Markets are stronger, but “careful is the watchword”


Dairy markets are getting stronger, and dairy farmers are earning higher paychecks as a result. Ted and T3 welcome Vice President of Powder Sales Jeff Johnson to The Milk Check to help project how much higher the Class III price goes by the end of the year.

But, as Ted warns when things get too bullish, “careful is the watchword.”

The Milk Check: Markets are stronger, but "Careful is the watchword"

Episode transcript

Anna: Welcome to “The Milk Check,” a podcast from T.C. Jacoby & Co., where we share market insights and analysis with dairy farmers in mind. Today is May 10th. This is Anna Donze and with me, I have Ted and T3 as usual. We also have a special guest, our vice president of powder sales, Jeff Johnson.

Things have changed over the past month and instead of our usual “wait and see” discussion, we seem to have good news to share. The Class III market bottomed out in February at $13.40, went up to $14.22 in March, and $14.47 in April. So what’s going on?

T3: Well, not only that, but it’s probably gonna come out somewhere around $15.30, $15.40 once May’s done pricing. To be honest, markets have gotten stronger. We’ve seen good exports, good cheese exports, we’ve started to see, I think, good powder exports. It’s not the environment that we expected back in February. We’re seeing much better demand not just domestically, but internationally. And that started to kind of change the supply and demand dynamic.

Ted: What do you mean we didn’t expect this in February? You wanna go back and listen to the last podcast?

T3: Okay. So, I didn’t expect this in February. You did, you did.

Ted: If I recall correctly, we said exactly the base for what we’re talking about right now. And I don’t think there’s any mystery at all as to what’s going on right now. We have a good economy. We have increased demand in the U.S. as a result. The world economy is also strong and we have increased exports at almost 2014 level. In fact, in some areas, actually a little bit higher. Now, the markets have gone up, they’ve gone up. If you wanna look at February versus May, the Class III price has gone up something a little less than two bucks. But if we look at the cheese market now, using that as a barometer, the spread between the European prices, the Oceania prices, and the U.S. prices has narrowed.

So, it doesn’t mean that the increase is over, but I think that we’re probably looking at a plateau here for May and June as far as Class III pricing is concerned somewhere in the $15, mid to low $15s. And then depending on how the harvest goes and depending on how the summer goes, if it’s hot, you know, we could be looking at $16 by the time we get to July. I think we’ll be at least another couple of bucks higher than that by the time we get to November. So…

T3: So, you think we’re gonna see $18 Class III in November?

Ted: I don’t know about $18. A couple of bucks to me is $17.

T3: Okay.

Ted: $17 to $17.50 on the Class III.

T3: And you think this is gonna be driven by demand?

Ted: I don’t see anything to stop it. Production has sort of plateaued, it’s still going up. But the European, the increase in production is down. And the U.S. increase in production is down. Culled cow rates in the eastern part of the country are up, but they’re down in the west, southwest and the west. So, I think that basically we’re gonna continue to see strong markets through the year. I don’t think it’s gonna be explosive. I think it’ll be a steady increase at least through November. And then we’ll see where we go from there. If, you know, we’re gonna see some attrition with dairy, but we’re seeing it. But it doesn’t mean we’ll have a negative number. At least I don’t see that yet. But, you know, zero growth with an increase in demand is a very bullish situation.

T3: And to be honest, I would 100% agree with that.

Ted: It took you a while.

T3: As John Maynard Keynes would like to say, “When the facts change, my opinion changes. How about you?” Jeff, you’re our powder guy. You just came back from Southeast Asia. Do you agree with what he’s saying about the international markets?

Jeff: I think markets are strong. I mean, I don’t think it’s a runaway situation because people don’t wanna believe it and they’ve had a lot of opportunity to buy at really low prices. The real question to me remains, you know, what changed, you know, from six months ago to today. And, you know, we’ve been in this market for a long, long time. So, I guess the thing that I was advising people, customers that I was talking to at the recent convention was, you know, what’s the risk to the upside versus the risk to the down? We’ve been…we bounced off these two bottoms a couple times now with whey and nonfat. And I don’t think, I think the bottom is in. So, a slow, sustained rise is healthy and I think we can keep on going for a while.

Carb demand continues to be strong in Southeast Asia and particularly in China. They’re buying just about everything they can get. And I wouldn’t say just China, but South Korea, Vietnam, every market that we’re in and other peoples play in, too. It’s just, it’s kind of concerning because we went from a…and I keep going back to the supply. We went from a place where we couldn’t get rid of solids and now there’s good demand for it. So, apparently the buyer sentiment has changed and they’re ready to start loading up.

