The bears of Jacoby have a classic market discussion


Our team is (mostly) bearish right now. We’re seeing signs that recent Class III price rises aren’t supported by demand, and the lack of Asian demand for powders continues.

In the August episode of The Milk Check, we discuss a recent LinkedIn post Ted made and whether there’s any strong case against bearishness when looking at dairy prices.

Butter continues to feel like an exception, and Joe Maixner wants to go “on the record” with a bullish outlook for the rest of the year but also into 2024. The international outlook, according to Diego Carvallo, couldn’t get much more bearish.

Ted: Welcome everybody to the August version of the Milk Check. Today we’re going to have an old fashioned market discussion. We have with us, Josh White, Diego Carvallo, Joe Maxster, Jacob Menge, and I. So guys, I thought I’d start this conversation simply by mentioning the post that I just put on LinkedIn and you guys can tell me what you think of the post and if you think you agree with me or maybe where I’m wrong.

So it’s the middle of August, it’s hot outside, you’re seeing 100 degree temperatures all over the country. The milk supply is tightening as a result, schools will start up soon. So demand has picked up a little bit. The cheese market has popped, improving class three prices. And most of our other markets are starting to look like the bottoms are in. Does that mean the remainder of the year will be positive for dairy farmers?

My hunch is that domestic demand will not be good enough to sustain decent milk prices. I see subtle signs everywhere. Very few of our domestic customers are giving us glowing sales reports. Most are using descriptions like average at best or slightly under budget. And while Mexico continues to be optimistic, our Asian customers are using words like depressing and even horrific to describe their sales.

So even though milk production may turn negative year over year in the coming months, I just don’t see enough positive demand to be bullish milk prices between now and the first half of 2024. Guys, am I being too bearish? Josh, what do you think?

Josh: Just talking to different people I would echo what you mentioned. I had a few calls where people have said to date their overall demand has been lackluster. Their coverage going forward is taking into consideration some of that uncertainty about their demand, but we’re starting to notice a few more transactional type, a little bit more transactional type business happening in the recent weeks that leads me to believe that the forward coverage isn’t as strong as everyone thought from these type of companies.

Ted: So what you mean by that is maybe the spot purchasing needs of some of the big buyers out there domestically between now and the end of the year may actually be a little bit stronger than it has been so far?

Josh: I don’t know that I’m predicting it, but I think there’s a real opportunity for that.

Jacob: The thing that I think is a bit of a black box still to this conversation is US demand, and I think you mentioned it in your LinkedIn post, Ted, but I think that’s really the key here is that US demand piece. Because if you look at equity markets, for example, the US seems to be the favored child in the world right now where our markets are humming along, we’re having the soft landing. Meanwhile, Europe specifically the UK, seemed to be on the brink or in a recession. And so again, will this kind of fiscal strength we’ve seen on the equity sides carry over into our household purchasing and as such mean we have good demand in the US. I think it remains to be seen.

We’ve seen a number of arguments be made that the decent demand we’ve had so far this year is going to kind of falter in Q4. I think I might be in that camp. But if it doesn’t, you pair decent demand along with a contracting supply, and especially if what Josh alluded to comes true, you have multi nets come in and do some buying on products here or there, that would be the bull case I would argue.

Ted: So we talked about on the domestic supply side, even if we’re flat to lower on domestic supply, which considering dairy farmers are definitely losing money, I think that’s what most people expect in terms of how it’s going to play out for the remainder of the year. Even if cheese prices stay up here where they are right now, it’s all about varying degrees. If the cheese market goes back down into the 150s, you may lose more milk than if it stays up here in the 180s, but your domestic supply is probably flat to lower for the remaining of the year.

One of the things I’m hearing about the international market, and the statistic I heard was this, since 2020, so just the last three years, China has increased their milk supply from about 30 billion pounds to 37 billion pounds a year. Just to think about that in terms of relative metrics, the US we produce about 200, 220 billion pounds of milk a year. So 7 billion pound increase over three years is 4%, roughly, 3.5% of the US milk production. It happens to be almost 100% of Australian milk production. It’s a big number.

And I wonder how much of that is affecting international demand and if it’s sticky and if it’s sticky that we’re going to continue to see poor international demand out of Asia for a little while. How much does the US market need to contract and do we think that’s how it’s going to play out?

Diego: That’s a tough one to be honest. Yeah, I always treat the information coming out of China with a grain of salt. But as there are as many rumors of Chinese production moving higher, of Chinese production actually being impacted by the low margins, so yeah, probably last year they increased something close to 10%. But I think right now with the low margins and hot temperatures that they’re experiencing right now, they could also be heavily impacted to the downside. They moved up really quickly, but we could see a similar reaction to the downside faster than maybe in the US as well. So hard to tell. But yeah, the number is indeed an impressive number.

