Optimism amid mixed signals


Some “ugliness” in dairy product markets remains, but Anna, Ted and T3 discuss how it’s not as bad as it could have been.

  • Higher EU cheese prices bode well for the U.S.
  • Butter prices aren’t stellar, but they’re not awful either.
  • What will a gradual shift from Holsteins to Jerseys mean for milk markets?

Ted cautiously predicts when dairy farmers may begin to see higher milk checks.

What’s the situation where you are? Send your observations or questions to podcast@jacoby.com.

The Milk Check: Optimism amid mixed signals

Episode transcript

Anna: Welcome to “The Milk Check,” a podcast from T.C. Jacoby & Company where we share market insights and analysis with dairy farmers in mind. Let’s start today with a follow-up on a topic from last month’s discussion, the Gulfood show was in mid-February and T3, you mentioned being interested in feedback from that show, particularly in getting some indicators of whether it be the U.S. or Europe getting the export sales in the coming months. I’ve only heard a little bit of the feedback, but it sounded to me like the answers were pretty mixed. What were your impressions?

T3: I think they were mixed by product. So the nonfat dry milk market is, in a word, ugly. There’s too much in Europe. There’s too much in the U.S. There’s too much everywhere. And that’s a problem that’s getting worse, not better. So I don’t see a quick recovery from the price issues we have with nonfat dry milk powder or skim milk powder anytime soon.

And unfortunately, the weakness in the nonfat dry market is cascading over into the other powder markets. Lower nonfat prices lead to lower protein prices, and so you’re getting weak prices in the milk protein concentrate part of the business, the whey protein concentrate part of the business and ultimately, even in the sweet whey powder part of the business because some of the older nonfat dry milk is starting to enter into the feed market. And it’s an issue of sweet whey powder’s 12% protein. Nonfat dry milk is about 34% protein, and so it’s close to a three-to-one ratio which means if we’re at 60 to 65 cents a pound for older nonfat dry milk, divide that price by a third and you get 22, 23 cents, which is why that’s where the whey prices is.

The good news is on the cheese side, we came out of that show more bullish. Cheese demand globally was surprisingly good. Europe is getting a fair number of decent cheese contracts, and the U.S. is getting a fair number of decent cheese contracts. I think global demand for cheese is up, and I think it’s benefiting everybody at the moment. We came away with some good opportunities, some good export contracts. We know that some of the big manufacturers did as well. The mozzarella market was particularly strong, but the cheddar market was strong as well. Well, I think right now while we’re during the flush, the cheese market, and the cheddar market specifically because that’s what drives price, is going to be well enough supplied that I don’t expect any sudden big increases in cheese price today in March or in April. I think it sets the tone for the rest of the year where cheese inventories are not gonna become terribly burdensome and cheese demand will probably be pretty good. And as a result, I think we can be optimistic about the trajectory of cheese prices between now and the end of the year.

Ted: I agree that the prognosis for the rest of the year isn’t as bad as it could be. Powder nonfat dry milk, SMP is bearish. It’s probably gonna be bearish for quite a while, inventories in Europe, inventories in the U.S., and I agree with you, inventories everywhere. However, the other side of that line is butter. While it’s not as strong as it has been in prior years, it’s certainly not weak. The prices are still holding above two bucks, which will tend to hold the Class IV price up. We watch the synthetic Class III and Class IV prices which come out at the end of every week closely, and one thing that we look at is the difference between the synthetic Class III and IV prices vis-a-vis the EU. We can look at vis-a-vis New Zealand also, but given that EU is the much bigger player, we think it has a much more important impact.

If we look at the Class IV price or the combination of butter and powder vis-a-vis the EU, there’s a $3 per hundredweight of milk difference in the synthetic price. Where the United States price is running around $12.80, $12.90, the EU price is running around $15.80 to $15.90. That’s a huge difference. And it would argue that the U.S. is gonna be in a strong exporting position probably mostly based on butter, which right now hasn’t really been that shining of an example but neither has it crashed either. So, yes, we do have inventories and we do have sales which are marginally good, but given a strong economy in the second half of the year that could change in a hurry.

