With milk production low and showing no sign of turning anytime soon, the dairy industry is bullish about 2022.
What type of bull market are we in for? That’s up for debate. Inflation and continued logistics issues have roles to play.
Ted and T3 agree on the strength of Class IV milk and the shock buyers are in for next year. They disagree on most everything else, including the proper way to do math.
In the end, Ted enlists Anna as reinforcement.
Ted Jr: I’m not sure what the right approach is. Sort of a rerun of what we had the other day with regard to the potential, the upside potential of the markets right now might be useful. We’ve got a dichotomy between hedgers and actual market demand, I think, which is useful to note.
T3: I would agree with that.
Ted Jr: I don’t want to profess to be an expert of the hedging side of the issue, but the other side of the issue is the overall world marketplace is very strong. We have a continuing decline in milk production because of a number of factors, but primarily high feed costs worldwide. Barring some economic, call it black swan or whatever you want to call it, the market for dairy products is going to be a heck of a lot higher than it is right now. It could be a lot higher than the current world market price. I know interest rates right now are low, but we have dairymen basically getting out of the business, and when interest rates go back up, it’s going to be that much harder for them to get back in. At the expense of sounding too bullish, my position right now is very bullish.
If we look at the gross returns on the GDT and the world markets and the continuing decline in production in Europe, $27, $28 of gross, not net. That transflates to the dairy farmer in the $22, $23 range. Right now, the futures market is two and three and four dollars lower than that. Now, we’ve got a couple of cycles to go through before we get to anything, but we’re in the middle of, or actually, at the end of stocking for Christmas and Super Bowl. We’re supposedly going to see some sort of a decline after those markets are fully satiated. Whether we see it or not I guess remains to be seen. Months later, we have the flush right before us, and whether or not that’s going to actually amount to anything, that remains to be seen, too.
But we have a scenario which is extremely strong as far as the future is concerned, and even if we do have some blips in there, for the reasons that I just described, odds are we’re going to look at pretty strong markets the second half of next year. A lot of things can go wrong: economic collapse, stock market collapse, a resurgence of the virus. I mean, all of those things are threats, but from my perspective I think those threats are pretty distant. Tell me about it from the standpoint of the futures market, which is considerably lower than that.
T3: So, I would look at it this way, and I’ve been pretty consistent on this topic. I think you can make the case that we could touch $25 cwt for Class IV milk at some point next year. Now, I’m not going to say it’s the second half of the year because I think markets can be anticipatory, and so they often tend to find their peak before the real problem occurs, but I do think it’s possible when you’re talking about butter and you’re talking about nonfat dry milk, you can plausibly create a market scenario where we’ve got milk in the $25 cwt. At the same time, though, I struggle with math that would bring Class III milk over $20 cwt. I’m just not as bullish Class III as I am Class IV, for a number of different reasons.
My approach to looking at next year is that just because the demand is in the second half of the year doesn’t mean our highest prices are going to be in the second half of the year. I think that the market is already bullish. If you talk to marketers of dairy products today, almost everyone is bullish. Not the buyers, the sellers, because they see what’s going on in milk production. They see what’s going on in milk production in the United States. They see what’s going on in milk production in Europe. They know that nowhere in the world are we hearing about large increases in milk production. We’re either having conversations about milk production being flat or milk production being lower, and I think that more than anything else is what’s driving the bullishness in the marketplace.
The question to me is: How is it going to play out? And we don’t know. Markets all have their own personality, but the one thing I think is going to happen is I think this market is going to be an anticipatory market. I think it’s a market that’s going to peak early, and then it’s going to have a really long tail, which means I wouldn’t be surprised if we have our highest Class IV price of the year in April, which is usually when you have the lowest Class IV price of the year, but you have it in April, and then you have it just a little bit lower every month for the next 12 to 24 months as milk production slowly comes back.