Jacob: I am, and I think Josh should maybe disagree with me on this a little bit, but I am pretty skeptical that our problem, and our problem being $17 to 18 milk, our issue with prices here can actually be solved with the supply side. I just do not see enough contraction be able to happen in a short enough period of time to actually stimulate prices to reach $21, call it, for a sustained period. I think really it’s going to be a demand side that solves that. You can just, in the US for example, this is a very rough estimation, but supply minus demand equals surplus product, and you can kind of estimate that with reports put out by the USDA.

For example, if you look at the dairy products report for cheese and you take out cold storage, you can come up with some kind of rough trend line on demand, and we are way off trend. It’s kind of been buried by a number of things. I shouldn’t say buried, but it’s been overcast by things like the international demand being terrible. But we’re still off trend even in the US I would argue. And so does that come back? Without it I just do not think we can get enough supply contraction to actually turn things around.

Joe: How do we end up with stronger demand with more supply scheduled to come online on the class three side in the next two years?

Ted: That’s a fair point. We’re going to be making more cheese, but we’re not going to be making more milk, and so that milk is coming from somewhere else. We obviously know it’s going to probably continue to clump from class one because class one continues to decline, but it’s also probably going to come from class four.

Joe: That was why I led into that question, because there’s your contraction on the supply. Because if milk gets pulled out of class four and that will ultimately tighten up the non-fat and the butter piece.

Jacob: I think the kind of cop out answer is global economic cycles. I just don’t think there’s a magic bullet here. Until we start seeing turnarounds on employment and other things internationally. Again, this is not an issue we’re witnessing in the US, when we see this turnaround internationally though, I think your demand comes with it.

Ted: If we’re going to see a situation where dairy prices improve or milk prices improve for the dairy farmer, you break it down, it’s got to come from three places. Increased international demand, we’re pessimistic about that. Increased domestic demand, I’m pessimistic about that. Is there anybody who’s more optimistic about that? The one place where I can see domestic demand improve is I think there’s enough room for SKU prices for dairy products to come down, and that may encourage at some point some growth. It’s not a game changer. I mean, it’s not going to create 3, 4% growth in demand. It really ends up being on the edges. And as I think we’ve all seen being in this industry long enough, it tends to be clustered, which means, oh, hey, prices got lower, I’ll buy more. But then that means the next month or the next two months down the road they buy less.

So the third is, you lose enough supply to equilibrate the market. My fear is that means we’re going to have to lose 2 to 3% right now. That’s scary. The only other possibility I can think of is input costs for the dairy farmer change, which means corn prices come down, soybean prices come down, cost of labor comes down. I don’t think labor is going to come down. Is there any reason to think corn prices or feed prices are going to be coming down anytime soon?

Jacob: No. We’ve seen labor costs seem to be turning a corner right now, so I’m with you there. I just don’t think you can have a big enough change on the input side to suddenly make $17, $18 milk work on a balance sheet these days. So let’s just even say the supply side is kind of going to contract. Let’s just write that off. That leaves us with the only variable left of US demand, as you said, domestic demand. And I think right now a middle of the road approach is what’s priced into the market.

So if you surprised to the upside in Q4 that could change these markets. And conversely though, if demand does end up being weak, with student loan repayments happening coming up in October, and that might shock the system a little bit, then I would argue there’s downside from the $18 we’ve got priced in right now.

Josh: I think I want to be real clear on something though. This is a bearish market, this is a bad situation and I am also in that camp. What I’m looking for is what’s going to change. And as we start to kind of dig into this, I think we still tend to paint the broad brush between supply and demand, and I think there’s going to be some interesting variables that Joe’s comment earlier got me thinking about as to the product mix. Because the product mix is a big contributor not just domestically in the US but in other parts of the world. The bearish powder environment right now is driven by weak Asian demand and we all need that demand.

There’s kind of three variables driving a production response. There’s temperature and seasonality, and that’s clearly having an impact. There’s the economics of producing milk, and we’re clearly seeing calling at a high level and sustaining a high level. But it really can’t increase, if I understand it right from here, we’re 60, 65,000 dairy cows a week is about the maximum that we can process. So we’re not going to see a big jump there. And then where is it happening and how is that impacting the products that we have? And we’ve had this discussion a few times this week that if a lot of the response is coming out of class four markets, does that alleviate some of the pressure to go out and chase the international sale today? And on the powder side, I guess I don’t have the impression in the US that we’re busting at the seams. Cheese might be a different story.

And so I really think that this is going to be an inequitable impact on the different products that are made from milk, particularly in the US, and I’m just not sure what that’ll mean.

