On this two-part edition of The Milk Check, the Jacoby team lets listeners in on a monthly mass balance meeting. The meeting splits neatly into two episodes, one led by Global Strategy Director Don Street and the other led by Head of Risk Management and Trading Strategy Jacob Menge.

In part one, we evaluate milk production data and forecast what Q2 will look like in terms of overall milk production and class allocation. Ted disagrees with Don about supply-side expectations moving forward, and Don puts forward a modification to his predictive model.

In part two, we will zoom out to talk inflation, interest rates and the macroeconomic factors impacting dairy markets. Jacob presents a bird’s eye view of various commodities markets and interesting trends to note in dairy and beyond.

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T3: Hi everybody, and welcome to the Milk Check. This month, we recorded our monthly mass balance and charting meeting. It is a monthly meeting that we hold internally where our whole trading team gets together. We look at the milk production and cold storage reports, and we look at some of the technical charts and we share our opinions about what we think this data is telling us and what we think this data is predicting about what’ll happen in the future.

We had some really interesting discussions this month. I think you’ll really enjoy eavesdropping into these discussions. It was a long meeting but it was a really good meeting. So, what we’ve decided to do this month is split it into two parts. The first part is Don leading the discussion about the mass balance. What we think is happening in Class I milk, Class II milk, Class III milk, and Class IV milk. It was a great discussion. I hope you enjoy it. Thanks for listening in.

Don Street: All right. You should see the PowerPoint for Mass Balance, April 2022. At this point, not completely, but all the data for Q1 that really counts we have. We’ll get more early next week with dairy products. But we have it and now we’re really at the point of what will Q2 hold. And I’m going to walk you through a couple of scenarios on that, and then we’ll look for your guys’ input.

So again, Q1s in the book, down 9/10ths of a percent on milk for the quarter. But clearly a steady progression towards trying to get to zero change year over year on milk. January was the big down, February less, March even less. We still have this reality that Q2 of last year was up 4% on average. And I think that’s going to be difficult to be positive over it. It’s just a question of how much negative under that will be.

But nonetheless, with these improving milk numbers, my projection is getting stronger. So, a month ago I thought we’d be down 1.7% for the quarter. Now I’m at 1.4% negative. You could argue, well, it’s all in the same ballpark and I would concede that point. But nonetheless, two months ago I think I was talking over that we would have a reduction of over 2%.

So, when you add two months together, the second quarters not looking as dire as I once thought, but I still don’t think the market’s anticipating this very well. And to maybe add that, had several people tell me in Chicago this week that they thought we’d be even on milk production year over year by the end of the quarter. I just don’t think that’s possible. And mainly it’s because of cow numbers.

Now, USDA really threw a curve when they restated the February numbers last week, adding about 10,000 cows that apparently shouldn’t have been taken out of the herd. But I’ve now taken this forward projection and trying to listen to all the voices that will not see a strong change in cow numbers, but we should be past bottom. So, I’ve just added or increased this herd at 5,000 head a month from March. March is a known number until it’s revised.

So, you can just see this as you go down on the 2022 column. It’s 5,000 head more a month. And that puts Q2 down on cows at about 0.9%. So, two months ago, that was 1.3% down, now it’s 0.9%. If we add more than 5,000 cows a month, well, this number looks better. I still think it means cow numbers, as well as milk production will be negative for the quarter just on cow numbers alone.

So, here’s my two options that I wanted to go through. We know that Q2 of ’21 was up 4%, USDA hasn’t revised that number. And the big pushers of that, and I apologize because the monthly numbers are quite a bit more bearable and I’ve just averaged them for a quarter.

But the people who really drove that were California, New Mexico, Texas, and Wisconsin. Not always in the same month. California was every month. But we’re talking 45% of the milk supply in these four states. And this green column, Q2, scenario one, this is what I currently have the model set at. And again, this assumes 5,000 more cows in total for the 24 state herd. And I think California is down 2%, New Mexico 1.7%, Texas less so, and that’s primarily driven by the way their monthly numbers played in. Same on Wisconsin, and there’s my projection for Q2 minus 1.4%. If I just take all of these four states and say flat, and again, we’re adding 5,000 ahead a month, then this drops to be a much more cautious number. Who would like to give me a strong opinion that these states can overcome plus four last year, or am I just wrong?

Joe Maixner: I don’t see California overcoming or even becoming flat. Nobody’s adding anything in California.

Don: Right. And the cows are lost in the state by state numbers in this table. They really only apply to the 24 state total. But you’re right, California’s not going to add cows. That’s for sure.