If we look at the synthetic Class III price, which is cheese, the U.S. synthetic price runs in the range of $14.30 to $14.50. Price this week seems to be a little bit higher because the cheese market has gone up a couple of cents on a weekly basis. It’s about 20 cents a 100 weight of milk. Price in Europe on the other end is in the $16.50 to $16.60 range per 100 weight of milk, and their cheese price that they’re using for that number is about a $1.70 to a $1.75. Our current cheese price is about a $1.55 to a $1.58 on the block at least.

T3: I need to make a quick comment just to clarify for everybody. The cheese price in Europe tends to be based on what the cost is delivered to the port, and the cheese price in the U.S. tends to be what the price is, FOB the plant. And so there’s about a 10 cent factor that you gotta adjust in that. So if we’re at a $1.55 in the U.S., by the time we deliver it to the port, we’re closer to a $1.65.

Ted: But the point I wanna make is, is that we should be exporting quite a bit of cheese, and we are. The futures market basically in the U.S. is running actually below the cash price on current values. And, yes, it is a spot price FOB the plant. But on the other hand, if you put in the promotional programs like CWD and so on, the U.S. is in a good position to export cheese which should sustain that difference in the synthetic pricing.

T3: I’ve been hearing a lot of mixed signals, seeing a lot of mixed signals when it comes to domestic demand. I think there’s been a lot of transition over the last three to six months in the domestic demand department. I think some of the traditional players who drive demand on a full category basis have been losing volume. And I think that’s been making the numbers look worse than they are, but I also think that there’s a lot volume getting picked up in non-traditional sectors. An example of what I mean by that is I believe the latest IRI data reflects that sales of Kraft cheese is as down as much as 4% year over year. But what’s happened is supermarkets like Walmart have switched. They’re no longer carrying Kraft. They’re carrying brands like Crystal Farms and they’re carrying other brands whose volume is up. I think you’re seeing things like that happen in a number of different places that cause that. It’s pretty difficult to get a read on exactly what’s going on in the domestic demand front.

Ted: And I agree with that also. If you wanna refer to the Class I sales, they continue to decline even though whole milk sales are going up. But one of the publications last week made a good point that we are seeing an increasing amount of enhanced Class I products. Without naming names, we see high-protein products where the protein’s been increased 50%. We see athletic recovery drinks where it’s very high protein. We see GNC selling, whey protein concentrate products flying off the shelves. That’s not Class I but enhanced protein on a lot of these products is also making up for a lot of the decline in Class I sales. No question that some of this decline is due to ersatz milk products.

From our standpoint, Class I milk is our milk, and we’re seeing a lot of Class I products that are fortified and particularly whole milk products, whole milk yogurts, Greek-style, whole milk yogurts fortified with higher protein but also higher butterfat, which make a big difference. I’m of the opinion that while the domestic demand has been lackluster here in the first quarter. Going forward, there are some strong indication that that’s starting to change.

Anna: You guys have both mentioned third and fourth quarter, and I do wanna come back to that. But I think before we do that, production is something that we should talk about. We’ve mentioned several times in past podcasts that producers should be watching to see if production numbers decrease. February numbers for the 23-state and national milk production totals aren’t out yet, but January was up 1.8% for both of those. January was actually the highest recorded January production per cow for the 23-state average series ever. Are you hearing or seeing anything more current that would indicate these numbers are starting to decrease or that producers are starting to leave?

Ted: I think one of the key factors that we need to bear in mind on production is that the production numbers that we look at mostly either government numbers, or agency numbers, or State numbers, or regional numbers are all volume-based. They don’t say anything about components.

Anna: True.

Ted: And the components are up big numbers. I really am not in a position to say how much they’ve quantified because I don’t know. We don’t have anything to refer to. But I would be willing to bet that if you looked at it today, your average protein is probably running somewhere above 3.2 (percent) where the norm is somewhere around…the historical norm is 2.98 or something like that. That’s a huge protein issue, and to a large extent, it accounts for a lot of the surpluses of nonfat dry milk.