T3: Is it your sense that they’re building inventories or is it your sense they’re trying to keep up with end user demand?

Jeff: I think there’s a little bit of both. I think they’re scared that they’re gonna…they’ve missed the bottom because they’ve been resistant. Now, you mean you can’t place…on a way you can’t place, you know, $1,200 out there is one metric ton and they’re gonna go out and buy it. No. You have to be more realistic about your price.

T3: So, what is $1,200? What’s that in penny, in cents per pound?

Jeff: A thousand is about $0.40, $0.45. Somewhere around there.

T3: And $0.45 is how much freight are we talking about? Five, six cents?

Jeff: Yeah. Depending on which location.

T3: So if you can get $0.44, you’re talking $0.38, $0.39.

Jeff: Yeah. Somewhere in there I would say. And that’s for a really good, you know, premium brand. Now, we’re gonna have…we’re testing that market. I mean, I don’t know that we’re gonna get it done there, but we’re… I mean, that’s all everything that everybody’s posting is this and talking about. That’s the number that’s gonna be out there for Q3. So, we’ll see.

T3: So, off the top of my head, I would guess that if you can get a price like that for exports, you’d probably end up eventually with an NDPSR number right around $0.36, $0.37 for whey.

Jeff: Yeah. Maybe so, and I think that that’s kind of where the futures are pricing at today and it’s hard to argue with that. Because it is hard to argue the fact that we’re gonna be over Europe and be successful. And Europe has had a little bit of a push back of late. Suspect to that is that some of the intervention product coming out and, you know, at a pretty low number that maybe substituting some whey demand. We’ll see. I think the jury is still out on that, too, and there’s a lot more product to come out.

T3: Well, for the farmers in our audience, right now, whey NDPSR is coming out at around $0.2, $0.28.

Jeff: $0.26, $0.27. Yeah.

T3: So we’re probably expecting about a $0.10 rise in whey prices over the next three to four months.

Jeff: Yeah. Might be a little aggressive maybe towards the end of year.

T3: Okay. But that ends up translating to a Class III price rise of about $0.60 because a penny rise in whey ends up being about a $0.06 rise in the milk price per hundredweight. So, you’re looking at a $0.60 rise in the Class III price on whey alone and we’re probably looking, you know, cheese prices since February were up $0.20 which is approximately $2 a hundredweight which correlates well with $13.40 in February for Class III. And somewhere around $15.40 right now. And I would say from what I’m seeing from the cheese market, I wouldn’t be surprised if we start… Right now, our cheese market’s in the high $1.60s. I wouldn’t be surprised if we get into July and it’s in the high $1.70s. And I wouldn’t be surprised if later in the summer, early fall, we test $1.80. And to me, that’s about the upper end of what I’d expect which means we’ve probably got another $1.50 in the Class III price, as well. So, you take… Let’s call it a $1.40 from a cheese perspective, $0.60 from a whey perspective. That’s two more dollars that we tack on to the $15.40 we’re looking at right now which means late summer, early fall, looking at about a $17.50 Class III, that fits with kind of my view of this market. I can see us adding about two more dollars a hundredweight.

Ted: Yeah. If you look at one of the reports this morning, the Oceania cheddar price was moving at $1.80. Our current cheese price is $1.66. So we got $0.14. So, and we’re moving it at that number. Now, New Zealand is going into their dry period. So, you know, they’re not gonna be moving a lot of product off the market here for the next two months, three months actually.

T3: It’s more like five months. They’ll start up in August. They won’t start exporting until October.

Ted: Okay. And that again, that means that our competition for business is gonna come from Europe. And the European markets have been relatively firm. They’ve gone down a little bit, but we’re in the flush over there, too. So, I expect a… And I agree with your math. I think a couple of bucks from May between there and the end of the year is about where we’ll end up. And some sort of a weather event could cause it to be considerably higher.

Another issue that I have my eyebrows up a little bit is butter. One of the reports that I just read here in the last couple days was questioning the strength in the butter market. I think someone who questions that strength under these circumstances has to be a rookie because when we get into strong markets for butter, it’s almost exponential. It’s not a matter of we’re competing with margarine anymore. We’re not. We’re looking at butter as being the sole spread as far as that utilization is concerned. And again, a hot summer, you could be looking at a cream market like we haven’t seen until for the last 20 years.

