Dairy futures have been anything but calm. In just three weeks, prices across Class III, Class IV, cheese, butter and nonfat have surged, then whipped back and forth enough to exhaust even full-time market watchers.

In this episode of The Milk Check, Ted Jacoby and the T.C. Jacoby & Co. team break down why dairy futures can look irrational, even when the underlying fundamentals haven’t changed much.

• What’s driving the chaos (beyond fundamentals)
• Short squeezes 101: how a crowded short can turn into a domino effect
• Flow first, narrative second: why the buying often hits before the story shows up
• Realized vs. implied volatility: what the market did vs. what the options market is pricing in
• Why nonfat may be the center of the storm: the team debates whether this is a true regime change
• Why butter and cheese moved too: how spread relationships and algorithmic trading can drag correlated dairy contracts higher
• Spot market feedback loops: how NDPSR-linked spot markets can amplify futures moves (tail-wagging-the-dog dynamics).
• What usually happens next: why squeezes rarely park at the top

Plus: stick around for a director’s cut featuring the unedited, behind-the-scenes debate the team usually leaves on the cutting room floor.

Got questions?

We’d love to hear them. Submit below, and we might answer it on the show.

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Ted Jacoby III: [00:00:00] It has been wild and crazy every day for the last three weeks.

Welcome to the Milk Check from T.C. Jacoby and Company, your complete guide to dairy markets,

from the milking parlor to the supermarket shelf. I’m Ted Jacoby. Let’s dive in.

We’ve got a special treat for you this week. We’re gonna drop the director’s cut of this podcast where we include some of the conversations that usually get edited out: how we debate internally about some of these market dynamics. So, stay tuned after the end of the podcast and listen to the off-takes.

My name is Ted Jacoby, CEO of T.C. Jacoby & Co., and joining me today is Jacob Menge, our Vice President of Risk Management and Trading Strategy, Josh White, our Vice President of Dairy Ingredients, and Joe Maixner, our Director of Sales. We are in week three of a very high level of volatility in the dairy markets.

We’ve had a very interesting last few weeks. It’s February 9th, and since January 15th, our Class III March futures are up 18%. Our [00:01:00] March cheese futures are up over 15%. Butter futures are up over 26%. nonfat futures up 37% and Class IV milk futures up 36%. These markets have not gone up in a straight line.

There’s been a massive amount of volatility, a lot of green, a lot of red, and then a lot of green, and then a lot of red again, enough to make all of us who talk these markets on a daily and an hourly basis to be flat out exhausted. The question becomes, what’s causing this level of volatility?

 We are gonna talk a little bit about market psychology. Why can markets do what they’ve done in the last three weeks, and why our actual fundamental market analysis hasn’t really changed that much.

 To quote the famous British economist, John Maynard Keynes, “Markets can remain irrational far longer than you and I can remain solvent.” And I’ll tell you that the last three weeks reminded me repeatedly of that phrase. It serves as a warning against over leveraging or trying to fight the tape, trading against trends, suggesting that just because you are right about a trend’s [00:02:00] long-term direction, it’s useless if you run out of capital.

Ted Jacoby III: And I have a feeling that based on what we’ve been experiencing lately, there’s probably a few people out there that exactly that happened to. It has been wild and crazy every day for the last three weeks. Jake, why do markets do this?

Jacob Menge: You threw out your little soundbite anecdotes.

We will pull out some more of ’em during those podcasts, I’m sure, because those are all written by people that have been burned by short squeezes like we’re seeing, right? One that sticks out to me is: volatility is the tax you pay for liquidity and leverage, and that’s what futures markets are, right?

They are a way for people to express their opinion on price action. Obviously, even a hedger is in some way expressing an opinion using futures or options. They’re highly liquid. You don’t even have to pay full price for ’em because you only gotta put up that margin upfront.

And again, volatility is usually the tax that you pay for that. When you have this easy leverage, and everybody can get on one side of the boat you can’t have your cake and eat it, too. You can’t [00:03:00] have tight spreads, you can’t have the leverage and smooth prices all at the same time.

And that can result in things like short squeezes. We were primed for one. You’re right, we had low volatility. We had a lot of people that were short the market because that was the prevailing narrative. As a result, all it took was one little spark to set some pretty dry kindling ablaze.

That’s exactly what we saw, especially on the nonfat side.

