CoBank: Cautious optimism prevails

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CoBank issued its Quarterly U.S. Rural Economic Review, finding cautious optimism prevails across the U.S. agriculture sector.

Despite emerging economic weakness in China, turmoil in Ukraine, and severe winter weather in the U.S., the global economy appears to be gaining momentum, according to the report. The prolonged recession has ended finally in Europe, and the impetus for global growth has shifted from China and the emerging markets to the developed economies.

The underlying growth momentum in the U.S. economy has been muted – and clouded – by the severe winter that has impaired consumer spending, construction, motor vehicle sales, inventory adjustments and industrial production. Yet the medium-term U.S. economic outlook still looks robust, with a pick-up in growth expected for the rest of 2014 and 2015. Indeed, reduced debt levels, rising home prices, and steady job and income growth in coming months should support a strong consumer rebound.

U.S. monetary policy will remain accommodative even as the Federal Reserve continues to unwind its quantitative easing initiative, and fiscal policy will also remain accommodative with less fiscal drag and less political theatre since budget and debt ceiling agreements have already been reached. Against this backdrop, the U.S. economy is poised to resume its role as a major engine of growth for the global economy, with the U.S. dollar continuing to strengthen against the major traded currencies.

Record-high animal protein and dairy prices, lower grain and oilseed prices, and steady-to-lower cropland values reflect an agricultural market in transition.

 

Dairy review

For much of 2013, milk powders stole the dairy market headlines. So far this year, it has been the cheese market’s turn to capture attention. The climb to higher prices was swift. From Jan. 1 until Feb. 1, 40-lb. cheese blocks at the CME rallied from $2.02/lb. to a record high of $2.36/lb.. They stayed there just three days. But after falling back into the $2.10-range, the cheese market caught a second wind, establishing a new record at $2.42 on March 19.

Unlike powder stories where plotlines are almost exclusively international, the cheese market tale has a more domestic flavor. To a large extent, Idaho appears to be ground zero. Milk production there has fallen short of expectations, where for most of the second half of 2013, output lagged prior year levels. While Idaho’s production has picked up of late, it still is below what most analysts would expect given current prices and economics. Cow numbers there are down 11,000 head year-over-year (compared to gains of 1,000 in California and 3,000 in Michigan). In short, it is difficult to make more milk if the cow herd isn’t big enough.

The Idaho situation extends beyond the farm. Over the past five years, new plant investment has created increased competition for milk. With Class IV prices topping Class III, milk has been pulled from cheese vats. With flat milk production and increased yogurt and Class IV capacity, cheese plants have been the ones caught short. Moreover, cheese plants in the state have been making less commodity cheddar – the product that matters in the price discovery arena.

Adding further support for cheese prices is a sustained bid from the world market. Export demand remains robust, with U.S. cheese exports reaching a new all-time high in January at 70.8 million pounds. Consequently, Gouda and white cheese production levels have been raised in order to meet this demand. While not just an “Idaho problem,” the net effect is less cheddar with manufacturers positioning themselves to serve the international buyer.

As cheese prices soared, powder prices have plateaued or even, by some measures, lost some ground. Depending on the metric, U.S. prices near the end of the first quarter were not that different from those that prevailed when the year began. Reported USDA prices for the Central States moved just 4¢ higher, leveling off near $2.11/lb. At quarter-end, survey prices were about the same, with the National Dairy Products Sales Report’s weighted average price gaining about 7¢ from January’s $2.03 average.

International markets have softened. European skim milk powder prices have slipped 2.6% since January and now are on par with U.S. values for the first time since December. In addition, whole milk powder is also down 1.5%. Prices in New Zealand followed suit. On the GlobalDairyTrade (GDT) bi-monthly auction, the price of skim milk powder slipped 2.2% while the price of whole milk powder fell 10%.

