In the trading room (part 2): noteworthy market trends


On this two-part edition of The Milk Check, the Jacoby team lets listeners in on a monthly mass balance and charting 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 evaluated milk production data and predicted what Q2 will look like in terms of overall milk production and class allocation.

In part two, we zoom out to talk inflation, interest rates and the macroeconomic factors impacting dairy markets. Jacob makes a strong case that farmers should continue investing in increasing their capacity despite an increasing nominal interest rate before presenting a bird’s eye view of various commodities markets and interesting trends to note in dairy and beyond.

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. It was an hour long, but it was a really good meeting. So what we’ve decided to do this month is split it into two parts. And the second part is what we call our charting meeting led by Jacob Menge, our risk manager and trading strategy director, who talked about some of the technical charts and what they’re telling us about our dairy markets and even other markets such as the interest rate markets. It was a great discussion, I hope you enjoy it. Thanks for listening in.

Jacob: So I’m going to start kind of outside of dairy and move rapidly into dairy here, but there’s kind of a common theme at ADPI in before. And a lot of it was surrounding the dairy farmer and kind of the tough headwinds they’re facing here. You’ve got rising interest rates, you’ve got rising input costs. And at first glance, you’re going to say, “Hey, if I’m a dairy farmer that maybe is getting close to retirement, maybe now is the time to just get out.” And again, at first glance that passes the sniff test. The problem is there’s interest rates and then there’s real interest rates. And while interest rates have been rising, which is our little black line right here as has inflation, which is our red line, real interest rates have been dropping. And I’ll zoom back out a little bit more here.

We have not been at these kinds of levels since the inflation eras in the late seventies and early eighties, we are actually lower on real interest rate terms than we were back then. And so in these real interest rate environments, you tend to want to continue to invest. If you’re a business, that is telling you just keep pouring money into buying machines. In the economics textbooks, they always frame it as machines, buy the machine to produce the output. And that output is making you more money than you are not making by just capitalizing on interest rates. Opportunity costs pretty basic there, those economics should apply to farms as well. You have a machine. It just happens to be a living, breathing machine called a cow, but you’re facing kind of this classic economics example of real interest rates are telling us, invest in your machine to make your product.

And a really good example of that right now is happening over in crude oil. So we have the crack spread here and it’s a traditional 3:2:1 crack spread where they’re basically saying, “If you buy three barrels of crude and turned it into two barrels of gasoline and one barrel of diesel, how much money are you making?” And the answer is basically more money than ever before. They are making tons of money. So even though their input costs have increased, you’ve seen increases on corn, you’ve seen increases in oil, it’s manifesting itself as crazy margins.

And I am not at all suggesting that is the case for every farmer everywhere. And I am not as ignorant as that, but big picture here, if you are taking inputs and converting it to an output as a business, real interest rates are saying, keep doing that, increase your capacity, cetera, et cetera. So I think this is kind of an interesting phenomenon. And again, I’m kind of outside dairy here. I’m showing oil, but I really do think you should have some faith in the numbers. And it’s saying there’s no better place for your dollar versus investing and increasing your capacity here.

T3: Hey Jake.

Jacob: Yeah.

T3: Quick question. Is it possible that the data that they’re using to create these graphs has a lag? And so you’re not actually seeing the real prices and prices may be higher?

Jacob: On the crack spread or on the interest rates?

T3: I think more of the interest rates probably is where I’d apply it.

Jacob: This one’s really easy. It’s showing the current inflation rate is just shy 8% and it’s showing the nominal interest rate is between one closer to two. We know that’s right. Those numbers are really easy and the way you get to negative real interest rates is just subtract your inflation less your nominal. And you wind up with your real interest rate or vice versa. So, no, I know these numbers are pretty much right. I won’t say I vetted this all the way back through here, but this looks how I would expect it to look. We did go negative real rates. Some might be slightly off here, because we did go negative real rates. I didn’t think it happened until 2010. This shows it happened in a little earlier, but anyways, I have pretty good faith in this data.

T3: That’s also 2009, 2009 was a crazy year.

Jacob: Yeah. So yeah, that was just kind of my introduction here. There’s one last thing I’ll touch before we go to the kind of usual charts and that is Ted mentioned recession. We had a lot of talk about recession and if we do get one, how it will impact market. I think yeah, recession’s going to be probably the fastest way to take the edge off inflation in these red hot markets. The broader markets, so this is including equities, commodities, et cetera. Certain signals are discounting with chance of inflation. There are others. The classic one here is the yield curve. We went negative. We had a yield curve inversion back on April 1st.

