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

Class III finished sharply higher on Friday after sustaining sharp losses for the bulk of the shortened holiday week. Perhaps the correction is over. But the price increases Friday appear to be built on weaker buying as short-covering (likely some profit-taking) was a main reason for the end-of week rally. Open Interest was flat to lower — not higher — in the lead months of March to May. Buying, however, continued overnight Sunday, pushing prices to as much as 30 cents per hundredweight higher on healthy volume Sunday night. Look for the overnight rally to fade some to more of a mixed open, however, as the trade begins today.

We have been asked if commercial buyers increased their hedging activity during last week’s price weakness. The Commitment of Traders Report released on Friday indicates that commercial buyers have increased their Class III hedges, but it was not necessarily during last week’s price weakness. The latest report compiles “who is doing what trade” data as of Feb. 22; it reports activity largely from the prior week when panic was more palpable and buyers were more desperate to “just get coverage.” So, we expect that commercial buying activity is prevalent, but that it was not the cornerstone of last week’s trade.

So long as cheese stays steady to firm, commercial buyers will seek coverage and producers will cool down selling. The CME spot cheese market was mostly steady to slightly firm last week and trading volume thinned. The block price is nearly at $2, and while we expect the trade to print that price very shortly, we are uneasy as to the sustainability of the underlying fundamentals that got us here.

While milk has shifted from Class III to Class IV so far this year, tightening fresh cheese supply, the butter/powder markets all finished the week sharply lower. While the supply/demand equations for NFDM and dry whey are still tight and firm for prices, the market sentiment is perhaps becoming more mixed. We’ve found some support in butter lately, but butter futures have no problem trading lower still. And cream sales are sluggish. Moreover, the U.S. economy isn’t as strong as we thought it could be. 

Last week, it was reported that U.S. GDP growth for Q4 of 2010 was revised down to 2.8 percent from 3.2 percent, which is well below expectations of 3.5 percent. The U.S. economy is not growing as fast as it should and that should be on everyone’s radar. While weak U.S. dollar policies spurred exports and helped get us here, poor U.S. demand may be the market’s undoing during the next few months. At the very least, it should lead to more price volatility going forward.

Keep your eyes on the U.S. dollar here this week.  But, as unrest continues in North Africa and the Middle East, there may be a turning bullish tide of the U.S. dollar in March. Dairy market participants will also look towards this week’s Fonterra Auction (released tomorrow morning) and the USDA International Prices to be released Thursday for further fundamental direction. 

Grain prices skyrocketed Friday on strong export demand for corn and further talk of an overall view of export business. At the Ag Outlook Forum in Washington D.C. Friday, Ag Secretary Tom Vilsack led the Friday morning discussion with the statement, "The gas pedal is down to grow U.S. demand for grains and livestock by increasing exports.”

Look for corn to open mixed and soybeans to open 5 to 10 cents per bushel lower on light news this morning.
2/25  Class III Futures:   Volume:  2,160 Open Interest (OI) Change:  +64  Total OI:  40,337
2/25 Class III Options:  Est. Put Volume: 492 Total OI:  39,060 Est. Call Volume:  823  Total OI:  27,621
2/25  Spot Markets:   Block Cheese $1.9875 (UP 1/4, 2 Trades); Barrel Cheese $1.9500 (UNCH, 0 Trades)
Butter $2.0200 (UP 1, 3 Trades); NFDM: A $1.8300 (UNCH, 0 Trade), X $1.8025 (UNCH, 0 Trade)
2/25 Other Dairy Futures Volume:   Butter:  69   Dry Whey:  27  NFDM:  149   Class IV:  100  Cheese: 37  International SMP:  0 

2/25 Individual Class III Futures Prices, Change, Volume & Open Interest

Feb 11     $17.07                 UP 7                       Vol:   182              OI Change:     UP 100
Mar 11    $19.07                UP 34                    Vol:   310              OI Change:     UNCH
Apr 11     $17.81                UP 66                    Vol:   473             OI Change:     DOWN 167
May 11   $17.33                 UP 42                    Vol:   325              OI Change:     DOWN 66   
FEB-June 2011 Avg:     $17.65             UP 0.37/cwt
July-Dec 2011 Avg:      $16.92              UP 0.13/cwt
FEB-Dec 2011 Avg:       $17.25              UP 0.24/cwt

These data and 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