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

The Class III market trimmed Monday's gains slightly yesterday as the trade lost inspiration to push higher on a lackluster CME spot cheese trade and a weaker dry whey futures trade. Although the futures market was supported into Q1 of 2012, buyers cooled Monday's more aggressive approach and volume slowed to 1,453 contracts. Overnight, the trade was mixed and we look for a more mixed trade early this morning.

Despite a set-back for AMF prices, which fell 2.4 percent from two weeks ago, Fonterra's dairy price auction index registered a record high since its inception in July of 2008, driven by whole and skim milk powder. The cheese trade was steady to firm, but is losing momentum as the CME spot block price rose .25, while the barrel price held its ground at $1.90 in the face of selling interest. Three loads of barrels traded for the first time in six sessions.

Cheese -– largely the aged variety -- is freeing up at these loftier levels. We have been asked by many if prices are high enough to ration usage. Although most analysts think there is little rationing happening, the vigor that brought dairy product prices in general -- and cheese specifically -- to these unseasonable levels looks to be slowing dramatically. 

While it is clear we've filled some need for cheese supply to the world lately, history shows that even our most valiant efforts to be a mainstream, routine supplier of product falls on some deaf ears when the price gets too high. There is a good deal of nuance to international buyer preferences and -- in general -- we match up with their needs when the price is right.

Export deals, however, are still being done and the CWT program appears to be working overtime, having announced the sale of 3.6 million pounds this week. But should a more stable $1.90 cheese market falter, we expect U.S. buyers, too, will set down their phones for at least a short period of time to let the market retract. And Class III would then be vulnerable to a sell-off regardless of the fact that it is already pricing in a discount to spot.

One of the main reasons we could see a mid-first-quarter correction in dairy pricing is butter. Butter is the commodity that led the complex higher, and then it sat quietly watching the rest of the dairy prices scramble to more or less "catch up." With only a handful of trades during the past month, the price is finally moving and it is going down. CME spot butter has softly moved 3 1/2 cents lower since Friday and without a bid in sight. There may be a bid out there, but I wouldn't count on it until offers are below the $2.00 mark.  

To be clear, the overall fundamentals of butter are not bearish, by any means, as stocks to use ratios remain very tight. But buyers who are staring down a $2.00 price ahead of the U.S. milk flush appear calmed and ready to step back. CME butter futures, which like Class III have kept a safe discount to these unusually higher spot prices, also traded slightly lower Tuesday. Look for a mixed-to-lower trade early today as well.

While we see the potential for further declines in butter, NDM remains well bid in the mid- to high-$1.70 price range. The NDM bid translates into continued strength in Class IV prices, which now find the April through July contracts trading solidly above $20 per hundredweight. That $20 market may be under some assault, however, under some additional pressure from butter as we roll out pricing February and into the March NASS pricing in about a week. Look for a mixed-to-firm opening on NFDM and Class IV.  

Grains sold off aggressively yesterday on the heels of some push-back on soybean purchases, mixed with news of the USDA increasing U.S. corn planting expectations by 4.3 percent from previous estimates.  Further, according to an early Dow Jones news story this morning, a senior Beijing-based grains economist stated that China’s corn imports in 2011 may not exceed last year’s level of 1.6 million metric tons. Grains are lower again this morning. Early call is for corn to open three to five cents lower and soybeans to open seven to 10 cents lower.

2/15  Class III Futures:   Volume:  1,453 Open Interest (OI) Change:  +454  Total OI:  38,562
2/15 Class III Options:  Est. Put Volume: 1,110 Total OI:  35,645  Est. Call Volume:  719  Total OI:  26,837
2/15  Spot Markets:   Block Cheese $1.9375 (UP 1/4 , 1 Trade); Barrel Cheese $1.9000 (UNCH, 3 Trades)
Butter $2.0650 (DOWN 1 1/4, 0 Trades); NFDM: A $1.7975 (UP 1/4, 0 Trade), X $1.7750 (UNCH, 0 Trade)
2/15 Other Dairy Futures Volume:   Butter:  75   Dry Whey:  20  NFDM:  17   Class IV:  65  Cheese: 61  International SMP:  0 

2/15 Individual Class III Futures Prices, Change, Volume & Open Interest

Feb 11     $16.96                 UNCH                    Vol:   27                OI Change:     UP 16
Mar 11    $18.77                UP 4                       Vol:   460            OI Change:     UP 102
Apr 11     $18.65                DOWN 2               Vol:   293             OI Change:     UP 182
May 11   $18.23                 DOWN 7               Vol:   233             OI Change:     UP 55     
FEB-June 2011 Avg:     $18.10              DOWN 0.10/cwt
July-Dec 2011 Avg:      $17.11                DOWN 0.02/cwt
FEB-Dec 2011 Avg:       $17.56              DOWN 0.02/cwt

These data and comments are provided for information purposes only and are not intended to be used for specific trading strategies. Although all information is believed to be reliable, we cannot guarantee its accuracy and completeness. Commodity trading involves risks, and you should fully understand those risks before trading.

Source:  FCStone/Downes-O'Neill