I think the other big question is once you get there, how much demand do you kill? I think that’s the other big question, and that’s a really hard question to answer because how much demand you kill, especially in food, usually has to do with: What’s the replacement product? And it’s not just milk that’s going to be expensive. Corn futures are over $6 a bushel right now. You’ve got soybean prices over $12 a bushel. The prices are high.
Ted Jr: Let me interrupt a moment. You’re undercutting your own argument. When is corn and soybeans going to go down?
T3: I don’t know.
Ted Jr: Next harvest.
T3: Not necessarily. That’s the whole point of my argument. I think if you assume that the second half of the year is when all these changes happen and the market shifts, I’m not going to buy into that. I think both these markets are going to be anticipatory, meaning they’re going to try and solve the problem before the problem actually arrives, and markets will do that. If everybody is afraid that you’re not going to have enough product, everybody’s going to go out and make sure they have enough product early because they don’t want to be the one caught short, and I think that’s exactly what’s going to happen in dairy, especially in powder and butter. In corn and soybeans, I think that already happened. I think everybody already went out last harvest to make sure they have enough, and I’m not convinced that this market’s just going to flatline here through the first half of the year. I think we’re going to have to wait and see what demand does. I think we’re going to have to wait and see what the inflationary pressures are like for everything.
Ted Jr: Well, I certainly agree with that, but I think inflation now is embedded into the system, and from my perspective, I don’t think corn and beans are going down, so I think feed costs are going to hold relatively steady, and if anything go up. There isn’t any way that inflation is suddenly going to go away, and we’re going to have, let’s just say, costs of production anywhere close to where they’ve been the last eight years with $2 and $3 corn. I don’t see that as possible. I suppose it’s possible.
We could have a depression, considering all the monkey business going on right now, but the odds of that are very unlikely, which would argue for high feed costs, and basically that the current futures market is probably as low as it will ever get on a correction. Because anything lower than where we are right now would be into the negative area in terms of manufacturing costs and so on. So, I think inflation is a way of life, and it’s coming, and I think a lot of people are locked into the idea that, no, it can’t change, but it will change, and I think it is changing. And I think when it blows its top and then falls back down, it’s going to be very painful for everybody, but I don’t see it happening in the next few months.
T3: Oh, and I agree with you. Next few months-
Ted Jr: Maybe 2023, barring an overall economic collapse, what’s to keep it?
T3: Well, and I think that last statement’s the key statement, and right now I think most economists would agree that you’re not going to get negative growth in GDP in 2022. 2022 looks — even with inflation, it looks like it’s going to be a pretty good year. The government is still pumping a lot of money into the system, and most likely, barring a collapse, who knows? Maybe COVID gets a lot worse, but let’s assume for this argument that COVID gets a little bit worse, but overall, we’ve kind of got to the point where the effects of the pandemic create less volatility on our markets than they did a year and two years ago. And so I think you’re right. I think we get there 2022 in pretty good shape.
I would say that I think you’re very likely correct about Class IV milk, that there’s a lot more likelihood of higher prices than lower prices from where we are here in the middle of December in terms of button and powder prices. I’m not as convinced with cheese. In fact, I’ve already gotten to the point where I’m wondering if cheese is overpriced for next year, and we’ve talked in past podcasts about why I believe that. It’s because even though we’re going to lose milk, I do not believe we’re going to lose that out of cheese plants. I believe we’re going to lose it out of butter/powder plants. But at some point, these higher prices, and let’s face it, what we’re saying is yes, dairy farmers will get better prices for their milk, but they’re also dealing with higher feed costs, higher labor costs, higher operating costs. They’re pretty much dealing with higher costs across the board, and so even though they’re getting higher milk prices, it doesn’t necessarily mean they’re becoming wildly profitable.
Now, I think it’s fair to say at $25 cwt, any farmer who’s getting that probably is going to be making money, but I don’t necessarily think that even if you have $25 cwt Class IV milk, that doesn’t mean that’s what the farmer is getting. By the time that’s a blended price, it’s a lot lower, especially when you calculate in hauling costs and things like that, which means yes, you can be pretty bullish for 2022. But at some point, all those costs feed through the systems, and it means that buying power is lessened, and ultimately, that means the economy starts to feel the effects of it. Basically, what we’re saying is inflation is not going to be transitory. Inflation is here to stay, and ultimately, when inflation is here to stay, it means that costs are going up faster than income is going up.