We have bounced way off of that. We basically retraced back to where we were. A month ago, now it’s showing weakness again. It’s volatile. That’s really the takeaway from this year. It’s volatile on these recession predictions, but that’s something we look for. The market doesn’t seem to think it’s imminent. But when you talk to people out in the real world, some are maybe contending that, “Hey, we could be in it.” And that absolutely could be true. Some are saying it won’t happen for three years. So kind of mixed signals on the market there. Anything on that stuff before I go to the kind of more normal charts?

Don: Jacob, just a question. The first graph’s showing the negative real rates?

Jacob: Sure.

Don: Is that also a reflection of the market’s view that the current inflation event is temporary? Or am I trying to read too much into that?

Jacob: That is beyond the scope of what I would even hazard to guess at, because you do have to remember that really half of the equation of the real interest rates is essentially dictated by the Fed, the market isn’t even having any kind of opinion on that. Now I’m going to give one example here. The market has an opinion on it, in this sense. In Nigeria, in the seventies and eighties, the government of Nigeria basically set these interest rates, but the interest rates on the real world were completely disjointed from what the government’s interest rates were. There was this black market of interest rates. If you were to start seeing that, it’s not going to happen in the U.S, I would say. But if you were to start seeing that, then yes, the market would be taking an opinion on this. I just don’t know that the market really has any say in this outside of consumers and inflation in all of that. It was a dodgy answer, but that’s best as I can give you unfortunately.

Don: Okay. All right. I’m going to think about that for a while. All right.

Josh: It also looks like it takes years to correct, right?

Jacob: Yes. Again, could the Fed wave its magic wand tomorrow and dramatically change what real interest rates are? Yeah. But this is typically a pretty slow moving thing and we can go back more here. Back in the forties war tends to do funny things. So that was maybe a quicker correction, but otherwise this is a slow moving beast.

T3: I was on that Hoard’s Dairyman live stream yesterday with Mike Brown and Ted Galloway and Andy Novakovic. And what was interesting was Dr. Novakovic mentioned that what we’re experiencing today with regards to inflation was a lot more like what happened in the 1940s and early fifties, than what happened in the seventies. And in looking at this graph, you can see it.

Jacob: Yeah. I agree with that statement completely. I haven’t heard many people make the argument, but I agree with it. One other thing just regarding recession that I forget to mention, we’ve seen equities kind of faltering lately, and I think that might be a leading reason that people are discussing, “Hey, are we in the middle of recession right now?” I personally think that’s because the so-called “Fed put” is probably gone. The “Fed put” is just people assume that equities start really going south. The Fed’s going to step in to bail it out.

I think the broader market has kind of accepted the fact that the Fed doesn’t have many good duals left in its tool chest here to potentially bail the market out. And so that “Fed put” is gone. And so maybe there’s some risk premium being taken off the market. And so maybe I just don’t like equities faltering as an example of, maybe we’re in recession already. But that was my last point on that.

Over to dairy charts. Really, besides nonfat, I don’t have much to comment on here. Biggest thing I’m going to show on Class III is really the Class III, Class IV spread. This is a weekly chart. So this is going back to 2019. We got pretty darn premium Class IV to Class III, three and a half bucks at the beginning of the year. That has erased. We’re pretty much dead even now. That was a pretty quick about fees. And obviously that was thanks to Class IV coming off while Class IIIs can hung in there. We’ll touch on that again later, but that was interesting on the Class III Class IV side. Class III itself is hanging out near these highs. It hasn’t broken it’s 10-day moving average pretty much since last November. So yeah, we’ve had a small pull back on cheese and thus Class III lately, but it’s hanging in there strong.

I’ll show the cheese chart, I guess it looks a little bit different. It has basically hit this 240 level that it hit twice in 2020, hasn’t broken it. So that seems to be some kind of good resistance number for now. We’ll see if that gets broken. Over to butter, I really don’t have any comment on butter. We’ve been hanging above the 250 line for long enough. Now that I probably think 250 is a very strong support level, there’s nothing on the tea leaves to me that’s telling us where it would go to if we do go up in price here. So not much of a comment on butter.

We got way here. Way is probably the powders way in nonfat. Definitely are the two most interesting charts going on. We had a really strong breakout back in January to the upside, and that has completely reversed. We’re hanging out at the 68 level. That used to be your resistance for sure. It served as really strong resistance back in April of 2021. Typically, the rule is when you break resistance, it becomes support. So I would argue that maybe we are forming some support here around the 67, 68 level.

The problem is, if this support is broken, there is just an air pocket of volume all the way down to 50. So pick a number anywhere in there and tell me that’s going to be the new support and I’ll believe it because there’s just really no indication that this has strong support anywhere between the 68 to 48 level. So something to keep an eye on there. Nonfat, kind of the same tone with pullbacks and volume. So this is zoomed out pretty far. It goes back to May of 2021. We’ve come off our highs a bit, but we’re on this support level of 174 and 75.