T3: Well…

Ted: And people don’t remember that. So, look out. If we’re gonna get into that kind of an environment, the butter market along with the Class IV pricing could drive things.

T3: Well, I’ve been the bear in the room and you’ve been the bull in the room for the last few months. But I’m actually gonna agree with you on that, this one. And I’ll even take it a step further. We may be at $2.35 a pound for butter here in the U.S. right now. Last time I checked, last price Europe posted was $3.20. So, they’re 80 cents higher than we are. Now, keep in mind, their butter is different. We’re 80% dairy, they’re 82%. But 2% butterfat is not an $0.80 change in price. And the big difference between the U.S. and Europe right now is you can look at the U.S. in a bubble and say we’ve got more than enough butter inventory to handle our needs. But we’re not in a bubble anymore. This is a global market. In spite of what our president wants to do, it’s still a global market. And the European market is short butter, and that is either directly or indirectly going to affect the U.S. butter price. We’re either gonna be exporting into the world market to help importers who need butterfat and can’t get it from Europe or we’re gonna backfill other people who fill those markets.

Ted: A useful bit of information that we should look at is keep our ear to the ground for when the buttermakers start making 82%. That would be an indication that butter exports are beginning to take off. And given the time of the year and so on, that would be a very bullish thing to have happen. Now, all the butter inventories that everyone has right now just like your cheese inventories are all hedged. So, inventory is strictly a cost item. Whatever it is, it is and no one’s gonna lose money on their inventory if the market goes down.

T3: You know, you bring up hedging and I’m gonna go off on a tangent for a second. We’ve been watching open interest in our futures markets at the CME. Open interest in butter futures is, I believe, flat to higher. Open interest in nonfat is up. Open interest in whey, I think, is slightly lower, but open interest in cheese in Class III is definitely lower. It’s our experience, at least it’s personally my experience, that when there’s significant differences in open interest especially when open interest year-to-year is lower in our futures and options markets, that that means that market is vulnerable to a major change in price. And what I’ve seen in the…

Ted: Which way?

T3: Usually up, but it depends, you know. But it’s usually to the upside.

Ted: So, the lack of open interest is telling you that people’s…

Jeff: Don’t believe it.

Ted: …proclivity to change, to hedge is minimal.

T3: They’re in a comfort zone. They’re not believers.

Jeff: And that’s would very much so line up with where the powder market thinks that nonfat skim and whey is at and isn’t going to go. I think there’s gonna be plenty of opportunity. So, be careful.

Ted: Yeah. I think “careful” is the watchword because it could change, but…

Jeff: That could be the explosive environment right there, the unwillingness to accept what may be going on.

Ted: One of the issues is how many small dairymen are gonna throw in the towel. In this environment, even the change that we’re talking about will not keep the small dairymen alive. They’ll keep the big one alive because their cost of production and efficiencies are much better. But the one, two hundred head cow herd, doesn’t really benefit until the price gets up into the $18 range. So, we’re not looking at… Based on what we’re projecting here or think we’re seeing, we’re not looking at a change in the production dynamics at least as I see it which is another bullish indicator from my point of view.

T3: That’s where you and I, I think, are a little bit different. I still maintain that we weren’t low enough, long enough to cull the herd enough which means there’s still a number of inefficient producers out there. And now, we’re gonna go back up into the fall where a lot of those inefficient producers, maybe they’re marginally profitable, in some cases, there’s some that would probably be very profitable for a little while. But I don’t believe that we cut the farm numbers and the cattle numbers enough for this to be an extended run. And so, one of the things that I’m still keeping my eye closely on is what milk production will continue to do. If it stays somewhere between 1% and 1.5%, that’s bullish because generally speaking, demand grows at somewhere around a 1.5% to a 2% rate. And so, if our milk production is growing at a slower rate than demand, that makes higher prices. But my gut tells me that we’re gonna see milk production move back towards 2% and then even if I’m bullish September, I’m bullish into the fall, I’m not gonna be bullish through the holidays and into the first quarter of next year.

Ted: Well, I guess we’ll see. I tend to think that the production will languish. I don’t think it’ll go negative. But it could be less than 1% year-on-year. So…

T3: I wouldn’t be surprised frankly if that’s what we get in April because the weather in the Upper Midwest and Mideast in April was bad. It was basically, we had another month of winter. One of the things we saw in the month of April was that we didn’t see a typical spring flush like we usually do in the Upper Midwest and we kept saying, “Well, it’s late. The weather is cold. It’s late, it’s late.” Now, we’re getting into the middle of May, what we’re hearing is not it’s late. What we’re hearing is it looks like it just didn’t happen. And that tells me that April probably had milk production, but on a per cow level that will be especially in the Upper Midwest and Mideast surprisingly low. And I wouldn’t be surprised if we kinda are surprised by the milk production report in April that it’s lower than maybe what the models would predict.