Ted Jr: I agree with you that Class IV is going to lead the way. I think it’s questionable whether if there is a big difference in the price of Class IV and Class III and the price of cheese milk versus butter/powder milk. Let’s just say it’s a couple of bucks cwt. I think milk will find its way towards the butter/powder plants. Yes, butter/powder will lead the way up, but cheese is going to have to be dragged along with it.
Ted Jr: I think it’s just the realistic view of the market. I mean, I know that a lot of people have contracts to supply these humongous cheese plants, but wait ‘til you hear the whining going on when you got $2 or $3 cwt better return by going to the butter/powder plant.
T3: But Dad, at the end of the day, it’s a blended price. Anybody who’s in the federal order, the prices get blended anyway, regardless if we-
Ted Jr: Well, I agree to a certain extent, but you still have premiums involved when markets are exuberant, to use the old adage exuberant markets, and it will indeed drag milk out of the cheese plants. It wouldn’t drag it as much as it would be if there wasn’t any classified pricing, but it’ll still happen, and Class IV will go up, and cheese won’t necessarily languish where it is now. It’ll be dragged up with it. If you look at just regional costs, for example, a lot of dairymen — take for example Kansas, just pick one out of the air. They could go to order 32, or they could go to 126, Texas order. I mean, if a dairyman is at a bad juxtaposition because of the butter/powder and cheese spread, they have options too.
So, you’re right. The classified pricing will mitigate that pain somewhat, but it’ll still occur, and the Class IV will drag the Class III up with it, and if you look at it from the GDT standpoint, there really isn’t that much difference in the gross return anyway. I’m going to go from memory. The cheese was, for equivalent, 40-pound blocks for cheddar on the GDT was 250. I think maybe I’m high. I think it may be 240. Then you had another four-and-a-half for whey, you’re up in the $28 range on the GDT now. So, to think that cheese is going to stay down around $1.70 or $1.80 I think is wishful thinking. I don’t think that’s going to happen. Maybe wishful thinking, maybe a little bit too bearish thinking. You got the whey market at about 72 cents I think at the moment. That’s $4.20 cwt just from whey.
T3: You’re at 237 in cheese.
Ted Jr: Which is $23.70, and then another-
T3: You’re at 263 in butter.
Ted Jr: You add a little bit for that.
T3: You’re at about $1.70 right now in skim milk powder.
Ted Jr: Just stick to cheese for a minute and simple math. You’ve got $23.70 at a 10 yield. You’ve got what? 30, 40 cents in butterfat. Then you’ve got $4.20 in whey. So, you’re at $28 gross. Now, out of that all comes manufacturing and shipping and so on. That puts the Class III price at $22 to $23 on the world market.
T3: So, I’m going to do my math a little differently than you. I’m going to plug in 65 cent whey. Instead of plugging in 237 cheese, I’m going to discount it by 25 cents because that’s more or less the freight difference right now going into many of these markets in New Zealand versus the US. So, instead of 237, I’m going to plug in 213, and I’m going to do that for both blocks and barrels. 65 cent whey, 213 cheese gives you a $22.66 Class III price. So, you’re right. You’re over 20 bucks for Class III, but to me that does… Unless we are exporting a ton of cheese, and if you’re going to export a ton of cheese, you got to ask the question: Where are the containers going to come from, since they don’t want to give us the containers to export, and then compare that to what I think is entirely possible in Class IV.
I think we could easily get to $2.50 butter next year, and I think we can easily get to $2 nonfat next year, and that gives me a $25.62 Class IV price. Now, I think that’s very doable, and maybe if we get that high in Class IV, we’ll get to 22 or to 23 in Class III, but Class IV is going to lead the way. But again, I don’t think either of those is sustainable. I think we’re talking about the peaks of the market, not the average of the year by any means.