I’ll pull out my second anecdote. I’ve always heard: squeezes are flow events first, narrative events second. That’s exactly what was going on with nonfat. Meaning we get this massive bullish order flow coming in.

The market goes up 30%+ in a few week period, and it’s only after that happens that all of a sudden we start having these conversations of, well, what was everybody missing in nonfat? I think the market probably was missing something on the nonfat side. But at the end of the day when you have volatility near lows, volume that was [00:04:00] fairly average, it makes sense that really the only way to go is gonna be up. If there’s any kind of news. And the news this time turns out there’s a whole lot less nonfat out there than people probably expected. And away we go. And it turns into this snowball

where there’s the first people to see that and start wanting to buy, and the second they start wanting to buy, turns out there’s not a whole lot of sellers there, because everybody that wanted to sell already had sold. You get that first nice air pocket jump higher.

That really is that first domino where if you’re a market maker, say, and you need to hedge your book, you’re trying to run a delta neutral trading book as a market maker, you might say, “Okay, well hey, I need to go get some long delta myself.” And you might go try to buy some options, to buy calls, to offset that.

And then all of a sudden the market maker that is selling the calls want more for the calls than they wanted just a day ago.

Ted Jacoby III: A day ago? Try an hour ago.

Jacob Menge: Yeah, an hour ago. Truly. And so [00:05:00] that would be what we call implied volatility. Right. And I think that’s one important distinction here is we have volatility, what we call realized volatility, which is what the market actually did, like how crazy the market is, and then implied volatility, basically what the market is charging for options usually and implying what the market thinks the volatility will be in the future. And that’s where it gets really fun because even though we didn’t have a lot of realized volatility, if the market thinks it’s gonna become volatile and starts charging more for these options,

it can almost be a self-fulfilling prophecy, right? Because now you have to pay more to buy that insurance policy, and you can see how that snowball really can grow fairly fast. We have one other really

 fun part in dairy markets that I can’t help but mention, and that is that we also have spot markets.

Those spot markets indirectly are linked to the futures prices because of our National Dairy Products Sales Report (NDPSR) system. And so we [00:06:00] can really wind up with the tail wagging the dog in our futures markets and in our spot markets where, say the spot markets were driving the ship on the way down.

People had a lot of products, they’re selling them. Well, all of a sudden, if we start getting a little bit of a squeeze in our futures markets, now if you have product, you don’t wanna sell it on the exchange, you wanna just hold onto it and capture the carry in the futures curve.

And so you’re not gonna sell. And so any bidder on the spot auction has to bid it higher. And guess what? Now the futures see the spot auction being bid up and they say, “Well, well, we are right to be panicking. We need to go higher.” And that’s just pouring gasoline on the fire.

We’ve already got a raging inferno at this point, but that adds the final pour of gasoline.

Ted Jacoby III: You remind me of one of my learning moments 20 some odd, almost 30 years ago, when I was watching these markets, as the futures markets were just becoming relevant to the dairy industry.

And it was the realization that futures markets and spot markets are [00:07:00] two different markets with a different set of drivers of supply and demand. On the spot market, supply is, let’s talk about butter, is the supply of 80% bulk butter. Demand is the demand for that 80% bulk butter. The futures butter markets,

it may settle to that NDPSR price of the bulk butter market, but the reality is the supply is the number of people who are willing to sell those futures, and the demand is the number of people that are willing to buy those futures. And so you can have people coming into the market that really don’t care at all about how much block butter are out there because they’re actually trying to hedge cream cheese or a chocolate shake or something completely different that has butter in it, but they need to own those futures, and that futures market can move quite a bit and has nothing to do with the actual supply and demand of the market it’s based on.

Jacob Menge: Anecdote number three. I always have heard squeezes feel irrational because risk systems are mechanical. And I think that is true here, right? You have stops in place. A lot of [00:08:00] companies will have risk management policies that say, “Hey if VAR gets to a certain point, you have to get out of your position.” Or on the opposite side, you have to hedge your product if something has happened, or you have to hedge your buy price if the market hits a certain threshold. And so, that can really send the market in the short run to some

areas that feel irrational, but again, it’s because the systems behind it are mechanical sometimes and not even human. Obviously, the human factor makes things even spicier. But once your mechanical stops have all been hit, and the party is coming to an end very, very rarely — I’m struggling to think of one short squeeze I’ve ever seen — that actually goes to the top and then just starts trading sideways. It is almost always an overshoot and a retracement back down to some level.

