Behind the scenes with Jacoby’s dairy traders (part 2)


On this two-part edition of The Milk Check, listeners get a seat at the table during our mass balance report meeting, held after the release of monthly milk production numbers. Our traders gather to evaluate the data, forecast class allocations, share what they’re hearing from buyers and sellers, and chart price data to predict market developments. 

Our regular cohosts, Ted, T3 and Anna, are joined by Don Street, director of global strategy; Gus Jacoby, executive vice president of the Fluid Dairy Group; Jacob Menge, director of risk management; Brianne Breed, vice president of cheese and butter sales; Joe Maixner, cheese and butter sales manager; and Diego Carvallo, director of dry dairy ingredient trading.

In part one, we evaluated the fundamentals of the dairy markets and what the monthly production numbers mean for different industry sectors.

Now in part two, we look at anecdotal evidence in the wider marketplace, such as the consumer price index and international trade, to forecast dairy’s future in the global economy.

Anna: Welcome back to part two of the March episode of “The Milk Check,” where we’re going to continue to listen in as the team participates in our monthly mass balance report. If you missed Part 1, make sure to go back and listen.

T3: Thanks, Anna. In this section, we’ll rejoin Jake and our dairy product trading team as we talk this time about things on a much more macroeconomic level. Jake gets into a fascinating discussion about what we think inflation is going to be doing over the next few years and, from that, we’ll dovetail some of the more kind of higher-level issues that we’re paying attention to and how those issues might affect dairy production. Jake, take it away.

Jacob: Alright. Let’s kick off the product trade discussion side of things. A lot of times when we discuss the product group, we’ll start kind of with a macroeconomic outlook. And I think today the obvious place to start is inflation. And we’ve been talking about inflation for a while. This week and last week, some really notable things happened on inflation, so I have to talk about it for two seconds here because it actually relates directly to milk in my opinion.

OK, so let’s talk about the consumer price index for just one second, right? It’s what everybody uses to gauge inflation. You’ve probably heard, like, “Oh, for the last decade, we’ve had very low inflation.” And if you use the CPI as your gauge for that, then it’s true.

I think the CPI is broken for gauging inflation and here’s my reasoning behind that. Over the past 10 years, the wealth gap has gotten larger between the top 25% and the bottom 25%. And the CPI is terrible, terrible at capturing inflation on the assets where the wealth is actually growing.

And so here’s my example. CPI. What is it? It basically looks at a basket of things like fuel, of food, of housing, stuff like that, OK? I’ll be very blunt. If one person makes $100,000 extra in a year or 10 people make $10,000 extra, it turns out that person that made $100,000 extra doesn’t go buy extra bread with their $100,000, right?

And so the CPI does not reflect that. What does the person that made the extra $100,000 buy? Stocks. They invest it. That, in my opinion, is where inflation has existed; it’s the stock market.

And that is actually pretty well-reflected in P/E ratios, right? Everyone these days is saying like, “P/E ratios are worthless,” blah, blah, blah. Well, why is that? It’s really a function of inflation. It’s a different type of inflation but that is really, really, really, really important to commodities to understand.

So when the inflation was kind of happening for the rich but not necessarily the poor, it’s not reflected on things that the government uses to gauge inflation. And so the government hasn’t really done anything to deal with the inflation because it’s inflation that makes people happy. People think they’re investing geniuses. You basically could have bought anything in the past five years and looked good, OK?

But one other point I’ll make on this. So you’ve probably heard the feds say like, “Hey, we’re going to look at inflation and we’re not going to really raise rates until inflation starts kicking in.” OK, they’re looking at this, right? The CPI is primarily what they’re looking at. Those rates are big, and what those interest rates are doing is really going to have a big impact on our commodity.

So here’s one other thing I’m going to show — the 10-year breakeven inflation rate. This is basically what the market is guessing inflation is going to be. Let’s just note that we have gotten back to where we were in 2018. There is a way that you can basically take this 10-year breakeven inflation rate and compare it to the 10-year treasury and kind of see how big of a panic the market’s in about inflation. So, again, we are back where we were in 2018 on this breakeven inflation rate.

If we look at the 10-year note though, 3.19. We’re at 1.48 now. It’s basically half of where it was even though our breakeven inflation rate is back where it was in 2018. So not keeping pace with each other is starting to have the market…as you can see, it’s trying to catch up. This is the last two weeks I’m talking about. These 10-year notes are just going nuts. This is going to be something that’s going to basically kick any inflation into overdrive. It’s a hit.

And so now here’s the crescendo of this thesis I’m laying out here. What could cause this inflation a.k.a. the CPI to kick in and go higher? It would be exactly like something like a $15 minimum wage or exactly like the economy re-opening and suddenly maybe people didn’t spend their stimulus checks and it gets poured back in. It’s stuff like that. And if the Fed sees the CPIs start really getting steeper, that would be something I could see them saying, “OK, now we’re going to raise rates.” That takes a lot of money from the equities and puts it into commodities. And so that’s where we’ve wound up.