It looks pretty darn good to me. We had really good volume all the way between 173 and 185. Like with way the caution here is if we break this support, it’s an air pocket. There is almost no volume between 173 and 161. It blasted through that on the way up. That typically means on the way down, it won’t find much support. So something to keep an eye on very similar to way, we’re going to zoom out on nonfat, just to put some perspectives on this massive run up. We got really extended away from this previous nice and steady upward trend line. Could I see us pulling back to this upper 160 level? I guess I need to draw it so everyone knows what heck I’m visualizing in my mind.

But could I see a pullback somewhere to up in here? Maybe. Do I think that’s guaranteed? No, not at all. And the reason is we’ll go back to the daily chart here. We are on this support. We are probably still supported by this a hundred day moving average. This seems like a pretty sticky level to me. So anything else kind of on our basic commodities there before we hop over to the more exotic charts? Okay. I do want to show the nonfat versus way chart we were just talking about both of those that has been with these. So this is a month chart.

So this goes back a long, long ways to 2012. What this chart is showing is the spread between nonfat and 2.5 times way. It’s just way price times 2.5 versus nonfat. We were nearing the lows of this spread as early as February. And now we’re nearing the hives that spread. That was a heck of a move in a month. Nonfat basically held up a bit longer than way was able to hold up. So we’ll keep an eye on this. That’s a big one month candle there. Anything else on dairy? I’m going to hop over to ags and other commodities if nothing else.

Don: Just a question where you had the real breakout in nonfat, going back to above front line. There we go, which was going back to the end of last year, this year, right?

Jacob: Yep.

Don: That was more the rest of the world moving up ahead of us?

Jacob: Yes, yes. I would say that is largely true. We kind of got dragged higher. There’s one other thing we’re going to cheat and look at the dollar index here, but we were roughly here. So the dollar had appreciated a bit at the end of the year and that’s good appreciation, but it didn’t have this latest, really big leg up. We moved from 96 and a half to a buck three, basically in the last two months. So the headwinds weren’t there on the dollar strength back in November, December, January. So I think that made that move higher on.

Don: So the other way to say that is the dollar has strengthened. Our market has on protein at least flattened, if not pulled back.

Jacob: Yes, I phrased it poorly, but the dollar is a headwind today. It wasn’t a headwind as much back in that big rise higher back in December.

Don: Got it. Thank you.

Jacob: Okay. Here’s corn. So I did new corn and old crop soybeans just to kind of give perspective. This is a month chart. So we’re pulled way back. This goes back to 2001. I just wanted to show everybody how meteoric this rise has been. It looked like we were stalling out for a time. And then early February, we start moving higher. And then the situation in Ukraine gave us a whole other leg up. So new crop at 751, that is a big, big number. We’ve seen this back in 2012, but again, this is just for such different reason. This seems more sustainable. I’ll say that.

Diego: Can you go back to the corn one second? Wanted to point out that when we reached those levels, it hasn’t last for too long and the correction has been pretty steep. So that’s something that could happen this time around maybe.

Jacob: Keep our eyes out. Soybeans, same general feel. We’re pretty much at those highs. Soybeans haven’t been quite as impacted by Ukraine. And the only reason I say that is we made a high, somewhat close where we’re at on beans back in May last year. And so the run up on soybeans has just been a bit different, but again, this is old crop beans. So just note that. I’m going to hop over, we did talk about this dollar index. This obviously is very important for what’s been going on recently with our commodity prices. And I would trust, especially the international ones, like the powders, this massive move higher in the dollar has not been helpful to our export prices. So that could explain a bit of the weakness lately.

I think the last one really to talk about maybe is just commodities as a whole. I wanted to give perspective on this. So this is a commodity basket. This includes energies, metals, grains, you name it. Commodities have continued to largely move higher, but ags are much stronger than commodity baskets. It’s notable because I talk to a lot of people that are still saying, “Oh, how strong commodities are?” And again, we are following that trend higher, but I feel like a lot of people in our industry have maybe got latched on to what’s going on in greens and dairy and cetera, and maybe lost to the big picture perspective here of, yeah, commodities have been having money flow into them and it certainly looks better than equities, but not at the rate that we’ve seen in ags. That’s not been across the board. That’s really all I had. Any other requests here?

Don: Just since we’ve been looking at it most months, lumber, what it looks like?

Jacob: Oh, I should not have neglected our favorite child here. Volatile, but not remarkable.

T3: Hey, Jake, that looks like an upside-down W. What does that theoretically mean?

Jacob: Yeah. I mean, you would expect if it breaks out below this level, it has not done it yet, but if it breaks below this call it 811 level, it would continue on its way lower.

T3: Okay. Don, Jake, thank you very much. I thought this was really, really great this month. Thank you.

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