Josh White: Hey, Don, I’ve been watching the auctions ever since I learned of the auction website too. And out of Michigan, there’s a few online auctions and they went from a pace of a half dozen auctions annually to almost three a week right now of these 100 to 300 cow dairies. Now a good portion of those cows will land somewhere else and be milked, right? But there’s also quite a few of them that are not on those exits. So, Wisconsin, some of these states, I find it hard to believe that the amount of cows and the way we’re feeding the cows is going to improve that much. But seasonally, obviously, weather is an impactful thing for a bit yet.

Don: And you know, up until yesterday and today’s cash pit markets, and especially on protein, you would’ve argued that the flush is real. There is more milk and that’s true. Seasonally, there is. Even though we still think it’s going to be reasonably tempered this year because we were having weaker prices. Then you have post ADPi, a price balance. So, I still think scenario one is more likely than two. Meaning I think we’re going to see some pretty sizable numbers on the decline side on milk, but we really won’t have a publication on that until roughly May 20th when we get the April milk production number.

T3: Don, I’m going to push back on you. In March, just announced, California was up half a percent. Wisconsin was up 0.2%, Texas was up 6.7%, but New Mexico was down 9.3%. So, in the month of March, three of those four states were positive.

Don: Right. But over pretty poor marches of the prior year.

T3: And the second quarter is much stronger.

Don: Correct.

T3: Okay.

Don: So, that’s the whole premise of this analysis, right? Is that Q2 number of 21 was up 4% and we really haven’t had a quarter like that for who knows how many years? Maybe back to ’07, ’08 timeframe.

Joe: Well, again, remember what we went up against with Q2 of 2020 numbers. I mean, Q2 of 2020 was when everything was restricted, there were quotas.

Don: But almost only in New Mexico, Joe, because I did go back and look at that. And if you looked at 2020, Q2 would’ve been up about 1%, maybe a little more. So, it wasn’t a total debacle. It’s just that when you came to Q2 last year, COVID at that point was much more optimistic. Vaccines and grains were still cheap and perhaps even weather, but you just had this super strong production response last year off of, say, a modest year in ’20. This quarter’s going to take several years to wrinkle itself out of being a factor in these forecasts. So Ted, you’re still going to take that Q2 this year will be better than I’m predicting.

T3: I’d be more likely to take column three where we’re only down about 0.8. I can confidently say that Texas will be a positive number. The question is really Wisconsin and California. What’s really happening between New Mexico and Texas is the cows are moving from New Mexico to Texas. They’re balancing each other out in the grand scheme of things. It’s a question of what California and Wisconsin do. So, I’m going to say we’re going to be closer to unchanged than down one to 2%.

Don: All right. I like it. We’ll hold you to that, okay? I’m sticking with this column too. So, I’m being more negative on Q2. But looking at Q3, so just try to keep that in mind, 5,000 heads a month. A year ago, Q3 was up 1%, we’re rapidly approaching where cow numbers will be equal to a year ago. So, I’m now totally confident to say that Q3 production will be up, let’s say, approaching 1% year over year. Below the long term demand, average of 1.5%. But I think we’re going to shift from negative territory to positive territory in Q3.

Ted, not T3, but Ted that may hinder a little bit your $30 milk price prediction, but I’m hanging it out there to see what happens.

Ted Jr: What is the normal increase in consumption? 1% plus, isn’t it?

Don: It should be. Something between 1% and 1.5%.

Ted Jr: Yeah. So, you’re saying 0.8%.

Don: That’s production.

Ted Jr: Yeah. That could very well be true, but you’re still in negative territory.

Don: As long as you have demand at a, whatever you want to call it, normal trend line level.

Ted Jr: Yeah. And I agree with that and it’s highly likely, I think, that we’ll have a recession. So, I think my $30 might be out the window in that regard, particularly. I also observed that in prior recessions, milk has a knack of leading the way by about two months. So, it is possible that we’re looking at that sometime mid-summer, which of course would also rule out anything that causes milk pricing to reach that kind of level. But you don’t know. The economic environment right now is very inflationary and milk could be no exception. It’s tough.

Don: Yeah. And Jake will show us shortly, but you’ve got corn and beans both at record price levels. So, that’s still a squeeze on the cost calculation in dairy for milk.

Josh: Hey, Don? Can I throw four or five things out? I’m just writing down that are kind of spinning around my mind? I’d love the group’s reaction to it.

One might be the simplest one. I’ve heard on a couple different discussions that the weather throughout the winter was really, really good in the Southwest and the Western states. But the drought, that might have an impact. And some of those conditions might have an impact on cow production going into the summer. I don’t know that I need a reaction on that, but I don’t know how to digest that information.

Another one is right now, cow numbers are largely believed to be partially ballooning, not on heifers entering, but on third lactation or older cows staying. After the flush, will they retire those cows? Will we see a massive jump in slaughter numbers as regional flush come to an end and they get ready to do that drying period? At what point do those cows get retired at a larger clip? And that, the third quarter, I think has some impact.

