On June 12, we brought a group together to share perspectives on the dairy markets, along with thoughts on what we might expect moving forward.

And there wasn’t a strong consensus. Josh thinks supply-side factors point to a relatively quick supply-side response playing out over months that produces some price upticks to offer some cover in the short term.

Ted Jr. thinks price recovery will be slow and has his own counterarguments against the expectation of further production slowdowns.

Jake feels bullish about spot prices on every product right now, but bearish in relation to current futures prices. Gus thinks dairy prices would need to climb above current futures prices to $19 or $20 milk before dairy farmers started feeling good again.

And T3 worries that any recovery in the second half of 2023 will act as a “head fake” leading into fallout from macroeconomic weakness in 2024.

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T3: Welcome everybody to The Milk Check. Today we’re recording this Milk Check on June 12th. The reason I’m giving you the date is because we’re going to have an old-fashioned market discussion today. I’ve asked Jacob Menge, our director of trading strategy and risk management, to join us. My brother Gus, president of our fluid milk group, my dad, and Josh White, our vice president of dairy ingredients, to join us.

In all of those markets, prices are low. I think probably the number one question dairy farmers are asking right now is, okay, these prices are really low. Are these prices going to stay down here for a long time? What are we dealing with?

Jake, I’m going to ask you the first question. Where did demand go? Are these prices low because we’re having a demand problem? If so, how’d we get here?

Jake: I think pretty indisputably it is a demand problem, or at least that’s a significant contributing factor. There’s lots of little data points that support that, some anecdotal, some not. I know internally I’ve tossed a few of these out before. But exports out of China, way down. You look at foot traffic in stores like Target, that is significantly off. Those are things that are hinting at poor demand. I mean you can go as far as to look at the amount of cardboard boxes produced in the US, and it’s a number that is significantly down year on year.

Demand is notoriously hard to measure, but it’s kind of like a black hole. You can’t measure a black hole by looking at it directly, but you can measure it by looking at what it’s doing to things around it. So looking at the things surrounding demand, they’re not good. They’re trending in the wrong direction, I’ll say that.

T3: How long do you think these demand issues have been happening? Has it just been 2023? Has it been the last couple of months?

Jake: It’s interesting. I think it’s probably actually started in 2022, and it’s something that just takes a long time to feel on the supply side here. When you have a push on one side of the market, it takes a while to feel that on the other side of the market.

So my feeling is it probably actually started last year. We saw the stock market have a really negative year last year, and, so far, especially over the last two months in 2023, we’ve seen the stock market go gangbusters a little bit, and we haven’t necessarily felt that bullish on the commodity side yet. So it’s just got a long tail.

T3: So even though we have a demand problem, unemployment’s still pretty good. It’s still quite low. Sounds like the Fed is still talking a more … That it’s more likely going to raise interest rates next than lower interest rates next. That seems to be a disconnect to me. How can demand be bad, yet the economy … At least the Fed seems to think it’s good? Does it mean demand is going to continue to be bad until something does break and the Fed has to start reacting to it? How do we get to a point where demand comes back?

Jake: Awesome question. Wish I had an equally awesome answer for you. If they can achieve their soft landing, let’s just say what a soft landing actually is is a very mild recession. It’s just a super mild recession. No, I think demand could start recovering a few months from now, say. I’m not saying that’s likely, but we get our soft landing, demand starts recovering, and, again, this is a slow-moving system where maybe the shock that caused demand to really slow happened 12 months ago. If the Fed reacts now, reasonably, demand could start recovering before the implications of the Fed stopping their increases is felt in the economy. I think demand could recover before that happens, but I don’t think demand’s going to recover tomorrow.

T3: I’m trying to think who I should ask the next question to. Gus, I think I’m going to ask you. We’re in a bad demand environment. Prices have really come down. What’s going on at the dairy farm level right now? Is there a dairy farmer right now in the country making money ends up being the question.

Gus: I think at $15, $16 milk, it’s really hard to say yes to that. Your feed costs are still relatively high. But there is an avenue, I guess, to make a little money, and that’s by slaughter, by culling cows. I mean the beef prices are way up, and there hasn’t been this strong of an incentive to cull in quite some time. I think the last slaughter report came out at north of 14% higher year on year, but the number wasn’t staggering. It was just still, I believe, under 60,000 for the week.

I would say, though, that at $15, $16 milk, even at $17 milk, if that continues into the fall, we’re going to see farmers really dig in. I don’t see any other avenue for them to make money on the cost of current inputs relative to that price.

