This has been a remarkable year for the U.S. dairy industry. But just when we thought we could step back, slow down and enjoy the summer sun, the dairy markets keep us on our toes. Indeed, the summer doldrums have side-stepped the dairy markets this year and, in my opinion, this is just the beginning of a volatile second half for dairy prices.
It’s not news to say that advances in export demand over the past half-decade are the linchpin of growth for the U.S. dairy industry. Stemming from a confluence of a weaker U.S. dollar, global weather-related production problems and a growing global desire for high-quality dairy foods, the U.S. dairy export market has more than doubled in the past five to seven years from around 7% to a 17% global market share through 2013, according the U.S. Dairy Export Council. According to the recent data, total U.S. exports for January through May of this year are up 16.4%!
The growth has not come easy, however, as ebbs and flows in both seasonality and taste preferences of other nations have made for tumultuous swings at the supply/demand margin and prices. This year, however, the world demand for dairy products not only exceeded our wildest expectations, but more importantly, it led U.S. prices.
Why is reviewing what role — leader or follower — the U.S. dairy markets played in the recent bull market so important to our ability to look forward? Because the world led U.S. prices higher and we ought to expect the world to lead the U.S. lower as well.
Take, for example, the tightness and resulting increase in prices that started in the powder markets and had quickly spread to encompass the entire dairy complex. Grade A NFDM (nonfat dry milk) in Chicago reached a peak of $2.11 in late December of last year. And it wasn’t until March 2014 that we saw the price of U.S. cheese top at $2.4325. And most recently, butter appears to have put in a top at $2.62. The structure was not random but based on the demand for the lead product of NFDM and resulting supply/demand fluctuations for cheese and fat.
Systematic decline of U.S. prices
We look then to the most recent price structure and we see a similar systematic decline of U.S. prices. NFDM was the first to fall and is currently trading around $1.65 with further weakness likely in store. The price of cheese is with 20 cents of $2.00 (as of this writing) again but largely stable over the past two months as domestic buyers continue to refill the pipeline and even pull some fall purchases forward. Finally, the price of butter is pulling up the caboose of the bull market trading over $2.80 a pound!
Meanwhile, international prices are weak and looking poised for more weakness. Month over month price declines since February on the Globaldairy Trade Auction (GDT) platform, our most transparent global price index to date, continue to puzzle market participants.
With the exception of NFDM, which remains quiet and sideways in price direction as we begin August, the dairy markets have served up plenty of summertime activity as U.S. buyers of cheese and butter, in particular, rebuild after the storm of dairy demand and high prices earlier this year.
U.S. products at a premium
The rebuilding of domestic demand has supported U.S. dairy prices as the globe finds cheaper alternatives to U.S. dairy product prices. The United States has shifted to a premium versus world prices, after having been at a discount.
We ought not to expect this de-coupling of the U.S. and international prices to continue forever. All things being equal, we will likely wake up one day and realize the U.S. prices are too high to remain competitive on the world stage. And when that happens, expect more downward price corrections for U.S. dairy markets.
Moving forward, keep in mind that the best hedging decisions are made when you acknowledge that market movements are largely unpredictable and that a hedge should always seek to minimize – not add – physical price risk first and foremost.
David Kurzaswki is a senior broker at FCStone LLC, Chicago. www.intlfcstone.com.