Are heifers there to bolster the herd going into the third quarter, at that moment? I have no idea. Has that situation improved or not on the heifer front?

And then another question I don’t know is when did the current crops and the value of the current crops and the feeding practices from that begin to influence the herd and feeding practices. Is that transitioning into the third quarter with new silage and other things? Or is enough of that been put up in the fall? This is a little bit of my ignorance of large scale farming practices. Is that already put up and that carries them into next fall or winter or not? Because that, I think, is another wild card. We’ve seen in the past how components and other things can be dramatically impacted by feed practices and quality.

And then on the $30 milk thing, sorry to blast all these points, but the $30 milk thing. August, September, October is always a low point here for production, regardless of our response. At the same time that we haven’t yet realized the full Southern hemisphere production or should be just coming into it, and they are in no position right now to overwhelm the world with milk. So, that $30 milk comment, I would just say I don’t know that I would draw that closely to our Q3 milk production versus what has to happen before that.

Don: Josh all good points and the short answer is, I don’t know. How far forward does anybody really fix their input costs? And if it’s perpetual, so you’re always 12 months out, let’s say, because you’re going to be feeding cows over that horizon, you’re not really feeling the full impact of $8.50 corn today. It’s worse or higher, but not at market.

And then I think there’s, not to get ahead of Jacob, but a backwardation on the corn pricing profile too, once you get into new crop. And if you grow your own feed, at what point do you say, “Wow, it’s worth more to sell than to run through cows and I’m going to change my herd size accordingly.” It just throws more questions and uncertainty into the whole complex than if you just had, like we had for years, a $3 and under corn price out as long as you could see.

So, I think it’s a chance to have a lot of surprises. These next two slides, I just like to show them because it fascinates me. This is January soil moisture in New Zealand, and you can see north island, almost totally in drought. South island and the production area is the same. And you get to the end of April and the north island’s flooded out here and the south island’s still got some issues, but not as bad as a year ago. So, I just show that, that I don’t think you’ll see any real recovery in New Zealand as the tail of this production season finishes. And I think they’re running down about 3% at this point year on year, season on season, I should say.

I left this milk component slide in because even though it’s unchanged from last month, the USDA is on a slower schedule to show March components. But this is important in about three more minutes. But two months, butter fats up really strongly over the prior year. And last year was up very strongly over ’20. The same on nonfat solids, but more so on protein. I don’t know if I believe these numbers. I don’t know how you get 2% more butter fat out of a cow herd that’s only turning over 20 to 30% a year with new animals genetically, but they’re so far suggesting that they’re pretty strong.

So, just hold that thought until we get into the forecast tables. We look at production by class, production sales by class. Class I, continuing decline. We have two months data, 2.3% down. That’s in line with the average of the last five years. So, I think that’s probably pretty logical. Class II is all over the place. So far, a good year for cottage cheese and sour cream. Ice cream continues, at least hard ice cream, to be down pretty significantly at 8%. Yogurt’s down, frozen yogurt’s down. If I had more time and really did all the milk equivalence through Class II, my gut is we’re probably down a little bit on production.

Class III and IV, little easier maybe to get our arms around, but cheese was up gangbusters in February on production, really strong two months at just under 5%. It is all being driven by Italian, and mostly the big piece of that is mozzarella. But parm’s up. A lot of the other smaller category of cheeses are up a lot, Swiss included. Only cheddar was off in February.

And Class IV, no real surprise. Butters down, skim and nonfat are down, even though MPC was up in January. And maybe to just highlight what we’ve all talked about this week, but logistical issues, we saw nonfat production is down, but stocks are down year on year, but up from January to February. And I think that’s just logistical issues driving that because everybody has sales on the books. They just cannot execute them on schedule.

Diego Carvallo: I would have to agree with that Don, that the US product, the price versus other origins, it’s never been more competitive. And even with that, the stocks have been increasing. So, it’s got to be the logistics in a few words.

Don: And we also or had the discussions of the basis pressure on the Mexican border. So, product that doesn’t go on a boat and a container winds up in El Paso for sale in New Mexico. And we’re just seeing a lot more competition on every transaction there. And now I want to go back and I want to pick this up.

Okay. We have the spreadsheet, everybody? So, at first glance, this model just looks all off. We have two thirds of the production data here, and I think this was actually minus 0.9. So, I’m going to change that. It doesn’t really change the way this model looks. We’re down on Class I, we’re down on Class II about a percent. I don’t hold a lot of weight on that number, but it’s only on 12% of the milk supply. But cheese is up and it’s, again, over half the milk supply.