T3: When you say dairy farmers are going to really dig in, what do you mean? What are they going to do?

Gus: I think they’re going to be forced to be a little bit more aggressive in culling. I think because they’ll have to. I also believe that culling opportunity will exist for an extended period of time. I think beef prices are still very healthy.

I think if you look at the beef sector, they’re not culling very strong. I think the overall cattle number was about 50,000 cows less while dairy is way up. So that tells me that there’s still plenty of time and room for this price, beef price, to further increase and provide opportunity to dairymen to get some quick cash if they need it, and of course the farm economics say that they will need it. So when I say dig in, what I mean is I think this industry is … Unless we see some big jump in milk price that we’re not expecting, traction is in our future.

T3: So, Josh, which do you think comes first, a contraction in milk production or a rise in milk prices?

Josh: Well, at the pace that we’re at now, I probably believe we’re going to see at least one round of price increase before we see the slow-moving supply machine retract.

We’ve talked about it a few times. Everything Gus said, I think, is spot on. It’s the first time in a long time that the dairymen has been under pressure. It looks like we’re going to continue to see pressure, and there’s an alternative, and there’s going to be a group of people that probably exercise that option.

That still takes a lot of time, and it’s really hard for us to envision slowing milk production when the middle part of America is swimming in milk. So we’ve got a bit of time, I think, before that happens.

So then we start thinking about demand. I think that demand equation is really complicated. I mean it’s the first time in a very, very long time that we’ve been genuinely concerned about what dairy demand looks like at certain prices. What I mean by that is normally high prices cure high prices, and we know what we feel like high prices are for cheese, butter, powders, whey, and low prices create demand.

Well, for the first time in a while, with higher interest rates, some demand destruction, not just within the US but globally, in markets that aren’t mature dairy users. We’re really unsure if the demand curve shifted and what low prices are as defined in these different parts of the world. What I mean by that is do we still have some room to go down before we start to create that demand?

Generally speaking, though, I think the market is moving, prices are moving, and I think we’ll find demand creating prices, or at least a wave of short covering, before we really see the supply response in full effect.

T3: So if I understand what you’re saying, you’re saying that $1.50 cheese, $1.15 non-fat dry milk, $0.30 whey is probably enough to stimulate some demand, but not enough to get the dairy farmer back to being profitable.

Josh: Yeah, and I think the important part of that note is I’m not so sure that that’s a total reversal of those markets versus a short covering. I do think if there’s any positive out there right now is I think the global supply chain for dairy products is relatively thin as it gets closer to the consumer.

A year ago, people were loaded up after supply chain issues of 2021. They made large commitments for 2022, and, frankly speaking, most people in buying positions across a lot of commodities. Demands have been relatively predictable, and this is the first time that it’s a little bit less predictable. It really isn’t is $1.50 cheese cheap enough? It’s do they even want it regardless of what that price is right now? That creates a bit of paralysis.

Now, again, I don’t believe people are all that well-covered forward. There are some inventories of some of the commodity dairy products, but they’re enhanced closer to the producer than they are the consumer in my opinion.

T3: So after everybody basically filling up their supply chains as full as possible during COVID, because people were having issues getting the product they need, now the increase in interest rates has basically caused the whole industry to flip on its head and now everybody’s trying to empty those supply chains out, which is almost causing prices to be lower than they need to be. Once that process is done, you’re going to see a bit of a pop in demand, but we’re not going back to $2 cheese tomorrow.

Jake: I wouldn’t say a pop in demand, but I would say less supply there to meet the demand. So that supply going back into balances, which should increase prices.

T3: I can see that, and that fits with one of the things that I’ve been saying for some time, is I think … It’s been 20 years since we’ve dealt with interest rates like this and we’ve dealt with inflation rates like this. I think one of the things that is happening that nobody really has a lot of experience with, at least not recently, is we’re creating an incentive to not carry inventory. So all the manufacturers are pushing all that inventory out the door as aggressive as possible, while the buyers are saying, “I don’t want it. I don’t want it,” because neither of them wants to pay the interest cost, or even the storage cost, which creates this glut in the market.

By the way, it’s spring when we’ve got more dairy supply than usual, but it also may mean than in the fall, there’s more spot demand than usual. So we may actually feel like demand’s better than expected this fall. I don’t know if I can promise that, but I wouldn’t be surprised at all. Dad, what do you think?

Ted Jr: I think that Jacob has hit it about right in that this started a year ago. I think the impetus for it is the chaotic logistical situation, not only domestically but internationally. I think we’ve grossly underestimated the effect of that.