And that is really where our different volatilities really matter because on that collapse back to reality, and reality can [00:09:00] be very different than where we started, just to be clear, if nonfat started at a $1.20, and we go way up to a $1.60, and then settle at a $1.40, we’re still 20¢ higher than where we started. So, don’t get me wrong, right? Short squeezes, there’s usually some fundamentals behind it, but it’s that blow off top that we might say feels super, super irrational. And again, we’ll have kind of this realized volatility going higher

as we are going up and going down. But the more interesting thing in my opinion is that as we’re doing that retracement off of this super high blow off top, implied volatility tends to drift lower. That’s actually an important concept to really understand because as implied volatility is moving lower with the market moving lower, it gives the market breathing room, and that is the point where we can really find equilibrium and come out at maybe the price we should have been three months ago, but [00:10:00] shouldn’t have been last week during that crazy short covering rally.

Josh White: Hey guys, what should we make of the fact that our least volatile product over the past, I mean, what decade, 20 years, is the most volatile right now?

Or is it is nonfat technically the most volatile product? That’s it.

Ted Jacoby III: It is.

Josh White: Yep,

Ted Jacoby III: it is.

Josh White: What should we make of that? I mean, that to me should be the definition of a market cycle change, right? Do we believe that?

Joe Maixner: If the market with historically the lowest amount of volatility now has the highest amount of volatility, does that mean that there is a structural change in the way that the market is operating?

Jacob Menge: Yes.

This might mean regime change for the nonfat market. But we’ve also had these other short squeezes in butter, in Class III. We’re still in a volatile period, but those could just be because we have algorithms keeping Class III and Class IV in check.

We’re pondering the question: is there this regime change in nonfat from a low volatility commodity to a high volatility commodity? It’s probably too early to tell. My [00:11:00] guess would be yes, we’re not gonna go back to this boring state nonfat had been in, because it’s just a very evolving market with what we’re seeing on the protein beverage side, you name it: the market’s doing a really good job of taking a boring commodity and finding these new, exciting uses for it. And, and so it kind of passes the sniff test. What probably doesn’t pass the sniff test is what we’re seeing on the other commodities right now:

butter and just the Class III products, frankly, I should say cheese in general. What we’re seeing right now with those is they’re following along with the nonfat rally. This really seems to me like nonfat is in the driver’s seat. And I think there’s pretty logical explanations for why we’re seeing cheese and butter do what they’re doing along with nonfat.

We’ve got algorithms that trade spreads within our market, right? We do have a crushable commodity. We can take Class III, Class IV, and break it down into its components. As a result, [00:12:00] there’s some opinions on, say the Class III, Class IV spread.

And so if we get this massive rally in nonfat, well then any algorithm that’s trading the Class IV crush is probably dragging butter along with it. And now we’ve got Class IV rallying, and there’s probably other algorithms and other people with opinions in the market on what that Class III, Class IV spread should be.

And so, even if the absolute price is seeming outta whack there’s enough people with opinions on maybe spreads or calendar spreads or what have you, that are causing the reactions that we’re seeing.

Ted Jacoby III: This is the scenario that I can imagine.

Everybody has been short, pretty much all of the dairy markets for about six months now. Maybe it took other people longer than it took us to realize that there was gonna be too much milk out there all over the world. But by the time we got to the second week in January, I think everybody who wanted to be short this market already was.

Then people started to realize that maybe they weren’t entirely right about the nonfat market. Kind of makes sense if you think [00:13:00] about what we’ve been talking about over the last six months, which is: too much butterfat, too much cheese, but protein’s still really in good demand. Guess what? Nonfat is 34% protein.

So, all of a sudden people realized, shoot, maybe the nonfat market has a different dynamic to it and it might need to go up so they start buying it. Well, that causes the Class IV market to go up. And if you have insurance companies that are part of the DLP program that are short this Class IV market, then all of a sudden it’s going the other direction on ’em and they need to go figure out how to get some length in the Class IV market.

But shoot, they can’t find any liquidity in the Class IV market. So, instead they’re gonna buy nonfat and they’re gonna buy butter. Now think about it. Now they’re gonna go buy butter. Everybody that wanted to be sure at the butter market is already sure at the butter market. There aren’t any sellers left in the butter market because everybody already did their selling.