A lot of the dairymen are going from Holstein black and whites to Jerseys because the Federal Orders are switching to component pricing. In fact, Order 5 and Order 7, which is basically the southeast with the exception of Florida, are applying for hearings to switch to component pricing. This is long overdue but also indicates that a lot of the dairymen favor high-protein, high-component cattle as opposed to the boxcar-size Holsteins that produce a lot of milk but relatively low solids. So I think this is something that we need to be aware of.

With regard to butterfat, even though as I stated earlier, butter is seasonally at it’s, probably, lowest point. Butter is no longer on the forbidden list and people are eating high-fat ice cream. People are eating high-fat yogurts. People are drinking high-fat whole milk. And I don’t think a lot of the people in the market today have ever seen a really wild butter market such as we used to have 20 and 30 years ago. And if it goes the way I think it might, we could be in store for a butter market of historical proportions here this fall.

T3: I’m gonna disagree with you about the butter market. We are building butter inventories faster this year than we have in the last few years. We entered the year with bigger inventories of butter than we have in five years, and that hasn’t slowed down. I’m actually getting a little bit bearish butterfat or butter prices the second half of the year even though I’m bullish cheese prices because I think one of the things that’s happening in the butter market is along the lines of what you’ve been talking about with components, not only is the components in terms of protein up. The components in terms of butterfat are up too. Let’s not forget the relationship between nonfat and butter is complimentary. The more nonfat you make, the more butter you spin off.

Ted: Let me give another perspective on that. The European price last week was $2.75 for butter, is 82% butter, of course. And our butter price which is 80% butter is $2.20. Those prices are varying on a daily basis. But if you look at the export numbers on butter, they barely are recognizable on the scale. If we were then gonna be that long on butter, we would be exporting butter, and we’re not. We’re exporting a little bit, but we’re not exporting much at all. So, yeah, I agree with you. The component value is certainly up, but is it up enough to offset a really good demand during the second half of the year? Well, it depends on a lot of different variables, but the economy is one variable, and temperatures, and ice cream, and so on are another variable, and cream cheese and butter sales are another variable. So if the stars line up, you could be looking at substantial demand for butter products, not only butter itself but butter products in the second half of the year. That’s the point. It’s not just butter. It’s butter products.

T3: And I think that’s an important thing to keep in mind because we have seen not just a growth in the demand for butter, but we’ve seen a pretty significant growth in the demand for normal products that for 20 years had been moving towards less butter are now moving towards having more butter in them. And I agree with that point. I think on the international market, there’s some dynamics going on that are worth mentioning as to why assuming that we’d have larger butter exports are probably not in the cards.

The first is we have found most, if not almost, every manufacturer in the United States is extremely reluctant to make 82% butter. To be honest, we’re not exactly sure why except to say that the efficiencies of their plant move down considerably when they’re making 82%, they’re just very reluctant to do it. In the second part, I would say is that Europe is in an interesting point right now. There was a shortage of butter in Europe last year. The price of butter in Europe went up extremely high last year, and then it came crashing back down to earth when they realized that the price had gotten so high that they killed demand. But it doesn’t change the fact that they had no butter in inventory. And what Europe is going through right now is a classic inventory building scenario after they have had prices go to the moon.

Europe will not be exporting any butter. Europe is using all of their butter internally, not only for their own domestic demand but also to refill all of the pipeline to the market that usually has butter, you know, stored and balanced in certain places because when butter prices go as high as they went last year in Europe, one of the effects of that is everybody who tends to hold a few loads of butter in inventory uses those loads and that goes to zero. And so what’ll happen with the European butter price, it’ll slowly go lower but they will also use it all internally. Meanwhile, Fonterra who usually exports butter to Europe, is not. They’re exporting butter to everyone else. And so our competition in the international market for butter has been Fonterra, and Fonterra has actually been pretty successful this year at exporting butter and has been doing a pretty good job of keeping the international butter market cleared up.

Ted: Well, I can only say that I agree with everything that you say, but the point that I made earlier, I wanna reiterate is that there’s a heck of a lot more to the butter market than butter.