And we know what milk was for the quarter. And we should be seeing this huge drop in Class IV production of 20%. But yet we’re only seeing skim and nonfat down in the 7%, 8% range and butter down about 5%. But I ask that you guys remember the components for year to date, which are up about 2%. And I just want to change that number. If I do 1.5, if you will, we don’t have 1.5% more milk, but we probably have 1% to 1.5% more components or solids. And then this model says, well, Class IV would be down about 5%. And that’s where we have data. It’s showing skim and nonfat down a bit higher and butter just under 5% down. So, I’m just wondering out loud if that’s really causing some of the distortion of what we would expect to happen.

T3: I think that’s a great catch. We’re down on milk, but we’re up on components.

Don: We’re down on skim and nonfat, but we’re not down as much as we would expect. And I think it’s all being driven off of components.

Ted Jr: Why would components be up with the corn price the way it is? The fact that you got the components up so much, that means that supplements are being used. And of course the corn is last year’s corn crop, not this year’s. They’re still in the last year’s silage. I know you’re right. I know the USDA is right on it because you can sort of see it in the marketplace, but what will happen when all of a sudden the price starts to bite?

Don: I think there’s two partial answers. I certainly don’t have a complete answer. But one would be just genetic progression, so that that’s adding two components. And I also think, and I’m going to maybe have three answers, one would be continued expansion of genetic material, genetic, heredity of Jersey cows, whether cross breads or actual Jersey herds. I think that’s part of it. And I think also it’s a bit like the spring versus fall split where milk volume is up in the spring and components are down just naturally and it’s the reverse in the fall. So, while we’ve seen just modest reductions in milk year over year, I think that adds by default to components if the cows aren’t pushed quite as hard.

Ted Jr: And you said it just a minute ago, but I think it reflects a switch away from Holsteins to Jersey. I think that’s a big part of it. I know that’s been going on for several years, but obviously it’s starting to pick up speed. And if that’s the case, we’re going to see continued decreases in volume and increases in components.

Don: Right. Or more modest increases in milk, like I’m suggesting for Q3. But then it’s even more critical to watch what these components are doing because then all of a sudden you’re, if you will, in a three year ago conceptualization, you’re looking at 2% to 3% more milk or 2% more solids instead of just 1% more milk. So, I think it really bears watching.

I’m going to scroll this down for the last slide, which really doesn’t tell us anything more than where I was on the Q1 slide. So, this is Q2. But again, down 1.4% on milk. And if I just take that to zero to adjust out the solid, well it drops that Class IV decline almost in half. And I just think that’s something I need to rework into how this model operates and do a better job of thinking about these increased components as we go forward.

Josh: The percentage increase in components is outpacing, say, a typical three year average or something, correct?

Don: It’s only two month’s data. So, could that be distorted by a single month’s bad reporting? But just remember the components were up really strongly for all of ’21. And maybe if you allow me, I’ll go back and just look at that. Think this is the slide. In ’21, butter was up almost 1.5%. I would call that a pretty strong change in one year. And protein was up over 1%. So, if your components are up 1% and milk’s up 1%, that’s 2% up on the same components and I think that’s what’s going on.

Josh: You’ve got genetics, weather, feed quality, farming practices, right? The larger farms are pushing more out of it. I think there’s maybe an argument that in the first quarter, all of those things were good. Margins were good, feed quality was already put up and good. We know some theories that had already been planned were going in. So, that was good. Weather, I think, was good for production across most of the country, particularly the big areas, right?

Don: Right.

Josh: So, I would say that does leave us a little vulnerable that can all four of those continue to be good and can that pace continue?

Don: Right. Now, what will start to happen in Q3, just mathematically, is cow numbers will look better year over year. So, that piece, we know the herds, barring some other major change, the herds going to continue to show growth month to month.

Diego: Versus last year, one of the main changes, I would say, for a new crop is fertilizers. The price has probably doubled. If that has a big effect, maybe on the quality of the feed, maybe that yield on the milk solids, could that change maybe going on? I know it’s a tough question, but it’s something that could happen.

Josh: When does that finally start to impact? Is that 2023 or do we already feel that?

Diego: Yeah, probably next year as probably most dairy farms have the stock inventory and feed to cover for the rest, at least of the summer, I would say. Yeah.

T3: They usually try to get to the next harvest.

Don: So, let’s say harvest is anywhere, depending on south to north, is August through October.

Josh: So, Q4 would be really the first full quarter, should see those results.

Don: I think it would be Q4 at the earliest where you would see change on solids and then you have a further lag on reporting. The pricing could reflect it much faster, but you wouldn’t have the backup to say why it was happening until you actually get the data. That’s what I’ve got for this month.

Josh: Great stuff, Don.