Editor’s note: This market commentary is provided by the Dairy Division at FCStone/Downes-O'Neill in Chicago, Ill.

Class III volume spiked yesterday, nearly doubling Tuesday’s lethargic post-Labor Day trade with 1,419 contracts changing hands. From the start-gate, 2011 Class III had a somewhat weaker bias as buyers found motivating news in short supply. But it wasn’t until sell pressure during the spot session pushed barrels down 3.25 cents that futures lost their footing, trading as much as 50 cents lower intra-day (October). We are seeing that commercial buyer pipeline refill of the past few weeks, which was spurred by the initial decline into the $1.70’s, appears now to be losing steam.

2012 contracts traded mostly mixed. Sell pressure picked up for the first quarter at one point, but commercial buy interest is alive and well next year and ultimately supported all of 2012 yesterday.  Both the memories of a $2 cheese market still fresh on the mind and a $7 corn market outstretched in front of all, has buyers finding the mid-$1.70 price as an attractive price level to layer in coverage for next year.  Meanwhile, producers are using the same reasons for largely not selling. 

One area both buyers and sellers agree on is that the use of options, in general, and option risk reversals (min/max), in particular, make sense.  Eighty-three of the January to December $16.25 puts traded against the $18.25 calls at even money (i.e. puts and calls have an equal premium cost). While the aforementioned min/max represented the lion’s share of the option volume Wednesday, a host of other fences traded for the first half as well as all of next year.

The comment we hear frequently when what appears to be commercial buyers take a noticeable stand with options —or futures — as they did today is: “they must know prices are going to be higher”.  While that would make managing risk a great deal easier for you and us, it is simply not the case.  The only thing we can truly understand from sizeable buy-side hedge interest is that they want to give their commodity pricing some level of certainty.  It is not a market stance as much as it is a way of mitigating the potential price risks for their business.

In following Class III activity, 2011 Cheese futures traded 36 contracts between 0.012 and 0.035 cents lower.  2012 contracts were bid unchanged to 0.009 higher with no trades.  Class IV futures were inactive Wednesday and the only price movement was a 5 cent increase in June 2012.

Overnight class III opened quickly lower with both Oct and Nov losing ground and prices remained that way into the late evening with 47 trades having taken place Oct and Nov remained lower while activity from Aug through Dec 2012 had prices there steady to 1 higher. By morning prices turned mixed across the board from -1 to +1 throughout the complex and volume rose to 64 contracts by 6:45 am.

We look for milk to open mixed to firmer, for spot to be steady to lower and for milk to close lower.

The negative price bias from a sub-$2 spot price Tuesday spilled into butter again Wednesday with both trades and offers pushing prices from 0.500 to 1.000 cent lower in November through March (all else finished unchanged).  The market is on pins and needles to some degree as stories of cream surpluses mingle with discussions of continued large premiums to the world market and the potential for that pricing disparity to draw product to U.S. shores over the coming weeks/months.  Further, while there likely remains some seasonal buy interest, sellers are warming up to the idea that there was more coverage attained earlier in the year. Concern is growing over how far we can fall if the bid steps away.  We expect that 20 or 30 cents over the coming weeks is not out of the realm of possibility. 

Overnight 10 butter contracts traded all in November at unchanged.  We look for Butter prices to open steady.

Grains started firm underpinned with a lower U.S. dollar and another trimming of “good to excellent” ratings posted late Tuesday.  CROPCAST released their corn yield expectations of  145.2 bushels per acre with production of 11.913 billion bushels and soybean yield at 40.3 bushels per acre with production of 2.924 billion bushels.  The trade didn’t seem to care as gains were fleeting and markets gave up their early gains.  The bullish news thus far is priced in and there is more concern surrounding positioning ahead of next Monday’s USDA reports.   

The market now seems to be shaking off bullish news and trending lower even despite outside market support so the market that couldn’t fall seems to be quickly becoming the market that can’t rally. We don’t see this as a reversal of the trend yet but our eyes are peeled as the bullish supply concerns seem to be factored in and the demand deterioration is seemingly yet to come at these high price levels.  We will see how export sales look tomorrow morning because of the shortened holiday week.

Ukraine’s Ag Minister is expecting record wheat (10 million tons) and corn (12 million tons) exports in 2011/12.  Ukraine exported 4.2 and 5.1 million tons last year, respectively. Total grain exports are seen at 24 million tons, double the ‘10/11 numbers.

We look for corn to open 2 to 3 lower, soybeans to open mixed from -2 to +2 lower, meal to open steady to 1 higher and for wheat to open 2 to 4 lower.

Daily CME spot market prices:

Block cheese: $1.79 (unchanged)

Barrel cheese: $1.725 (down 3 1/4)

Butter: $1.995 (unchanged)  

Grade A NFDM: $1.490 (unchanged)

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