T3: And I agree.

Ted: Cream sales, which we’re heavily involved in, are the issue that control what butterfat values are during the second half of the year. And if it turns out that the churns are gonna have to bid for cream then bet that the butter market is gonna go up because they’re gonna have to pay for the cream that they’re buying. And they’re gonna be competing with ice cream, and cream cheese, and a lot of different cream usage that always rear their heads starting about August of every year. And I’ll just tell you right now that when that rush starts, if it starts, it could really be shocking to a lot of people who have never seen it before.

T3: Yes, it could be. But if we have more than enough butter in inventory, and again, I’ll go back to one of the things I said earlier, which was right now we’ve got more butter in inventory this time of year than we’ve ever had in history. We’ve just started the year with a lot of butter in inventory. What will happen is the butter manufacturers, they won’t need the cream. They’ll just micro fix the butter they have in inventory into quarters.

Ted: Well, I guess we’re gonna find out.

T3: Yes, we will. I’ll bet you a dollar.

Ted: Okay, you’re on.

Anna: Since we’re back to third quarter, we’ve always talked about that as if it’s the light at the end of the tunnel. Has anything changed that, especially given the news of a lot of producers looking for markets right now? We know there are a lot available.

Ted: I think that there’s gonna continue to be a lot of milk available. And one dynamic in this whole situation, first of all, feed prices generally are pretty decent, and there isn’t any indication that’s gonna change at least as we look at it today. One of the major bottling companies has dropped 100 odd producers, and we would note that these producers generally are truckload shipping producers, if not exclusively, truckload shipping producers. If you accept the premise that competition for the milk is what increases the price to the producers, it’s pretty hard to visualize with the prospect of 100 odd truckload shippers coming on the market in June and early July that there’s gonna be any demand for milk until that whole situation settles now.

So, markets moving up will be one thing. Milk supplies and the reallocation of milk to different milk users will be another. So, my contention is, is that we may see the market moving, but it probably wouldn’t reflect itself into higher milk prices until probably like September, maybe even October. So we have marginally higher production in the United States, something less than 2%. And then in Europe, you’ve got…4.6% is the number that I saw recently, the higher production. I don’t see that changing, but the European milk price is a little bit higher. So they’re not gonna probably have much attrition on production.

T3: I’m actually gonna disagree with you on that too but in a way that I hope our farmers would like. One of the anomalies of Europe being up 6% in December and then 4.2% in January is that they were measuring against extreme weakness at the time. And as we move into the second quarter, the simple measurements year over a year move that number down because measuring against extreme weaknesses where a year ago they lost 3% in milk production versus in March or April where I believe they were up 2% the previous year changes that percentage number without really changing what was going on in milk production. And so I actually expect the year over year percentage numbers of growth of milk production in Europe as we get into the second quarter to actually move towards 2%. Now, it’s still the largest milk shed in the world, that’s still a lot of milk, but I don’t think the situation in terms of this size of surplus milk in Europe is as dire as those numbers we’re painting in the fourth quarter of last year.

We’re also hearing, and I think I mentioned this in an earlier podcast that prices in Europe, farm prices and milk box prices of milk to the farm in Europe are coming down, which will also start to have an effect on milk production increases. And ultimately, that becomes bullish our markets. It’ll take a while for that to play out though.

Anna: Before we wrap up, is there anything that our producers should be looking at over the coming month before we come back here again to do March?

T3: Weather.

Ted: I would say that the most relevant factor in trying to paint a picture as to what’s gonna happen at the end of this year and in 2019 are the inventory values and where they go. If we start chewing into cheese inventories, that’s a big item, a huge item. And if we start working our way down on nonfat dry milk inventories, that also would be a significant item that could affect the overall picture. Those two items are probably gonna tell the biggest part of the story.

T3: And I agree with you. I think you’re absolutely right there. I’m gonna switch back to weather, and I got a question for you because you’re closer to this than I am, is the flush lake this year?

Ted: It’s March.

T3: I know it’s March, but my point is it seems…

Ted: The flush doesn’t start until April.