And so now they’re buying butter, driving the butter market up. And then the last few people who sold the butter market, those who were late to the party, all of a sudden are noticing their margin accounts go negative. Now they’ve gotta throw in the [00:14:00] cash. Maybe they don’t have the financial resources to fund a margin call.

And so now they have to buy their futures back, and all of a sudden it becomes this domino, forcing more and more people, for one reason or another, to have to buy back their positions. The next thing you know, you’re up 26%, even though the reality is supply and demand to butterfat, not just in the U.S., but frankly, probably in the world, hasn’t changed one bit in the last three weeks,

and that’s why we’re up 26% right now.

Jacob Menge: Crowded trades don’t break because they’re wrong. They break because they’re crowded.

Ted Jacoby III: I like that. I haven’t heard that one before. I like that .

So what happens next?

You talk about markets being in strong hands and weak hands. Moments like this force everybody who is a weak hand out of the market, and so the only people left with a position in the market are the ones in strong hands. Does the market go back, and I’m thinking butter, not necessarily nonfat.

I think we were all in agreement that the nonfat market has probably had somewhat of a dynamic change. I don’t know if it’s a 36% change, but it’s had [00:15:00] somewhat of a change. But now the butter market, which really probably hasn’t had the same amount of change, the supply and demand for butterfat probably is the same thing it was four weeks ago.

And I don’t think you’re gonna find many people out there who are arguing that butter needs to be at $2, like the current March futures say it should be. So what happens in the butter market next? Does it go back to where it was? How do these short squeezes usually play out?

Jacob Menge: As an economist, I will say the markets are a perfect system and they will

find the exact right price where buyers and sellers meet and everybody is happy. The reality is, short squeezes are really good for hitting the reset button and finding a new equilibrium.

And sometimes that is right back to where they started. Sometimes that is closer to the top of the squeeze than the bottom. I think we’re still in that reset period. I don’t think we know where equilibrium is on all of our commodities. It’s gonna still take some time, right?

[00:16:00] Because let’s just run with the theory of cheese is gonna go back to where we kinda started all this thing in the $1.40s on the futures. It’s gonna take time for sellers to step back in the market and chew through all this new buy-side liquidity. This buy-side liquidity can come from risk management plans that are in place.

And so it just takes time to find that equilibrium. But that is in theory what the market’s going through.

Ted Jacoby III: I wanted to have this kind of a conversation because the reality is this was one of those where there’s a lot of people out there right now, they’ve got about half the hair they used to have.

Jacob Menge: I don’t think we made them feel any better.

Ted Jacoby III: Unfortunately. I know.

Stay tuned for the deleted scenes from this podcast.

 And now the director’s cut.

Josh White: Protein’s demand has absolutely changed.

Ted Jacoby III: All along we were saying protein demand was strong. To me, this is more about butter than it is about nonfat.

Why in the world [00:17:00] is butter up 30¢?

Jacob Menge: I think we need to gut check every single model we have in any spreadsheet anywhere.

Josh White: A hundred percent.

Jacob Menge: Because it’s a new era.

Ted Jacoby III: I would argue though that, I mean, we can talk all day long about whether or not our market analysis is right or wrong, but the reality is this was everybody’s market analysis.

Josh White: That’s the point we’re making.

Ted Jacoby III: I think the irony is, I think the short squeeze had absolutely nothing to do with underestimating how much protein was going to fluid. I think it started for a completely different reason, but once it started moving, we all started looking harder at our analysis.

And said, “Man, maybe we’re missing something,” and then actually found it.

Josh White: That’s the part that I’m struggling with is I’m actually thinking butter’s easier to rationalize in my mind than nonfat. I think nonfat is a bigger story right now than anything else because butter, what’s the elasticity of demand? And there’s a shift in it because we’re exporting again. Yeah, it’s making it hard for us to measure, but we definitely have been cheaper. And so for it [00:18:00] to be buoying around for price discovery, to try to find that new equilibrium with seasonality, with different products and all that, to me that’s actually easier for me to understand.

Like it drops from a price that was significantly higher. Upper twos even pushing three and exceeding three for a short amount of time all the way down to a $1.50. If we don’t think there would be some demand response to that globally and that we would have some retracement or volatility for the opposite reasons that nonfat is probably going too high and gonna have to retrace lower.

That to me, like I don’t think we should be super shocked that butter’s doing that. You know what I mean? Like trying to find its equilibrium. To me that’s easier to explain.