If you think about it, when things gradually started to tighten up and the delivery time started to get pushed back, people were ordering three and four, maybe even six months in advance, particularly in the international markets. They wound up having all these orders placed and getting screwed up and showing up late, and people didn’t get their product in a good order. Then all of a sudden … Or not all of a sudden, but slowly, the logistical situation gradually straightened out, but people still had all this product heading their way.

So by my mind, I think that’s probably the biggest factor in this current malaise as far as dairy products are concerned, that there is such a glut of orders that were pushed back and not delivered and so on. Then when they finally do get delivered, all of a sudden the consumer end of the supply chain has too much product, and now that has to get back to where it’s supposed to be.

Also, we’re heading into a recession, I think, and I think most people think, which affects how they’re going to carry their inventories. If they think a recession is here, or coming right around the corner, they’re going to be conservative on their inventories.

I don’t think the interest rates have a lot to do with it. I think interest rates right now are normal. We seem to have forgotten that we used to think a 5% assumable rate on a housing loan was terrific and we would leap at it. Today we can get loans less than that actually. I don’t think the interest rates that we have right now are going to slow inflation down at all.

So the Fed has the money supply, they’ve got the discount rate. They’re pushing the discount rate. They can also tighten up the money supply and they can eventually win the war against inflation. It’s not as severe as it was in the late ’70s or early ’80s by any stretch, but it’s got to be dealt with, and that’s going to tighten things up further.

But it also means that the timeline here could stretch out, and a lot depends not only on the dairy industry’s timeline, but overall, whether or not we have a recession. If we do, how deep is it going to be? I’m inclined to think it might be a little bit deeper and longer than we think.

Josh: As I’ve mentioned in some of our meetings, that generally speaking I have the view that these low prices will create demand, and prices are moving faster than the consumer can realize. The commodity price declines. After some period of time, they will start to see these prices and respond positively.

T3: Our crystal balls seem to be hazy on necessarily when demand and prices recover today, understandably so. Anybody have a stronger opinion on whenever it does start recovering, how quick the recovery is?

Ted Jr: I think that it’s going to be slow. The reason I think that it’s because it’s slow getting there.

Josh: I don’t disagree and nor am I in a position to disagree with Ted’s experience, frankly, but I would say if we get a little bit closer to just dairy and history, what I believe is this might be one of the quickest milk production responses that we’ve seen, which, again, is still slow. It takes a long time for milk production to respond to price signals.

That being said, with the alternative of culling, with the age of a portion of the US dairymen, with the age of the herd coming off of years where heifer supply was a little thinner, you’ve got quite a compelling case for those that are on the fence or considering exit over the next few years to do two things. One, exit now on herd dispersals. Secondly, I think that over the past few years, dairies are running very full and the cows are older.

So I think that there’s an argument there with high other costs other than just feed, high everything, that people might scale back their production further than they normally would. So less cows going through the same parlors. Then on the demand side, I just don’t believe the consumer is yet to see these price declines.

So although that might not turn us from a recessionary environment, it could be that we’ve already reduced it enough to stimulate some additional consumption for food products.

Ted Jr: Let’s say you’re a dairy farmer. You’re sitting there with a high cost feed and a bunker full of corn silage. You’ve got corn silage that’s going to last you at least through the end of the year that’s based on $7 corn. What are you going to opt for? Are you going to opt for culling?

Traditionally, the choice that he first makes is cash flow. If there’s an empty stall down at the end of that freestyle barn, he’s going to make damn sure that that barn is filled, because he’s already got the feed sitting there. The quicker that he uses that feed up, the quicker he can get to lower cost feed as the new crop comes in in September, October, November.

So that’s another straw in my argument that this could drag on a little longer than we like, if you base it on milk production. I don’t see milk production dropping off much more than it already is, at least for a period of time.

T3: Gus, what do you think? You’re talking to dairy farmers every day.

Gus: I think it’s a little chicken and the egg is the way dad put it. If it were easy to just turn around and get some cash flow on selling their silage or whatever feed they have, then they’d do that. So what they end up doing is they end up holding onto the cows, or at least not culling too aggressively, so they could utilize as much feed as they’ve stored and get some return on that in the form of milk.

It’s always a strategic play. They’re going to figure out what they can do with their feed and what they can do with their cows and how to either beef or sell feed or whatever appropriately. That’s something that dairymen will do over the next few months if they’re in a cash crunch.

