spot prices for cheddar cheese blocks and barrels at the Chicago Mercantile Exchange (CME) were $1.6525 pound and $1.6750 pound, respectively. CME block and barrel cheese prices are up since late May (5/29/12), +$0.0825 pound for blocks and +$0.1750 pound for barrels. During the same time period, butter is up (+$0.1275 pound) to $1.5200 pound. The CME Class III futures average (6/27/12) for 2012 was up (+$1.1200/cwt) to $16.91/cwt, the next twelve months was up (+$0.6783/cwt) to $16.62/cwt and 2013 was up (+$0.5808/cwt) to $16.49/cwt. These Class III futures averages correspond to potential USDA Michigan mailbox prices of $17.61/cwt (2012), $17.90/cwt (next 12-months) and $17.48/cwt (2013). Figure 1 shows the current (6/27/12) CME Class III futures averages for 2012, the next 12-months and 2013 are at the 54th, 58th and 53rd percentiles, respectively.
Figure 1: Cumulative probability graph of USDA announced Class III prices (2007-present) and current CME Class III futures averages.
Supply: In May U.S. milk production increased above trend (+1.6 percent, 1995-2011) at +2 percent compared to May 2011 (+2.1 percent in Top 23 dairy states). May was the tenth consecutive month milk production grew above trend increase. May production in Michigan increased 3.5 percent compared to May 2011. The size of the U.S. dairy herd shrank by 4,000 head from April to May, but is up 76,000 head compared to May 2011. Dairy cow slaughter numbers in 2011 ran well ahead of 2010, up 106,600 head and are up in 2012 through May (+80,900 head). Average cull cow prices remained very strong in May at $87.30/cwt (+11.6 percent compared to May 2011). Milk production per cow in 2011 was below trend increase (+0.9 percent), however, it has rebounded and averaged +2.6 percent January through May, plus May marked the sixth consecutive month it grew at or above trend. USDA reported an increase in dairy feed prices in May of +4.8 percent compared with May 2011. May’s income over feed costs was down 33.3 percent (-$2.35/cwt) as compared with May 2011. And May’s milk:feed ratio was at an all-time low of 1.38.
Demand: USDA reported all categories of wholesale dairy products showed above trend increases for 2011 commercial disappearance except fluid products. Total commercial disappearance for 2011 finished the year slightly below trend increase (+1.6 percent) at +1.5 percent. So far (January-March) 2012 is off to better start with total commercial disappearance up 2.1 percent. Mysteriously the USDA failed to report total commercial disappearance for April. However, the January through April disappearance of individual dairy product categories was: American cheese, +1.3 percent; other cheese, +2.1 percent; nonfat dry milk, +30.1 percent; butter, -4.5 percent and fluid milk, -3.2 percent.
U.S. dairy trade has shown trade surpluses for twenty seven consecutive months. April U.S. dairy exports were valued at $464 million, a record for the month of April. April also marked the fourteenth consecutive month exports exceeded $400 million and the twenty fifth consecutive month exports equaled twelve to fifteen percent of total U.S. milk solids production. January through April dairy exports equaled 13 percent of total U.S. milk solids production (as compared to 13.2 percent January through April 2011). So far (January through April) in CY-2012 U.S. dairy exports accounted for 44 percent of nonfat dry milk/skim milk powder produced by the U.S., 5.4 percent of cheese, 5.8 percent of butter, 47 percent of dry whey and 66 percent of lactose.
Dairy Product Inventories: The latest USDA Cold Storage Report showed an inventory increase in May for American cheese (+0.1 percent at 623.2 million pounds) and an inventory decrease for total cheese (-2.2 percent at 1,025.8 pounds) as compared to May 2011. May marked the third time in five months total cheese inventory was greater than one billion pounds. May butter inventory was 55.4 percent above May 2011 at 264.3 million pounds, marking the tenth consecutive month butter inventory was above the same month last year.