And I think the market is way, way, way underpricing inflation. And that is going to matter for probably the metals and stuff first, but sooner than everyone thinks probably the softs and ags. It’s going to have an impact. If so, I’m bullish commodities here, and I’m bullish commodities sooner than the market is really pricing it. The market kind of thinks maybe we start seeing inflation five to eight years from now. I think, in commodities, it’s more like one or two or it’s happening right now. I really do think this is going to just hit. I might be wrong, but I definitely don’t think we’re going in with deflationary environments or something like that.

OK, with the inflation discussion kind of in the back of our minds, let’s go ahead and transition to talking about commodities. Corn’s sitting at, like, mid-five bucks. It really stopped going up. It’s kind of just been from August to now more or less this linear line higher. Really impressive. I am surprised with some data coming out of China that this didn’t slow down a bit. I mean, it slowed down relatively than it was during December, but it’s still on a tear. Really the same story over on the soybean side of things. I’m personally, again, surprised with what has been some of the data that the last WASDE had. I thought we were going to get some kind of a slowdown here but not really. Any comments there, Diego?

Diego: Yeah, no. I agree. I also thought that this wasn’t going to last that long. Apparently, China’s space has been kept very high, and there have also been some problems with Argentina and Brazil’s crop. Argentina mainly with exports, government regulating the amount of product that can be exported in order to provide for their own country people, and Brazil with some weather issues, and the combination of those two high demands and some issues with the supplier has taken prices skyrocketing.

Jacob: I don’t think it can be ignored but relating to the lecture I just gave five minutes ago that I subjected you all to, let’s just look at these beans compared to just commodities in general. This includes metal. This includes everything. Not so different. I’ve heard a lot of explanations of why corn and why beans have done what they’ve done.

When you look at it though, compared to just a commodity fund, this commodity fund includes everything. A huge basket. It’s on the same thing. I mean, it’s up huge. It’s like up 4 bucks on a $13, $14 stock. I’m a little surprised we haven’t seen a bit more of it in dairy; it’s probably because we don’t have quite as much managed money. It’s got to filter through at some point though.

And this is kind of to Gus’ point that he was bringing up earlier. If these farmers’ input costs are spiking and stay expensive, it’s going to come through eventually. Maybe we’re one step removed here in dairy but just look at commodity funds. This market is hot.

All right. So let’s dive into dairy specifically a little bit here. This is our spot market, all of our Class III spot market. So we’ve got butter, whey, and the cheeses in here. So you can kind of see, you know, what’s the spread between the futures and the spot market has been. It was really wide last year. I mean, no surprise there. It’s really kind of narrowed up now.

My question, I guess, for the group would be, was the volatility that… last year purely coronavirus-related? Are we going to get volatile again? I mean, does the spot market keep a discount to the futures then because of some reason? Is sell-side liquidity just gone? I don’t know.

Ted: We’ve had periods where we’ve had commodity funds invested in dairy futures. Is there any indication that that’s going on now?

Jacob: Yeah, actually. Two weeks ago, the Commitments of Traders came out, and they had just taken a lot of money out. They had put a decent amount of money in in the beginning of January and they took it out at the beginning of February.

I would not be surprised to see that kind of trading happen where they’re just kind of dipping in, and I would kind of expect them to keep holding a bigger position, so it kind of grows. You know, so maybe they put 1,000 contracts in, and then only take 500 out, and then they do another 1,000, and it just kind of grows.

It’s just going to depend on what milk does relative to these other commodities. If corn stays really high, milk might start looking attractive because people can do the math that we kind of were just talking about where, you know, the milk cost will probably go up if corn stays really high, and they’ll just say, “Well, the better relative value is just to go buy milk instead of going and buying corn.” We’ll have to see. If corn collapses, that’s probably not going to be true. The managed money probably won’t come in as much.

I guess I want to talk about carries, too, real quick. So this is our Class III carries. We are pretty darn high for this time of year. It’s the third-highest ever. How does that work out? Does the back half stay higher because of re-opening and then we’re going to get this demand coming in? I don’t know. I think it sticks out quite a bit to me to have a carry quite as large as this. I would be surprised if it sticks around, but, again, it’s a very different circumstance coming out of lockdown and stuff.

What else we got? We got milk versus the ag products. This is just Class III. This is like a basket of agricultural products. We have just way underperformed relative to other agricultural commodities. You know, we’re down slightly on our Class III when you average it out over about the past year. The ags who are just on a tear. When you look at this historically, this is pretty wide relative to how Class III is relative to the other ags. Usually, they’re much narrower than this. So got to keep an eye on this. One of these has to give it up; either milk is going to have to go higher or, I would say, ag is going to have to kind of slow down.

T3: When the ags are significantly below the milk, it’s kind of an indicator that you’re going to have milk production increases. And when it’s significantly above, it’s kind of an indicator that maybe you won’t because it’s your inputs in the milk production.