You’re going to have some dairymen that are obviously able to sustain this better than others. We know of right now in South Dakota, there’s people filling up new dairies even though this would not be the best time to enter the market. But those big fellows are going to bring their new dairies on one way or the other, and that’s only going to exasperate the situation as we move forward nationally, because I think we’re just going to ultimately have more milk than demand allows. Then we’re going to have these cash flow issues that dad alluded to force some tough decisions for these dairymen over the next two or three months. That’s how I look at it when I discuss with dairymen, what they’re talking about.

T3: Let’s try to wrap this up. How do you think the rest of this … I’m going to ask each of you. How do you think the rest of this year plays out and at what point do you think milk prices get to a place where dairy farmers can feel good about expanding again? Josh, I’m going to start with you.

Josh: It feels like it’s setting up to be one of those long, drawn out low-price cycles. My argument against that would be we are at a higher overall price environment across the board than we’re used to. I think volatility is something that a lot of us are expecting because there’s a lot of uncertainty over both the supply and the demand cycle.

Then, third, if I think about some of the balancing products, the core storable commodities in the dairy space, non-fat dry milk being one of them, last time we were at a low-price cycle, there was a structural reason for that. European production quota is being lifted, government stocks, and we just don’t have those safety stocks around the board.

So I think we’re at risk of overdoing commodity prices to the low side and stimulating some demand. Whether or not that all materializes yet in the 2023 calendar year or not, right now I think the fundamentals are suggesting it won’t, but I’m just skeptical. I think the next upward price turn for dairy commodities won’t be the full reversal, but I do think that we’re going to see some shocks to the upside and some short covering at different points in time for the rest of this year.

Gus: I think right now you have some futures in that $18 range, and that, in my mind, is somewhere close to breakeven. The overall stocks and whatnot that we’ve accumulated over the flush, how long that haunts us and depresses prices does come into play with that question. But I think if we get obviously to $19, $20 milk, at some point dairymen are going to start feeling pretty good about growth again. But until then, I think we’re in a range where the farm economics are pretty adverse for a lot of dairies out there.

Don’t forget, one thing we haven’t talked about much at all in this call is dairymen are paying more and more for freight as well these days. So 30, 40 more cents cwt on freight alone. There’s more hurdles than just the on-farm economics that they’re dealing with these days.

T3: Jake?

Jake: It’s hard not to be bullish spot prices for pick your product. Cheese, we’re probably averaging in the 140s right now, 150s between blocks and barrels. Butter, non-fat, whey, all at the lower end of their normal ranges. At the same time you look at the futures and we’re at $1.95 in cheese in November. It’s hard not to be bearish, that to me.

So, yeah, as far as spot prices go, I think … I would hope we’re at the lower end of the range right now, but I don’t see it getting much better than what the futures are predicting right now, at least on the Class III side. I think the Class IV side’s probably a little more realistic in its outlook.

T3: Dad, what do you think?

Ted Jr: Pretty much agree with what Jake just said, but I also would feel that the harbinger of increase will be the whey price. Right now you’ve got 2 to 250 cwt, and the Class III price gone because of the low whey price. When the whey price goes back up to the 60, 70-cent level, which is probably where it ought to be based on the protein value, I think at that point in time you probably begin to feel a little bit better about where things are going to go, and I would suspect that that that’s going to lead the way.

We’ve got a lot of cheese out there. We also have a lot of cheese production facilities. So I don’t think it’s realistic to think that all of a sudden we’re going to see this explosion in the cheese price. I think the whey price, though, could take off and be the way out of the hole. When? I think fourth quarter maybe. Hard to tell, but I don’t see any real gyration up in pricing until then.

T3: Well, I’m going to throw my prediction out there. I actually think we’re going to have a bit of a head fake this fall. I think we’re going to see prices come back up, maybe not as much as the futures say, but we’ll get back up to maybe $18 Class III, maybe even $18.50 Class III for a couple of months, which will be just enough to keep dairy farmers who are on the edge of making a decision to get out from actually making the decision.

But then I think we get into the beginning of next year, and I do think the overall economy starts to weaken, and I think it takes a lot of our dairy markets with us. The scary one, I think, it’ll take with us is the butter market, because one of the things that is happening right now is the 240, 230 butter market is keeping the Class IV price up, especially in California. If you go under $2 in butter, I think the stress on the California dairymen is extreme, and I think that’s what we need to worry about in the first half of 2024.

But my hunch is we’re seeing the worst of 2023 right now, and as we get into September, it’s probably going to improve a bit. But we’ll see. Since we put it out there, we’re probably going to all be wrong.