Exports won’t sustain high milk prices in 2008
If you are counting on export demand to sustain $23 milk prices in 2008, you had better think again, says Wells Fargo economist Michael Swanson.
While U.S. dairy exports are important, it’s crucial to understand which players matter in the global marketplace, Swanson says. China may dominate the headlines, but it’s Mexico that moves the market for U.S. dairy exports.
Even so, Swanson cautions against expecting those two markets to support high milk prices in the coming year. In fact, he doubts whether 2008 exports, or even domestic demand, can sustain 2007’s high milk prices.
“We need a strong justification for continued $23 milk sales,” Swanson says. “If you’re reluctant to sell futures below $20 because you think prices will go higher, you should review the statistics.”
That demand concern, and a tendency for dairy prices to return to long-term levels, leads Swanson to see $18 as a more attractive milk marketing level for 2008.
Although dairy exports only account for about 4% of U.S. dairy sales on a dollar basis, Swanson doesn’t discount the role of exports in the U.S. dairy market.
“However, there are some stumbling blocks with key markets,” he says.
China, with its burgeoning 1.3 billion population, is a large market with a fast-growing economy. Yet, in 2007, only 5% of U.S. dairy exports headed to the Asian giant. In contrast, a hefty 28% of U.S. dairy exports made their way to the Mexican market.
China, Swanson says, is determined to remain self-reliant as a food producer. It doesn’t want to be a net importer of food. As a result, “China’s not interested in buying our ag products,” Swanson says.
Moreover, China is working hard to boost its own milk production. In the last 10 years, that’s jumped by 407% due to strong gains in herd size and productivity. Mexico’s milk production has risen only 28%.
When it comes to exports, no country matters more than Mexico. It tops the list in every U.S. dairy export category. In 2007, Mexico’s food imports rose 19% over 2006, while China’s climbed only 2%. Mexico also ranks No. 2 behind Canada in U.S. exports of manufactured foods. “This makes sense given the NAFTA [North American Free Trade Agreement] framework and lack of logistical infrastructure inside Mexico,” Swanson says.
Mexico also lacks arable land, and its government doesn’t support a modern approach to dairying, Swanson says. Mexico’s population of 100 million is smaller than China’s, and its economic growth rate slower. But its proximity to the U.S. and demand for U.S. ag products make it a huge market. Mexico also has higher per-capita income at $6,000 compared to China’s $1,700.
Mexico’s volatile economy, however, makes the country a precarious export market. Much of Mexico’s food production programs are subsidized by its oil production revenues. The Mexican government is predicting oil prices at $80/barrel. But a price drop, even to $60/barrel, could reduce Mexico’s food subsidy programs, creating a major export risk for the U.S. dairy market.
Where does that leave U.S. dairy demand? “Without a strong climb in exports, the U.S. dairy consumer will need to pick up the pace,” Swanson emphasizes. He’s just not sure that will happen.
The 2% growth in the nation’s dairy output in 2007 requires strong offset through consumption. Per-capita dairy consumption in 2008 would need to increase by a sizeable 2.9% over 2007. That’s unlikely, given the 1% population growth in the U.S. That consumption imbalance could rein in dairy prices in 2008, says Swanson, who’s also bearish on corn prices for the coming year. DT
No home-front recession
The U.S. economy remains fundamentally strong as it enters 2008, despite this year’s widely reported housing slump and stock-market turmoil, says Wells Fargo economist Michael Swanson.
“There’s a big disconnect between the nation’s growth and what we’re seeing on the nightly news,” he says.
The nation’s economic strength is spread out over so many places that it doesn’t make for an easy story for the news media to tell, Swanson says. But, in fact, the U.S. economy will see modest growth, not recession, in 2008.
Economic doomsayers who predict a U.S. recession don’t have historic trends on their side. The U.S. has only experienced recession 5% of the time over the last 20 years; normally, the country is in expansion mode. And late 2007 reflected that.
“The third quarter of 2007 saw an extremely strong gross domestic product [growth] rate of 5.2%,” Swanson says.
The consumer is the biggest force in today’s economy, he says. Most Americans don’t possess wealth, but steady employment keeps consumers’ role strong. “Employment is the No. 1 driver of consumption,” Swanson says. “Will people keep their jobs? Yes.”
Moreover, it’s the business cycle that rules, not the much-publicized housing downturn. Consumer and government spending, as well as business investment-all key economic drivers-will remain strong in 2008, Swanson says.
The housing market’s troubles stem mostly from adjustable rate mortgage (ARM) problems, not sub-prime woes. Even so, ARMs account for just 6% of home loans. The far bigger share, 57%, is found in fixed rate mortgages, which aren’t a problem. A surprising 34% of Americans don’t know what kind of mortgage they have. Swanson believes the debt market has been hurt, not crippled. “Housing is over-priced, not over-built,” he says.
The dollar losses sustained in the housing sector have been more than offset by improvement in foreign trade, which has been helped by the weakening U.S. dollar. The greenback stands at a 40-year low. Interest rates have reached their lows at 4.5%, Swanson adds.
Overseas overview
- U.S. dairy exporters can continue to expect more demand from Mexico than from China.
- Mexico’s economic volatility presents a number of market risks.
- Read more at: www.wells fargo.com/com/research/ economics/agriculture/index.
