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

U.S. markets rallied Wednesday as the Federal Reserve announced that it will stick to easy street, keeping interest rates low for an “extended  period” with  Chairman Ben Bernanke stating that he’s “not sure” when the Fed will tighten rates and that bond buying will continue although there will not be a QEII.

Class III moved sharply higher in the front months yesterday as traders were encouraged by increases in both the blocks and barrel prices, rather unexpectedly many might say. Prices were up 13 to 22 cents from May through July, while the rest of 2011 was steady to 5 cents higher. Class III had been carrying a premium to spot and we needed to see spot rise to even keep futures prices were they were at let alone push Class III higher.

With barrels moving 3.5 cents higher to settle ½ cent above blocks, some traders got long in Class III higher under the assumption that the inverted block/barrel spread will revert to historical averages (with blocks 3-5 cents above the barrels) via higher prices in the blocks. This remains to be seen and volume was relatively light (again, continuing the months trend) with only 623 contracts traded.

The USDA released its annual “Dairy Products” report for 2010 yesterday afternoon. Total cheese production increased 3.6 percent, an increase of 362 million pounds from 2009, marking the 10th straight year that cheese production has increased year over year. Weekly cold storage reversed last week’s decline of 0.7 percent by increasing 0.7 percent to 126.503 which is still 4.1 percent below a year ago.

Class IV futures traded only 13 times yesterday and price with all of the action in August through December where prices were mostly 9 to 24 cents higher. All other months were unchanged. The price disparity between 2011 and 2012 continues to widen, with the second half of 2012 being at almost a $6 discount vis-à-vis the same months in 2011.

Cash settled cheese traded seven times electronically but 97 total; 90 of those trades were either EFR’s, block trades or some other ex-pit transaction. Prices nudged up in May but were unchanged in all other months.

We expect Class III to open mixed.

Cash butter futures saw 136 contracts traded yesterday with prices up strongly 1 to 2.50 cents in every month from May 2011 through March 2012. Hedgers appear to be underpinning the price strength, now showing a belief that prices might stay at current levels or higher for an extended period- at least until these increases eat away at demand. The move was led by the spot butter market jumping 1.250 cents to 2.0150 on 2 trades and perhaps more importantly leaving 3 bids. There remains demand at these price levels and buyers are concerned that butter could break out with a strong move to the upside. One friend recently forecast $2.40 by September 2011.

We look for butter futures to open mixed.

While the collapse in the U.S. dollar following the Fed’s meeting and Bernanke’s first-ever news conference drove almost every commodity sky high (silver was up almost $3!), grains sold off strongly, as they had already been under severe pressure prior to any Bernanke news. Old crop corn fell 13.5-14 cents while new crop was off 8.50 cents. Soybeans fell 4.75-6.25 cents, and wheat fell 34.25 to 35 cents. Many observers are calling the sell-off weather related due to pockets of dryness that should help producers increase the pace of plantings.

One outside factor we would like to point out is the potential cotton impact on commodity prices. It was cotton prices that lead the commodity bull charge beginning last July. Market leaders in one direction usually signal the turn as well. Cotton prices peaked recently at just shy of 2.15, they have suddenly plunged lower to 1.48. This could herald a dip for the broader markets as cotton led the move up and it might very well lead the move down. Thus there is a case to be made to make sure and buy puts under any forward-contracted corn.

We look for corn to open 3 to 5 higher, beans to open 9 to 12 higher, meal to open 4 to 5 higher and for wheat to open 2 to 3 higher.

Daily CME spot market prices:

Block Cheese $1.6050 (Up 1/4)

Barrel Cheese $1.6100 (Up 3 1/2)

Butter $2.0150 (Up 1 1/4)

Grade A NFDM: $1.6100 (no change)

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