Jacob: The very last thing—and this is related, again, to kind of what we’re seeing happening in the bond markets—has got to be the dollar index. We’ve got to touch on this one. We are pretty much at the lows we saw back in early January. We’ve touched this morning 89.7, I think. If we look at a weekly chart and go back to now 2015, we’re pretty much at these same lows from 2018. If we scroll back even further, it doesn’t look like we’re on that low, right? I mean, prior to 2014 and earlier, something in the low 80s was the norm.

This is just going to be a…if we break below this 89 level and let’s say we head to the low 80s on the dollar index, that is going to have a huge impact on our dairy market. Really I think exports are just going to be gangbusters. So something to keep an eye on. Maybe logistics hamper that a little bit, but I don’t think there’s anything to note yet but if this thing starts to make another leg lower, that’s when we’ll really perk up here.


Don: So we have record crop planting intentions announced by USDA on both corn and beans, but it didn’t seem to have tempered pricing at all.

Jacob: I think it’s money flowing into commodities. I think it’s a big part of it. I will tell you I’ve heard people talk about…they’re worried about drought, OK? So, hey, we’re worried about a potential drought. I think any guess of drought before, like, March or April is just…I don’t think it’s worth much. Things can change so much.

So I don’t know how big of a factor that’s really having. I think it’s just the rising tide lifting all boats here. I mean, look at commodity baskets and corn and beans are following in lockstep along with those commodity baskets. So, I really do think it’s just money flowing into commodities, and I don’t see that stopping.

Gus: It’s got to affect these farmers here. And, you know, I know they all have their silage kind of covered for an extended period of time, but at some point in I guess, you know, late summer, early fall, we’re going to have to have higher prices or they’re just going to… Except for those who properly hedge that far out and except for those who have their own crops and plan not to sell and call, right, which might be a good move if you’re betting on most producers to call, but it doesn’t seem like these commodity prices will come down any time soon to put it in line for farm economics to work certainly at the futures numbers that we’re seeing.

Jacob: I’ve got to note, Gus, we are inverted on the corn market. So if you’re a farmer, you could go lock in 473 corn for December.

Gus: What is that, 75 cents or so difference in the current, but it’s still much pricier than it was, you know, a year ago.

Jacob: But you can lock an $18 milk which is better than you could lock in $18. OK, $17 average Class III, Class IV. I am with you. I agree. I think this comes through. I am not actually disagreeing with you. I just don’t want to make it seem like it’s 550 corn versus $17 milk. I mean that is a difference, right?

Gus: Yeah, of course.

Ted: Cyclically it looks like we’re sort of supporting something similar to what happened in 2014, doesn’t it?

Gus: A little bit.

T3: That’s a really good way to put it, 2014 was all about international demand, and I think the question is, are we going to get the kind of international demand that we did then?

Gus: At the moment, we are. Our CME and DPSR is relative to the GDT, and I know that’s not a perfect comparison. I’m just saying, if you look at that from a snapshot standpoint, there’s a large discrepancy there. So exports, as far as I can tell, are going to continue for a while unless there’s some drastic change in the international markets or our markets.

T3: Well, the big question I think we have is are the logistics problems we have going to get solved because my gut tells me, if we solve the logistics problems we have, we narrow that gap. If we don’t, we don’t narrow the gap, but we’re not really taking advantage of it and we keep that gap because we can’t get anything exported because we can’t get the containers under it.

Gus: Yeah.

Diego: Most articles and things that I have read about these logistic bottlenecks are already talking about this problem going through summer. So, some of them talk about July as going back to normal. Some of them are talking about sooner than that. But what they all agree is that it’s not going to get solved in the next month.

T3: Do we know, is Europe having the same kind of logistics issues that the U.S. is?

Diego: They are on a lower scale, that’s what I’ve read.

Gus: OK, but if you look at the production report we just got here the other day, their production isn’t gangbusters. It’s kind of been waffling around 1%. If you look at where they’ve been on milk production, you know, it doesn’t seem like they’re going to jump any time soon. And I’m making some assumptions here. You know, Jacob and others might know more than me, but the reality is, if we’re exporting commodities like we are, then I would assume that prices for feed over in Europe are adverse as well from a farm economics standpoint. And therefore if that’s the case for them to expand any time soon, you know, granted they’re running higher prices, but they have no exports, what does that mean, right? So I don’t know. It’s sizing up to be a very interesting marketplace for the rest of this year for sure.

Jacob: That was all I have. Does anybody else have anything they want to see or discuss further?

T3: I think we’ve covered it. I think we’ve had a fantastic conversation today.

Thanks, everybody, for listening. And Don, Gus, Jake, Diego, Brienne, and Joe, thanks for participating. This was part two of a two-part section where our listeners had an opportunity to listen in to our trading team talk about what we’re seeing in the industry today and what we think prices are probably going to be doing over the second half of the year. I hope you enjoyed the opportunity, and I look forward to talking to you again next month. Good luck, everybody, and keep on milking.

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We can put our insights to work for your operation. Learn more about dairy cooperative support services from T.C. Jacoby & Co.

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