Dairy Market Update, May 2012
Dairy fundamentals weaken further increasing downside price risk.
Prices: On Thursday, May 24, 2012, spot prices for cheddar cheese blocks and barrels at the Chicago Mercantile Exchange (CME) were $1.5025/pound and $1.4700/pound, respectively. CME block and barrel cheese prices are mixed since late April (4/24/12), -$0.0200/pound for blocks and +$0.0150/ pound for barrels. During the same time period, butter is down (-$0.0125/pound) to $1.3875/pound. The CME Class III futures average (5/24/12) for 2012 was up ($0.1359/cwt) to $15.93, the next 12 months was up (+$0.0683/cwt) to $15.77/cwt, and 2013 was down (-$0.0284/cwt) to $15.87/cwt. These Class III futures averages correspond to potential USDA Michigan mailbox prices for 2012, the next 12-months, and 2013 of $16.92/cwt, $16.76/cwt, and $16.86/cwt, respectively. Figure 1 shows the current (5/24/12) CME Class III futures averages for 2012, the next 12-months and 2013 are at the 47th, 45rd, and 46th percentiles, respectively.
Figure 1: Cumulative probability graph of USDA announced Class III prices (2007-present) and current CME Class III futures averages.
Supply: In April U.S. milk production increased above trend (+1.6 percent, 1995-2011) at 3.2 percent compared to April 2011 (+3.3 percent in Top 23 dairy states). April was the ninth consecutive month milk production grew above trend increase. April production in Michigan increased 6.2 percent compared to April 2011. The size of the U.S. dairy herd grew by 5,000 head from March to April and is up 90,000 head compared with April 2011. Dairy cow slaughter numbers in 2011 ran well ahead of 2010, up 106,600 head, and are up in 2012 through April (+33,700 head). Average cull cow prices remain very strong in April at $84.90/cwt (+7.6 percent compared with April 2011). Milk production per cow in 2011 was below trend increase (+0.9 percent), however, it has rebounded and averaged +2.9 percent January through April, plus April marked the fifth consecutive month it grew above trend. USDA reported an increase in dairy feed prices in April of +7.7 percent compared with April 2011. April’s income over feed costs was down 29.7% (-$2.17/cwt) as compared with April 2011.
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-February) 2012 is off to a weak start with total commercial disappearance at only +1.0 percent as compared with January-February 2011. January through February disappearance of individual product categories is: American cheese, +1.7 percent; other cheese, +1.9 percent; nonfat dry milk, +17.8 percent; butter, -2.1 percent; and fluid milk, -3.0 percent.
U.S. dairy trade has shown trade surpluses for twenty six consecutive months. March U.S. dairy exports were valued at an all-time record of $482 million and marked the thirteenth consecutive month exports exceeded $400 million and the twenty fourth consecutive month exports equaled 12-15 percent of total U.S. milk solids production. January through March dairy exports equaled 12.9 percent of total U.S. milk solids production (as compared to 13.2 percent January through March 2011). So far (January through March) in CY-2012 U.S. dairy exports accounted for 44 percent of nonfat dry milk/skim milk powder produced by the U.S., 5.3 percent of cheese, 5.2 percent of butter, 46 percent of dry whey, and 68 percent of lactose.
Dairy Product Inventories: The latest USDA Cold Storage Report showed and inventory increase in April for American cheese (+1.0 percent at 628.4 million pounds) and an inventory decrease for total cheese (-1.5 percent at 1,024.8 million pounds) as compared with April 2011. April marked the second time in five months total cheese inventory was greater than 1.0 billion pounds. April butter inventory was 79.1 percent above April 2011 at 253.9 million pounds, marking the ninth consecutive month butter inventory was above the same month last year.
Outlook: Dairy fundamentals are growing increasingly bearish as national milk production January-April increased at +3.9 percent as compared with January-April 2011, the largest increases since early 2006. As one major dairy cooperative president aptly commented, the increase in milk production is producing a “recipe for a crisis.” The primary reasons for the production increase are the relatively warm weather, growth in cow numbers, and growth in milk per cow. It is also alarming that the U.S. dairy herd continues to steadily grow in size (+5,000 head March to April, +90,000 head as compared with April 2011) despite high cull rates (January-April; 33.8 percent, 4.5 percentage points above the January-April average). The consumer confidence index fell to 69.2 in April from 69.5 in March and remains far short of the 90 level which is indicative of a healthy economy. Also, total commercial disappearance finished below trend in 2011 and has started off 2012 well-below trend. American cheese inventory is now above last year while total cheese inventory, even though below last, is again in excess of 1.0 billion pounds. Butter inventory is very high. Despite these bearish fundamentals the block/barrel cheese price average lost only a quarter cent over the past month and Class III futures prices actually strengthened slightly for the remainder of 2012 and dropped less than three cents on the 2013 average.
Schools will soon be in summer recess all over the U.S. which means the usual seasonal decline in fluid milk consumption. This will increase milk available for cheese, butter and ice cream plants. However, the increase in manufacturing milk will be moderated as warmer summer weather builds and milk components and volumes begin their usual summer decline.
There is the potential for cheese, butter and Class III prices to strengthen despite poor general fundamentals. The amount these prices strengthen will be highly dependent on the intensity of summer heat and the maintenance of our strong export market. Dairy producers should monitor the weather closely and consider selling small percentages of the remainder of their 2012 production when cheese price rallies translate into near term strength in Class III futures prices. April’s dry whey price settled at $0.5921/pound and the futures market is forecasting prices of about $0.49/pound by July. This holds the potential to erode $0.60/cwt off Class III prices. Perhaps this is already factored into the Class III futures market, but regardless, dairy producers need to be aware of this important factor as they make forward pricing decisions. The current spot block/barrel cheese price ($1.4863/pound) is only adequate to sustain Class III futures prices of ~$14.89/cwt at average whey prices.
Overall the U.S. dairy export market remains strong at +24 percent as compared with 2011 levels and the biggest bright spot in our dairy industry. Exports should remain strong; however, the U.S. dollar has gained about 5 percent over the past three weeks. Also, nearly every major dairy exporting country in the world is reporting strong milk output. But, high world demand for dairy products should allow the continued boom in U.S. dairy product exports. It should be remembered, however, that a cloud remains over the export market 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. USDA forecasters are bullish for continued growth in our export market and also believe domestic commercial disappearance will grow faster than population growth during the next decade due to increased “away-from-home” eating.
Even though dairy fundamentals remain bearish, there is some optimism that prices may strengthen due to the usual summer slump in milk production. However, producers need to be aware of the bearish market undertone. Producers need to recalculate their cost of production and consider marketing milk if summer heat causes any strengthening in the Class III market. I expect milk production and cow numbers to continue increasing above trend. It is very disconcerting that April milk production grew at +3.2 percent and we gained 5,000 dairy cows in the national herd despite record dairy cow slaughter. As a president of a major dairy cooperative aptly commented this is a “recipe for a crisis.” 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 is sure to simultaneously lock your feed. It is possible feed prices might drop if we have a good growing season, but I believe there is much more upside than downside risk for feed prices.