Ted: I guess we’ll see. But I don’t think it’s gonna set the world afire either. But, you know, feed these days is not out in the pasture. It’s in the free stall. So, corn silage is gonna show up no matter what and the thing that’s detrimental to production is heat. You know, the fact that we had temperatures in the 30s to 40s in April, I don’t think it’s gonna be particularly deleterious to production. It might make a little bit of difference, but not a lot. I think one thing that we could address very briefly is that when it comes time to move surplus milk, yes, we are moving surplus milk and yes, it is moving at negative prices which indicates that the manufacturing plants are all pretty well filled, but we’re not moving near as much as we did last year.

So, I think that’s another bullish indication. But again, it points to the fact that we have a lack of manufacturing capacity that needs to be addressed. And how that’s gonna be addressed in the long run, I think, is something that remains to be seen. If you think about it, we have only a few new plants in the dairy industry and the rest of them are…some of them are 80 years old and that doesn’t bode well. Particularly in the days of Listeria and Salmonella, and E.coli.

T3: But I’d also say this, what’s happened to dairy plants is very similar to what’s been happening at the dairy farm level. Every new plant is way bigger than the old plant.

Ted: Well, yeah, but you have a lot of different kinds of products. You’ve got yogurt, you’ve got 100 different varieties of cheese, you’ve got a lot of different products other than cheddar and mozz. And those plants are all old, the ones that are making the specialty cheese product.

T3: Well, the ones that are making the special cheese products are old because they were all…they used to be cheddar plants and they converted to specialty cheese rather than expand.

Ted: Exactly.

T3: Meanwhile, all the new plants that have been built, you know, you take Southwest Cheese in Clovis, it’s been around a little bit over 10 years now. It’s expanded a couple of times. I believe it’s up to processing 14 million pounds of milk a day. You’ve got a new plant and now, the new plant they’re talking about going in Michigan, the Glanbia plant that may be built in Michigan. They’re talking about starting at six with it being expandable up to nine. The land was guaranteed, the plot of land they’ll put it on is gonna make sure they can expand it up to 15 if necessary.

Ted: But that’s only one product.

T3: True.

Ted: There’s a lot more than just cheddar out there and those different varieties of of cheese and so on. None of the, all those plants are old. You almost have a market for new plants and new facilities, it’s gonna need. Because picture an old plant, it’s got an old sewer system, it’s got an old water system, it’s got an old wastewater system.

T3: And a whole bunch of really good places for Listeria to hide as a result.

Ted: Exactly. And the testing is getting so much better. You know, everybody’s running the gauntlet on testing and not only that, the customers where they used to drink raw milk 80 years ago, and developed immunities to these organisms, you know, they’ve been drinking pasteurized product now for their whole life almost and haven’t developed any immunities at all. So, this is an issue that has to be addressed at one day. I expect we’re gonna all of a sudden see an explosion in the manufacturing facilities for specialty products.

T3: I don’t disagree and I’ll even take it a step further. I think the true demand in our industry is actually in those specialty products.

Ted: I agree.

T3: Which means we’re not just having to worry about rebuilding old plants, but we’re starting to see some of that specialty cheese growth expand beyond the size of those plants. And we’re getting to the point with a lot of the food safety issues that we deal with today. It may be a lot more expensive, but it’s still a lot easier to just start over and build a new plant rather than try to keep expanding that old one.

Ted: Well, therein lies the problem. The cost of building them has doubled in the last 10 years. From the littlest plant to the biggest plant, it’s now an expensive proposition. But, you know, shipping a boatload of cheddar to China or maybe Australia or wherever we go with it is the pretty easy solution for handling surplus in trade. But the potential is so much bigger for shipping some of the new specialty products we see in our dairy cases today in the supermarkets. So, we haven’t even scratched the surface in that area.

Anna: We’ll keep a close eye on production numbers and exports, and come back next month with the latest update. Thank you all, especially you, Jeff, for joining us. We welcome your participation in “The Milk Check.” If you have comments to share or questions you want answered, send an email to Our theme music is composed and performed by Phil Keaggy. “The Milk Check” is a production of T.C. Jacoby & Co.

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