Editor’s note: This market commentary is provided by Dave Kurzawski, risk-management consultant with FC Stone/Downes-O’Neill, Chicago, Ill.

Class III traded firm early yesterday as prices sorted out the unusual pre-holiday weekend sell-off of last week. If the market takes off 50 cents, it is not uncommon for prices to “give-back” 20 or 30 cents as it did on Tuesday. The surprise, however, is that we continue to run a healthy discount to the CME spot market.  Given the calculus of CME spot product pricing, Class III futures in general could be — and the March contract should be — well north of $19 per hundredweight. They are decidedly not. Look for a mixed open this morning.

Looking a little closer, we note that open interest figures for these nearby contracts of March and April have been acting funny lately.  During Friday’s sell-off — a sell-off that was touted as primarily long-liquidation of contracts — open interest in both March and April rose by more than 50 cars a piece. More interesting than that, however, is that open interest during yesterday’s bounce was up a paltry six contracts in March and down 62 contracts in April. The pattern of building open interest on price rallies is slowing or changing entirely, and that may speak to the continuation of a corrective downward trade for Class III.

From a fundamental standpoint, we continue to hear that fresh cheese remains tight and it is clear that buyers find their way to the CME daily lately. But, at some point, we need to reconcile these bearish USDA numbers we keep getting.

The USDA Cold Storage Report released yesterday showed American cheese inventories are at 639 million pounds, up 8.6 percent from last year. Total cheese stocks again came in above 1 billion pounds with an increase of 7.1 percent. A downward revision of 2 million pounds of American cheese in last month’s report is hardly enough to shake the bearish numbers we’re looking at here for cheese.

The CME spot butter market is finding support here at $2 per pound and seems to be comfortable with that price for the time being. Futures, too, were mostly stable again Tuesday albeit at discounted prices. USDA Butter inventory numbers released in yesterday’s Cold Storage Report were down 29.2 percent at 118.9 million pounds.

What were relatively mixed days for Class III and butter, was a steady to weaker day for NFDM and dry whey. Both posted losses yesterday with the May NFDM contract closing down limit (2.50 cents lb.). This may have been a one-off corrective move by traders looking at the world around them desiring to exit the market, or it may speak to a larger downward corrective period we have been harping on lately. 

Soybeans and wheat had already started a slight corrective trade last week, but corn pushed fresh highs overnight Monday and then lost footing amid further tensions in the Mideast, turned lower and closed limit down by the end of Tuesday’s session (along with wheat and soybeans). Often times, a worried market is one that will move higher, but in this case the markets are really more concerned about inflation stemming the tide on global economic recovery. Look for further weakness on the grains to start the day in-line with the overnight trade.

Interesting note: The Federal Reserve Bank of Chicago reported a 12 percent rise in U.S. Midwest farmland values in 2010, the second-largest annual gain in 30 years.
2/22  Class III Futures:   Volume:  2,665 Open Interest (OI) Change:  +76  Total OI:  39,840
2/22 Class III Options:  Est. Put Volume: 941 Total OI:  38,363  Est. Call Volume:  381  Total OI:  27,117
2/22  Spot Markets:   Block Cheese $1.9825 (UP 2 3/4, 3 Trades); Barrel Cheese $1.9450 (UP 2 3/4, 0 Trades)
Butter $2.0050 (UNCH, 0 Trade); NFDM: A $1.8300 (UNCH, 0 Trade), X $1.8025 (UP 1/4, 0 Trade)
2/22 Other Dairy Futures Volume:   Butter:  28   Dry Whey:  16  NFDM:  42   Class IV:  9  Cheese: 17  International SMP:  0 

2/22 Individual Class III Futures Prices, Change, Volume & Open Interest

Feb 11     $16.98                 DOWN 1               Vol:   92                OI Change:     UP 6
Mar 11    $18.77                UP 26                    Vol:   508             OI Change:     UP 6
Apr 11     $18.15                 UP 9                       Vol:   452              OI Change:     DOWN 62
May 11   $17.89                 UP 4                       Vol:   268             OI Change:     DOWN 36    
FEB-June 2011 Avg:     $17.84             UP 0.05/cwt
July-Dec 2011 Avg:      $17.02              UNCH
FEB-Dec 2011 Avg:       $17.39              UP 0.02/cwt

These data and these comments are provided for information purposes only and are not intended to be used for specific trading strategies. Commodity trading is risky and FCStone Group, Inc., International Assets Holding Corporation, and their affiliates assume no liability for the use of any information contained herein. Although all information is believed to be reliable, we cannot guarantee its accuracy and completeness. Past financial results are not necessarily indicative of future performance. Any examples given are strictly hypothetical and no representation is being made that any person will or is likely to achieve profits or losses similar to those examples. References to and discussions of exchange traded products are made solely on behalf of FCStone, LLC. References to and discussions of OTC products are made solely on behalf of INTL Hanley, LLC, and OTC products are only available to eligible counterparties.

Source:  FCStone/Downes-O'Neill