A month ago, corn and soybean prices were moving lower following the March 31 USDA Planting Intentions and quarterly Grain Stocks reports. However, prices started to rally by mid-April over concerns with weather in South America (Brazil too dry and Argentina too wet). Speculative buying helped fuel the rally with soybeans advancing over $1.00/bushel (+12%) by early May, with additional gains from the recent USDA report showing a reduction in soybean stocks.
In the US, corn planting continues to move along at a fast pace, but some areas were slowed down by last week’s rain. As of May 8, 64% of the crop was planted (vs. 69% last year), compared to the 5-year average of 50%, with 27% of the crop emerged vs. 23% last year and 17% average. For soybeans, 23% were planted, a little slower than last year, but ahead of the normal pace of 16%. Early planting is positive for yields as crops reach critical stages (e.g. corn pollination) ahead of hot weather in mid-July and August.
While it is still early, focus is shifting to summer weather in the US, specifically the Midwest/Corn Belt. With the end of El Nino, sea surface temperatures are indicating a transition to La Nina. In La Nina periods, there is a higher risk of above normal temperatures in the Midwest, but less certainty regarding rainfall. The hottest summers in the last 60+ years were in 1983 and 1988 – both La Nina years with sharply lower crop yields. The next 8-12 weeks will be key to see how the sea surface temperatures off the US West coast develop. It is too early to confidently proclaim negative crop yield impacts from weather, but the risk is higher going into this summer and is a key watch-out for dairy markets.
Over the past month, grain prices have increased while milk prices have fallen. As a result, dairy farm margins have slipped to levels not seen in several years. They are not at 2009 or 2012 levels, but this recent downturn pushes more farms into the red for margins. In theory, farmers losing money would cut back on production. In practice, farmers tend to push production higher in the short-term to generate the same cash flow as before. Over time, culling increases and milk output slows. But complicating this math in the US is the increasing use of hedging tools for feed costs and milk prices. Assuming the larger farms, which produce the majority of the milk, employ hedging strategies to lock in profitable margins, to some degree, they are insulated from the lower margins and continue increasing milk production.
The story hasn’t changed much from last month on global milk production as it continues to be surplus to demand, led by strong gains in European milk output. February milk production in Europe was up 5.5% vs. year ago. Granted, the first quarter comparisons to year ago are easy due to near flat output in Q1 2015. The percentage increases are expected to decline from May forward as they start lapping strong growth in spring 2015 following the removal of quotas. Countries in northern Europe continue to lead the way in production gains: Ireland (+32.3%), Luxembourg (+22.7%), Belgium (+20%), and the Netherlands (+17.5%). Milk production was lower in Portugal, Sweden, France, and Finland. On the horizon, there are several factors that could dampen milk growth in Europe going forward:
US milk production in March was up 1.8% with only 5 of the top 23 states registering declines vs. year ago. Surprisingly, cow numbers moved higher, increasing 10,000 head from February, and hitting the highest point since December 2008. Dairy cow slaughter has been running below year ago in recent weeks, so there are no signs of the national cow herd contracting, despite lower milk prices and margins.
The spring flush is once again bringing challenges in handling milk in the eastern half of the US. Milk is reportedly being dumped in several states on the East coast. Spot milk in the Midwest was trading at $3-5/cwt under class in the past few weeks. In some areas, milk is being separated with cream being sold, albeit at low multiples (1.05-1.20), and the skim being dumped or shipped to digesters. These conditions are likely to continue for another 1-2 months, especially given the recent news out of Canada limiting imports of UF milk from the US.
There isn’t much new to report for US dairy product stocks. End of March total cheese stocks were up 12% vs. year ago, continuing on a stretch of similar gains. The absolute increase is over 125 MM lbs, which seems like a lot of incremental cheese. However, when factoring in the days of supply, cheese stocks are not at historically burdensome levels. In discussions with cheese converters and leading retail brands in recent weeks, they reported strong Q1 activity with an expected slow down in April following Easter. However, they are expecting volume to pick back up as grilling season gets underway. In short, domestic demand is strong and has, until recently, supported prices in the $1.40’s. Butter stocks continue to build with projections hitting near 300 MM lbs by May 31. In a normal year, that would be enough to keep prices from running away in the second half of the year. However, the market psychology this year is supporting prices well above what appears to be fundamentally justified, at least from a stocks standpoint. However, some caution should be used when looking at the USDA butter stocks figure as it contains other forms of fat such as AMF and fat blends, so the actual inventory of butter is somewhat lower.
The EU Commission made it official and doubled the amount of SMP stocks that could enter the intervention program this year. The initial cap of 109,000 MT was hit by late March. Between April 1 and April 19, before the limit was raised, another 22,623 MT was tendered. The cap is now 218,000 MT (480 MM lbs), but will likely be reached by July 1 if the current pace continues. The real question is what happens next – do they raise the limit yet again? Or maintain the cap and let the product hit the market? As noted in prior reports, the substantial build-up in SMP intervention stocks is bearish over the next 6-12 months, as it will come back onto the market at some point, thereby limiting any price rallies.
In relative terms, dairy imports into China in Q1 were strong. Chinese imports of WMP increased 31% vs. last year to 47,622 MT in March. For Q1, the total WMP imported was 204,153 MT, an increase of 24% from Q1 2015. SMP imports also increased in March, up 38% to 21,420 MT. Likewise, Q1 imports were up 29% from year ago. Cheese imports were also higher in March, growing 7% to 7,269 MT (16 MM lbs), bringing the Q1 total to 24,059 MT, a 40% increase vs. last year. Imports of value added dairy products, such as UHT milk and infant formula, were reportedly also higher in Q1.