Ted Jacoby III: Completely agree with everything you’re saying, but I would say this. What we’re arguing about butter is, it’s a vagueness of knowing the balance where the equilibrium price is. We’re just bouncing around trying to find it. I think that’s different from what happened in nonfat. I think with nonfat, the market, the physical market itself, literally [00:19:00] couldn’t get what it wanted. Joe, did we ever have a moment when we couldn’t get the butter we wanted?

Before the run started, could you get all the butter you wanted?

Joe Maixner: Not off exchange.

Josh White: Not 80% fresh salted product. It was being hoarded, right?

Joe Maixner: There’s multiple facets to this, right? Like yes, you cannot get any 80% fresh salt right now. But we’re also struggling on getting any old crop, 80% salt off of exchange right now because the old crop situation is much different than it was back when old crop was an actual market mover.

Five years ago, all the old crop butter was only at a 12 month shelf life on domestic salted. Everyone’s gone to a 18 or 24 month shelf life. So the product’s still good off exchange for a lot longer than it used to be. So nobody’s out there needing to technically dump it at this point in time if you don’t have a sale for it, because you could still use it off exchange.

For a brief period, yes, the salted market got tight, but it’s also because we had the carry in [00:20:00] the market that we had, right? We had the 20¢, 30¢ carry in the market. So, whether you had new crop, old crop, whatever, why would you sell it at a $1.35 in January when you could sell it for a $1.75 a $1.80 in March at that time? Now, we’ve come down, you know, now we’re at a $1.83 in March right now, but at one point we were at $2.00 on March futures with this rally. It’s simple economics. You can carry the products for 3¢ a month and you can make 14¢ to 25¢ depending on the month you wanna sell it in or you let it go for way too cheap.

Ted Jacoby III: I hear you. But to me, that’s wholesaler math, that’s trader math. At the end user level, at the people who consume butter, has there been a fundamental shift in how much butter is being consumed?

Joe Maixner: No, I don’t think so.

Ted Jacoby III: Whereas I think when we’re talking about nonfat and especially the protein in nonfat, I think there has been. It actually manifested itself as a lower amount of supply in nonfat.

But I think what’s happened is we were [00:21:00] taking that protein away from the nonfat dryer and using it somewhere else. Whereas with butter, I don’t think that’s happened.

Joe Maixner: No, but at the same time, I think that there’s similarities between butter and nonfat, whereas people came into this year structurally short.

They didn’t contract because they anticipated the supply to be there.

Ted Jacoby III: And then everybody showed up, that’s essentially being short the market.

Joe Maixner: Yeah.

Ted Jacoby III: When I talk about how everybody who wanted to be short this market was already short this market, so there were no more sellers left to sell.

So when somebody wanted to start buying, there was nobody to sell.

Joe Maixner: I mean, ultimately you’re just explaining the classic short squeeze.

Ted Jacoby III: Right? To me though, that is what we’re dealing with. That’s what we’ve been dealing with right now. That’s what the short squeeze is. It wasn’t just everybody was short this market.

Then they were ready to start buying ’cause the market was low enough. Then they found there wasn’t anybody left to buy from ’cause everybody had already sold everything they wanted to sell. And that caused the short squeeze, without any real rationality of there being a fundamental change in demand or supply.

It was all at the wholesale [00:22:00] level. Whereas with nonfat, I would argue that the market came to a realization that we were pulling protein away from the dryer to sell it into liquid UF, causing a fundamental shift in the actual supply and demand balance, whereas I don’t necessarily think that happened with butter.

With butter, I think it was just the noise in the middle of people making choices about being long or short of market. I don’t, am I making any sense?

Joe Maixner: I think you’re getting to the point where you’re talking in circles, if I’m being honest.

Ted Jacoby III: To me there’s a difference between talking tactics and talking trading strategy and talking about a fundamental supply demand analysis.

Josh White: I think it’ll make a compelling podcast for those that are wondering what’s going on.

I genuinely mean that.

Ted Jacoby III: We might actually want to have the 15 minute version of talking about what happened in market psychology. Then have an appendix to it capturing the discussion as to what is the real difference between what’s going on in butter and nonfat.

Josh White: Or how do [00:23:00] these guys communicate when the makeup’s off?

Joe Maixner: I think we leave, I think we leave it all in.