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

We’ve got milk…. and how! 

We know producers have had just about as hard a time as anyone during the economic recession.  We know that producers today have faced challenges to staying in business over the past 18 months that may not be seen by their next generation – or the one after that.  What we don’t know is how milk production increased by 2.4% nationwide after such a time of profit demise. One respected customer and friend suggested two plausible ideas: (1) producers will push capital investment when the futures board shows $14.00/cwt on the horizon as Class III has done since the beginning of the year, and (2) producers are doing their best to build a milk production base at any cost with the expectation that a supply management program will be implemented next year. There are likely many layers to the production increases, but those are two motivating factors we agree with that have not received much attention.

So, we’ve got a bearish report – what does it mean? 

The impact of such a report may be watered down due to the current strength of the CME spot market.  This morning (July 20) our “take” has not changed. Continued tightness in cream, a tightening of available fresh cheese and hot, humid weather in July has not changed overnight and will likely continue to trump the mild milk producing weather in June.  We looked for a weaker overnight Class III trade and that has not really happened.  We’ve been both sides of unchanged in a very light trade so far. We expect that, short of having a material drop in CME spot cheese, this bearish report may be shrugged off by traders in favor of the more immediate influences of spot cheese and butter markets.

To put the fundamentals of the Class III and butter markets aside, the technical structure of both futures markets is bullish. Both Butter and Class III futures markets are backward dated.  In other words, the nearby futures are running a premium to the deferred contracts. When that happens, the structure of the market is suggesting more price strength regardless of what we think. This is not a reason to throw caution to the wind, but it is on our radar. And if the dairy futures complex can finish higher after yesterday’s surprising production numbers, market bulls will have the upper hand.

The corn market turned lower yesterday and the bullish talk that pushes a weather market up subsided. Talk of wide-spread rain across much of the Corn Belt quelled talk of Russian drought concerns. We think there is about 50 cents of weather risk premium built into corn prices and probably another 20 cents of speculative froth. This doesn’t mean prices can’t go up, but we expect them to recoil here and as they do we will study the pullback. We’ve talked to many dairymen over the past few days and urged them to turn their back on buying feed needs right now. It is not the time of year to accumulate any long-term contracts. Look for corn to open 3 to 5 cents lower on follow-through from the overnight session.

http://www.cmegroup.com/daily_bulletin/Section04_Agricultural_Soft_AltInvestment_Futures_2010137.pdf

7/19  Class III Futures:   Volume:  484  Open Interest (OI) Change:  +122  Total OI:  27,701

7/19  Class III Options:   Est. Put Volume:  193   Total OI:  19,701   Est. Call Volume:  180  Total OI:  18,276

7/19  Spot Markets:   Block Cheese $1.5775 (UP 1/4),  Barrel Cheese $1.5250 (UNCH),  Butter $1.78 (UP 1/2),  NFDM: A $1.2175 (UNCH),  X $1.2250 (UNCH)

7/19  Other Dairy Futures Volume:   Butter:  3  Dry Whey:  1   NFDM: 34    Class IV:  3   Cheese:  0

7/19 Individual Cheese Futures Prices, Change, Volume & Open Interest
Jul           $1.456     UNCH                Vol:    0                    OI Change:  UNCH
Aug         $1.587      UNCH                Vol:    0                   OI Change:   UNCH
Sep         $1.595      UNCH                Vol:    0                   OI Change:   UNCH
Oct          $1.595      UNCH                Vol:    0                    OI Change:  UNCH
Nov         $1.58        UNCH                Vol:   0                     OI Change:  UNCH
Dec         $1.58        UNCH                Vol:    0                    OI Change:  UNCH

7/19 Individual Class III Futures Prices, Change, Volume & Open Interest
Jul           $13.75     DOWN 1            Vol:  10                   OI Change:      UNCH
Aug         $14.92     UP 2                   Vol:  180                 OI Change:     DOWN 14
Sep         $15.00     UP 2                    Vol:  168                OI Change:     UP 81
Oct          $14.92     UNCH                Vol:  27                   OI Change:     UP 8
Nov         $14.70     UP 2                    Vol:  23                  OI Change:      UP 2
Dec         $14.72     UNCH                 Vol:  37                 OI Change:      UP 6
Aug-Dec 2010 Avg:  $14.85                                       UP 0.01/cwt
Jan-Dec 2011 Avg:  $14.59                                         UP 0.01/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