As for the outlook for future demand, the Chinese government recently released their annual agricultural outlook and pointed to the long-term gap in supply of dairy products in the country. They also indicated dairy imports would grow substantially. As a result of growing domestic demand and a price gap between domestic and foreign products, China’s dairy imports, including raw milk, cheese and milk powder, are expected to rise to an estimated 15.88 MM MT in 2020, up 43% from last year, and to 18.8 MM MT by 2025, an increase of 69%. This is interesting news in a long-term sense, but commodity markets have heard similar pronouncements about future Chinese demand before, only to see them not materialize.
Last month’s report included a section on US dairy plant infrastructure and recent activity for new plants. As noted from recent research by The McCully Group on global trends in plant capacity, the US is expected to see the strongest growth in new plant investments over the next several years. Since just last fall, over $1 billion of new plants or plant expansions have been announced. The next big plant in the US is likely to be a cheese plant in Michigan. Rumors continue to swirl as to who, what, and when a plant will be announced. The most credible story I heard at the annual WCMA conference in Milwaukee was a large-scale cheddar cheese plant set up as a joint venture. However, there has been no confirmation of this, and there are other rumors with different parties. Michigan needs a large plant (or 2) to handle the excess milk and future growth. Several people close to the milk supply in the state say a 10 MM lb/day plant could be built with little/no impact on milk premiums.
In early May, a stock analyst report noted Borden’s was looking to sell at least ½ of their 20 milk processing plants in the US. With Borden’s supplying a significant amount of Wal-Mart milk, and Wal-Mart’s recent decision to build their own plant, the thinking is that Borden’s volume is at risk long-term. This follows on talk earlier this year of Lala/Borden exiting the US fluid business completely. Private equity was noted as the most likely buyer. The report also pointed out risk to Dean Foods’ business as more retailers become integrated with their own milk bottling plants. In addition, Kroger was mentioned as possibly building a new plant in the Midwest to supply their recently acquired Roundy’s and Mariano’s stores.
In the last month, I attended three major dairy industry meetings/conferences. The general mood was the realization dairy prices are soft (ex-butter) and are likely to remain in the doldrums for most, if not all, of 2016. In fact, I had as many discussions about 2017 as 2016 at last week’s ADPI conference. While a few green shoots of a price recovery appear occasionally, they have not had much follow through. After 2 events with modest increases, the GDT price index fell back 1.4% on May 3, as supplies continue to outpace demand. Most industry analysts are forecasting a modest increase in prices in the second half of the year, as do I, but the timing and magnitude keeps getting pushed farther into the future.
The probability of cheese prices slipping out of the $1.40’s into the $1.25-1.30 range became real last week with CME prices for blocks and barrels moving to multi-year lows. While domestic demand remains solid, buyers have got their fill of $1.40 cheese and are content to watch the market drop before stepping in for additional purchases. Looking at the calendar, and seeing more milk flowing to cheese plants over the next 1-2 months, I am expecting CME prices to remain in the $1.25-1.35 range with potential to drop under $1.20. While Q2 looks to see the lowest cheese prices since 2010, premiums in futures prices are starting to build in the 2nd half and into 2017 as traders expect the low cheese/milk prices to result in a herd contraction and slower milk growth. The natural reaction as a buyer is to ease up on coverage as prices drop. However, this ignores the risk that is building for higher prices over the next 6-12 months. My 2016 forecast was lowered in Q2 and Q3, but kept November and December at $1.70.
Butter remains the only bullish dairy market and continues to be divorced from the global market. Most fundamentals are bearish, yet prices stubbornly stay above $2.00 with brief rallies into the $2.10’s. The main bullish driver continues to be buyer nervousness/psychology following 2 years of $3.00+ butter in the fall. And the interplay between cash and futures prices have supported a CME cash price above what some will say is fundamentally justified. But that has been the case for more than a year, so this is not a new phenomenon. Most people I talk to thought butter would drop below $2.00 this spring. The weeks are counting down and prices are still above $2.00. At this point, I think CME butter prices remain in a range around $2.00 plus/minus $0.10. I don’t see why butter prices should rally above $2.25-2.35 this fall at this point. But butter prices have proven to be very difficult to predict.
It’s hard to make up much for bullish news for milk powder. Following the ADPI conference in late April, NFDM prices have crept higher, but remain near $0.80. With milk production hitting seasonal peaks in the US and Europe, and significant stocks in the EU intervention program, this seems like a market that will struggle with low prices for most of the year. I continue to forecast a modest recovery in the 2nd half, but stocks could weigh on the market. All of this could change rather quickly with an unforeseen event such as weather. Most everyone is leaning bearish. A quick change in the fundamentals in any of the dairy markets will cause a violent uptick in prices as buyers rush in. For buyers and risk managers, prices at these levels are favorable to budget and offer upside protection while not giving up much on the downside.
The dry whey market has not turned bullish. March exports were weak – sharply below last year and down about 6 million lbs from February. Exports to China fell by about half from year ago. Stocks were up 7% in March vs. last year although production was down, illustrating weaker demand. US, NZ, and European dry whey prices are all around $0.24-0.25, which looks to be the prevailing price level for the next few months. I am forecasting prices to slowly move higher in the 2nd half, hitting $0.30 by year-end.
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