In contrast to their traditional tendency for weakness from late autumn into spring, milk and dairy product prices rallied dramatically during December and January. Indeed, prices remained very strong during February, as exemplified by the fact that the official Class III quote for the month is likely to set a record around $23.20/cwt when it’s released in early March. The price strength seemingly reflects a combination of factors, but it’s rather evident that vigorous demand, particularly from export customers, has been the main driver of the advance.
The USDA’s February Milk Production report had several interesting aspects. The first of those was the persistence of the U.S. herd reductions seen in late 2013. The January U.S. dairy cow population was stated at 9.209 million head, which fell 13,000 below the comparable year-ago figure. The 23-state result actually rose 7,000 from last year, but that obviously did not offset reductions in the other states. The milk production total probably surprised many in the industry by surging 0.9% despite the reduced cow herd. That apparently reflected industry use of higher quality feed after having worked through lesser feedstuffs in late 2013, since frigid January weather was not at all conducive to increased productivity. Milk production per cow rose substantially last month.
As pointed out previously, late-2013 herd reductions very likely reflected annual declines in milk prices as well as poor quality feed and/or environmental conditions, but it has become rather apparent that producers respond most strongly to shifts in the former. The huge drop in feed expenses from late 2012 to the much more moderate quotes of late 2013 and the concurrent decline in herd sizes rather starkly indicated that input costs are of secondary importance. We believe major discounts built into deferred CME milk and product futures greatly discouraged producers late last year, thereby causing them to shelve expansion plans.
Conversely, the winter price rally to record highs will almost surely encourage dairymen to boost production this year. And while the deferred contracts still presage substantial price declines during the weeks and months ahead, the forecast levels are drastically higher than they were last fall. For example, June CME Class III milk futures dipped to $19.87/cwt on February 25, which was almost exactly $3.00/cwt over its November 1 close. Given these circumstances, the dairy industry seems very likely to expand aggressively this year.
Dairy demand still appears stunningly robust. Diminished fourth-quarter 2013 production almost surely boosted prices in late autumn and early winter, but the fact that milk quotes marched to record highs despite resurgent January output exemplifies the demand strength. Recent indications suggest domestic demand has remained quite firm, but export buying still seems to be the real force behind the active offtake. For example, December cheese exports climbed to 68.5 million pounds, which represented a fresh record. It also marked a 48.8% annual surge.
The fact that late-2013 prices were substantially higher than those posted during fall made that increase doubly impressive, as did the fact that wholesale prices moved above year-ago levels early that month. December butter exports posted a 158% rise. The real question facing the industry is how well those exports are holding up in the new pricing environment, especially with products trading substantially above early 2013 values. The industry has to worry about sticker shock.
Bottom line: the diary industry is probably looking at steadily declining prices through 2014, as implied by the latest CME futures quotes. Dairymen seem very likely to boost production in response to the huge price rally seen in recent weeks, especially with feed costs running well below the rates of the past few years. Conversely, the market advance may soon begin taking a toll on demand. Indeed, the milk products industry has to worry that demand will diminish significantly just as the traditional spring flush hits its stride. Such a confluence could weigh heavily upon the market and reverse much of the gain posted since Thanksgiving.