Meanwhile, the butter market has lingered somewhere in between. Butter prices have rallied to be sure, with spot values at the CME now hovering around $1.90/lb., up 20¢ since the start of the year. Exports remain an on-going theme, given about a 30¢ price gap between the U.S. and prevailing world markets.

 

Markets with benefits

While end-users lament the current high prices, producers couldn’t be more pleased. Dairy farmers worldwide are realizing some of their highest all-time returns. In the U.S., the all-milk price averaged $24.70/cwt. in February, beating the previous record by $1.20. And with the underlying commodity markets moving higher since then, the March and April numbers seem poised to ratchet still higher. The U.S. all-milk price has exceeded the $20 mark for the past six months.

At the same time, dairy producers have also been realizing benefits on the cost side of their ledgers. Despite some firming in the grain complex of late, feed costs have plummeted relative to previous years. Using a representative ration, U.S. dairy feed costs are averaging $9.00/cwt., well below the $11.00 average in 2013. This lower cost basis should insulate producers from any correction in milk prices for the foreseeable future, and dairy producers probably won’t be worrying about margin pressures until late in the year, at the earliest.

 

Riding a global tidal wave

U.S. dairy producers are making money today at a pace never seen before. However, those dollars are beginning to stimulate more supply. Western and southwestern dairies that used to stand empty are being repopulated. Greenfield construction is underway in some regions, and expansion projects are moving hurriedly from concept to reality. Culling has slowed to a pace not seen in five years, and higher margins are encouraging producers to boost feed quality and ingredients to maximize milk per cow. Unsurprisingly, February milk production topped year-ago levels by 1.1% (the largest year-over-year gain since October). Dairy farmers are just getting started on rebuilding their herds, however, as cow numbers were steady month-to-month and still 12,000 head below last year.

New Zealand output quietly remains strong, with production through January up 6% on a season-to-date basis. Some well-timed rains in March kept pastures green enough to hold more cows in milk later in the season than just one year ago. Stockpiles of feed from earlier in the season should also help bolster milk production as the season begins to wind down.

 

Not quite enough

Despite the rosy supply-side outlook, surplus product is currently hard to find. Exports have played a role here so far, with any excess easily placed into the world market. Such placements were much easier, however, when U.S. prices were at a significant discount to Europe and Oceania. Now, with that pricing advantage all but gone, it remains to be seen how much new business will come to the U.S. when both Europe and New Zealand have product to offer.

Higher prices are curbing domestic demand too. Cheese, milk and other dairy products are being moved to higher grocery store shelves as promotions and trade spend are being cut. It just doesn’t pay to promote cheese with the wholesale price hovering near $2.50/lb. Fluid milk prices are also creeping higher, as manufacturers tie their selling price back to the monthly USDA price. And, when fluid milk prices climb to current levels on a per gallon basis, it’s not surprising to see a large swath of consumers back away, with declining sales the result.

 

Where to from here?

The data point increasingly to a market moving from one of shortage to one of surplus. Milk production is moving higher, and sales have started to slow. With whole milk powder prices – the leading indicator for global markets – down about 10% year-over-year in the first quarter, it seems safe to say that the bull-run has come to an end. Anecdotally, slower offtakes from Asia are a commonly cited cause. Either China’s needs have been met, at least for now, or potential buyers have moved to the sidelines waiting for lower prices before restocking.

In any event, “uncommitted” product is starting to emerge and will be used to rebuild depleted inventories. If buyers have enough of what they need with no desire to buy any more at current prices, then it will just take a little excess to quickly pressure prices lower.

However, there are still concerns. While recent rains have eased the situation a bit, California’s drought will limit local forage availability later this year. As producers reach beyond the state to find feed, their costs will go up and those high margins will start to erode. It could easily take until late 2013 before those impacts affect milk production, but it is a concern for producers and end-users alike. Also, the persistent cold and snow across the Midwest and Northeast could mute the usual “spring flush.”

To read the full report, click here. Visit www.cobank.com



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