T3: Well, but it seemed to me by this time last year we were moving a lot of distressed milk, and it doesn’t seem as bad this year.

Ted: Bingo, exactly. This flushing never starts until April, or May, or June. And the fact that you’re having a normal March now all of a sudden is surprising. So…

T3: It also means that maybe people are a little bit too bearish.

Ted: Well, that’s my contention is that maybe this situation right now with the economy picking up the way it is and people finally starting to get used to it, when they do get used to it, it’s gonna be a surprise to a lot of people who have become very accustomed to 100 odd loads of milk a day moving out of the Upper Midwest towards Wisconsin. And when they figure out that, well, maybe that was sort of an aberration rather than a norm, then it’s gonna be a surprise to them. And that’s one of the reasons why I think that we’re really in a rather normal situation right now. With March, we’ve got a little bit of extra milk but not much compared to commitments [SP], and it won’t be until April or maybe even May that we will be wrestling with surplus and then maybe for a briefer period of time than normal.

T3: And I think that would be great. So I’m gonna say one of the other things that I think the farmers should be keeping an eye on is if they get the milk production report from the USDA. We were up 1.8% in January, and that was surprisingly high. February felt like we weren’t moving as much surplus milk as we had in years past. If we’re up 1.8% again, then that milk is… Something’s happening but it’s not happening in Michigan or places where we’ve had the focus on the surplus, the ugly surplus situation in the past springs. I would highlight that that’s probably Idaho in the Southwest, New Mexico, Texas and that area. We’ve seen pretty good growth in production in those areas lately. And one of my fears is that even though we are finally getting things in line in terms of surplus milk in the Mid-East and Northeast, let’s just say in line relatively speaking, we still got a long way to go. But the growths are slowing down there. They’re picking up in other parts of the country and causing the problem to continue because we just are not getting milk production down. I guess what I’m saying to kind of sum up this podcast is I am optimistic that prices are gonna be better in the second half of the year, but I’m only optimistic if milk production does what we’re expecting it to do, which is continuing to tighten up and move lower. And if we get milk production let’s say below 1% for a few months, then I think I get honestly bullish the second half of the year. But if we continue to see milk production in the 1.8% range, I’m gonna be pretty skeptical.

Ted: I think most dairymen have bought their feed to last them through the next harvest, actually, a little more than that. So I do expect the production to go down, and I expect where we had just hypothetically 60% of the milk was truckload shippers, by the time we get through with this cycle, we’ll probably be up in the 70s. And I don’t see that trend changing at all. And what I guess that means is, is that the dairymen are probably gonna feed the feed that they have, particularly the smaller ones and then the bigger will buy the cows. And that they don’t get 100% retention of the milk flow on that basis, but it’ll be a little slower for the production to drop. I think it will drop, but I don’t think the bottom is gonna fall out of it even with the current pricing because the feed’s already sitting on the farm. So when we get to September and October, we could see a significant exodus of smaller dairymen in the fourth quarter of this year particularly, where they choose to sell their grain on the world markets rather than use it to feed the cows. And that I think would be what we should look for. And that would be also combined with more exuberant markets. And you put the two together you could be looking at a significant increase in milk price, even. I know the dairymen would like to see $3 or $4. My thought is $2 to $3 maybe.

T3: Between now and the fall?

Ted: Between now and the end of the year.

T3: So maybe going from $13.50 Class III to $17.50?

Ted: Something like that, yeah.

T3: Yeah, it can…$16.50 to $17.50.

Ted: The markets are moving around right now and it’s pretty hard to get a fix on where they are. But, yeah, something like that right now I think would be realistic.

T3: You know what? That drives pretty closely with what I think they’ll do as well.

Ted: Yeah.

Anna: All right, we’ll close it up while you guys agree on something.

Ted: We might as well.

Anna: All right, thank you both very much. We welcome your participation in “The Milk Check.” If you have comments to share or questions you want answered, send an email to podcast@jacoby.com. Our theme music is composed and performed by Phil Keaggy. “The Milk Check” is a production of T.C. Jacoby & Company.

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