Ted: So much of it is tied to logistics costs too, because traditionally the farther west you go, the cheaper the milk was. The farther east you go, the more expensive the milk is. The farther southeast you go, it’s more expensive. But right now the most expensive place to milk cows in the country is probably California. I think it’s fair to say they’re going to probably lose some milk supply that’s going to be primarily class four. Maybe that syncs up with the loss of Asia demand, but it also means you’re losing butter fat. And we’ve been spending most of this time talking about our powder markets, which is kind of probably the most bearish part of our market right now. Whereas butter has held up kind of nice. And you might actually tighten up the butter supply even more by losing milk in California.

Joe: Yeah, I’m certainly not bearish butter. I’ll go on record saying that. If we continue to contract in the state of California, it’s only going to create more issues for butter pricing long-term because that historically has been the area that has carried, for lack of a better term, the class four market for the second half of the year. So yeah, we continue to lose milk out west, it’ll have a ripple effect throughout the country on premiums for butter.

We’re kind of seeing it already. I mean, three months ago, if you would’ve asked me where the butter market was going to be at the rest of the year, I would say that the price we’re at now is already the highs for the year. But at this point, all bets are off. There’s people out there saying we’re going to go north of three bucks again before the end of this year. And while it sounds crazy, not too many moves when we have 5, 6, 7 cent moves in a day.

Ted: And as long as cream is trading at multiples north of 150, it almost has to do that.

Joe: Yeah, exactly.

Ted: Meanwhile on the cheese side, cheese prices got really low, and then shortly after the 4th of July raced back up to almost two bucks. I think we feel like they’re a little bit too high now, and we’ll probably settle down a little bit, but they’re not going to go all the way back down to the 140s or 130s but I don’t think we’re going to average cheese prices between now and the end of the year that are above $18 and in a place where dairy farmers are making money. And so while we’re better than we were, we’re probably not good enough. Which means butter’s going to be carrying the market and it’s just not a big enough part of our market to carry the whole market.

Joe: No, but it eases the pain.

Ted: Yeah, that’s fair.

Joe: With that being said though, since it’s not a big enough player to carry the market, you’ll still see the exits, which would make the case for an even stronger butter market next year because we’re going to be that much shorter milk and that much shorter cream.

Ted: One way you could look at this market right now, if you really wanted to kind of break it down, butter we use often 99.9% of the butterfat we produce in this country internally. And if you consider that we import quite a bit of butter from Ireland, we were probably a net importer of butterfat. Cheese, I think we’re up to the point where we export somewhere between 6 and 8% of our cheese production a year. It’s a growing percentage. It’s not a small percentage, but it’s still over 90% of the cheese we produce we use domestically. Powder on the other hand is the market where we export over 70% of our non-fat. We probably export over somewhere around 50/50.

And that’s the market because the exports are the biggest source of our demand issues right now, that’s the product mix that easily feels the heaviest and the longest right now, and where we’re most bearish. And when you’re exporting 18% of your milk production and dairy is dairy’s a relatively inelastic market where 1 in 2% increases or decreases in demand have a major effect on price, that’s a big pill to swallow. And I think if we wanted to sum up what’s going on in the market right now, we sum it up right there. Domestic demand isn’t great, but the real source of the problem right now is international demand. Fair?

Diego: That’s a fair way to put it. My following question was going to be how long is this going to last on the international side? And that’s probably one of the toughest things to analyze right now. But I’m certain of the opinion that we’re probably at the point of the most bearishness right now, and we’ll probably be for the next couple of months. New Zealand, in my opinion, is sending a clear signal that they’re front loading all of their supply and they’re trying to find the bottom.

They want to find the bottom, they want to find the price where customers actually step in, where they create demand, and where they find a market that they can find balance basically and build from that up. So it seems like we’re going to find that bottom soon and next year is going to be a year where we slowly grind off, or at least that’s a 10,000 foot view or forecast of what I’m expecting.

Ted: Well, I think that makes sense when we keep in mind that the New Zealand flush, the Oceania flush happens in, what? October. So we’re building up to the biggest time of the year in terms of milk production in the Southern Hemisphere. And so they’re kind of desperate at this point because they export over 90% of their milk production. So they have to find the market and they’re going to find it right now, which as you said, Diego is creating an environment that feels really bearish internationally. But it also means, well, probably sometime in the next two months we find it and we’ll see where we go from there.

Diego: Exactly. And to add to all of the market fundamentals, something that we cannot forget is that China is going to start importing a New Zealand Oceania product with no tax starting next year. So that’s creating a huge incentive for all the importers and distributors in China to kick the bucket a little bit down the road and not buy right now, but to buy maybe in December. So that adds to the point that I mentioned before that we’re probably at the point of biggest bearishness.

Ted: So to summarize, we’ve got some optimism in butter, cheese is popped but is probably peaking right now and we think it’ll settle back down a little bit. But the real problem is in the non-fat side, the real problem is in our dairy ingredient side because that’s the part of our industry that’s most dependent on exports and the export market is what’s really driving the biggest problem we have, and the best opportunity for us to increase prices to the dairy farmer will be if we see the export market pickup.

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