Outlook: Dairy fundamentals are showing increasing strength as summer heat and drought conditions are affecting milk production (volume and components) and negatively affecting crop conditions, thus increasing feed prices. These factors should result in lower milk production as we move through the summer; however, Income Over Feed Cost (IOFC) may continue to decline due to much higher corn, soybean meal (SBM) and alfalfa prices. But, it is a positive that cow numbers April through May declined for the first time since September 2010. Hopefully dairy cow numbers will remain stable, or grow at slower rates, in the future as cull prices remain at historical highs and replacement costs remain reasonable. But, plenty of affordable replacements are available to sustain or grow cow numbers.
The consumer confidence index fell to 62 in June from 71.6 in February and remains far short of the 90 level which is indicative of a healthy economy. However, total commercial disappearance figures for January-March are now above trend (+2.1 percent) and set all-time monthly records in January, February and March. American cheese inventory is only marginally above last year (+0.1 percent) while total cheese inventory is below last year (-2.2 percent). Butter inventory is quite high, but not at unmanageable levels. The block/barrel average price showed much more strength over the past month than most industry experts expected and CME Class III futures responded favorably to the upside.
Schools are now closed releasing a great deal of Class I milk to manufacturing plants. However, continued hot and dry summer weather is taking its toll on milk volume and components. I would expect cheese prices to continue to strengthen as it appears summer weather will continue the current hot and dry pattern. Cheese prices could potentially rally into the low $1.80’s and dry whey prices appear to have stabilized in the mid $0.50’s. The current spot block/barrel cheese price ($1.6638 pound) is only adequate to sustain Class III futures prices of ~$16.33/cwt, thus, look for Class III futures prices to retreat to that level once summer heat moderates.
Overall the U.S. dairy export market remains strong at +23 percent versus 2011 levels and the biggest bright spot in our dairy industry. April dairy product exports marked the 14th consecutive month U.S. dairy exports exceeded $400 million and Apr exports marked the 25th consecutive month U.S. exports equaled 12-15 percent of U.S. total milk solids production. April exports set an all-time April record of $464 million (13.6 percent of total U.S. milk solids production). Exports should remain strong even though the U.S. dollar is gaining ground. Oceania’s production season has ended with milk output up (New Zealand, +9-10 percent; Australia, +4 percent versus 2011). Milk production has also been strong in the European Union (EU). World demand for dairy products remains strong and all the major dairy exporting areas (Oceania and EU) are reporting limited uncommitted stocks of dairy products. Therefore, the U.S. export market should remain strong. The only cloud hanging over the export market is due to the debt crisis concerns in many countries which could trigger another major worldwide recession. With uneven domestic dairy consumption, the current market is critically dependent upon maintaining high export volumes. Long term outlook for the export market is very bullish, but that doesn’t preclude the potential for short term problems.
USDA measured feed prices remain higher than last year (+4.8 percent versus May 2011). Also, CME corn futures gained over $1.10/bu since June 1, 2012 and soybean meal is also up about $45/ton. Milk per cow growth January through May averaged above trend growth at +2.4 percent and I would expect this growth to continue given the continued high culling rate and despite increasing feed prices. The USDA is currently forecasting 2012 U.S. milk production to increase at +3.1 percent. I believe this estimate is on target. They are also forecasting total commercial disappearance for 2012 at +3 percent versus 2011, which we are doubtful to achieve. Achieving this level of consumption will require sustaining our currently strong export market and a much stronger domestic consumption than currently exists.
Producers need to sharpen their pencils, calculate their latest cost of production and market some milk if it fits your risk attitude and financial condition. At this point hot weather is presenting opportunities to forward price milk. Thus, producers need to make a decision as to whether to market some milk now or wait to see how high summer heat will take this market. However, if there is a hiccup in our export market we could be in for really big trouble. Take all this into account as you make marketing decisions. Remember: marketing is first about risk management and secondarily about profit enhancement. To view a narrated PowerPoint based on this report go to Crag Thomas’ website and click on the button “Narrated PowerPoint.”