Ted Jr: I agree with that, and I agree that Class IV will lead the way, but I think you also need to accept that we have a new dynamic of price. Look at it strictly from an economic standpoint. We have inflation now at 6% or 7%, and I think it’s actually a lot higher than that. But let’s just say… Take the government number at 6% or 7%. Are we going to have 6% or 7% in economic growth? No way. So, in other words, you’re going to have a negative. You’re digging yourself a hole, which you got to dig out of, and to all of a sudden think the dairy pricing is suddenly going to go back in the hole where it came from, I don’t think that’s realistic. I don’t think that’ll happen at all.
T3: I’m not arguing with you and saying that the dairy pricing is going to go back in the hole. I’m not trying to tell you we’re going to go back to $1.50 cheese or $1.60 butter. I am more saying be careful of the statement that the sky’s the limit, because a market includes both sellers and buyers, and buyers I think are getting to the point where they want to push back, and you have to be prepared for that. Let me explain it in another way of looking at it. We may get to $25 cwt Class IV milk, and then we’re going to pull back because the buyers of that product is going to say, “There’s no way I’m going to pay that price,” and maybe we pull back to $18, $19, or $20 milk for another 12 months, but that’s not enough for dairy farmers to start producing more milk because their costs have gone up, and then we go up again.
Well, it’s that second time the market cycle’s higher, and it’s a higher high than before. Bull markets are a series of higher highs and lower lows. Bear markets are a series of lower highs and lower lows, and I think if we’re talking about inflation being something a lot more than transitory, the other way to explain what you’re saying is we are in the beginning of a longer-term bull market than we’re used to. In the dairy industry, bull markets tend to last somewhere between 12 and 24 months. Maybe what we’re looking at is a bull market of 36 months, but we’re not going to go straight to the moon. We’re going to go higher. We’re going to have a long tail, but we’re going to keep going higher.
Unlike years past, I think the big thing we’re saying this time is the production costs at the dairy farm are a lot higher than they used to be, especially for larger dairy farms. So, when we think we’re high enough to start producing more milk, I think we’re going to be surprised that we’re not going to produce as much more milk as we have in the past, but we’re going to have to go through cycles before we get to super high prices because you’re going to get pushback on the buy side.
Ted Jr: You’re already getting it. I mean, the way I look at it right now, I think the buyers are already pushing back because they don’t want to see price go up from where it is.
T3: I agree.
Ted Jr: You know what? They’re going to get surprised.
T3: I agree.
Ted Jr: When all of a sudden they can’t buy the product, and then the pendulum goes to the other direction, and everybody has to restock at the same time.
T3: Well, true, but the other thing that’s also going to happen, and this is my point, is they’re going to say, “I just don’t need that butter. I’ll figure out how to make my pastry with something else as a butterfat, or as a fat.”
Ted Jr: I know all that’s going to happen, alright? I realize that it’s not going to go in a straight line. It certainly isn’t. We’ve got the flush coming up when we’ll probably have some sort of a relapse when people are fully stocked up for Super Bowl weekend and so on. The whole dichotomy over the last year has changed, and I think as people come to recognize it, then all of a sudden their mindset will change. We’re recognizing it a little bit earlier on the supply side than the buyers are. I don’t think the buyers are really with it.
T3: I guess that’s what I’m saying, Dad, is I don’t think the buyers are ready yet. I think they’ll reach a point where they are. I don’t think they’re there yet.
Ted Jr: Alright. You remember, and I’m not sure of the year, but I think it was 2014, when we had what we all considered was a very long inventory of cheese.
T3: It was 2013 as we were transitioning into 2014.
Ted Jr: And the cheese magically in two months disappeared and went to zero.
T3: I agree, but here’s what happened that year, and that’s a great topic because one of my questions is, is that happening this year, and I can give both sides to that argument. What happened is towards the end of 2013 we had a ton of cheese in inventory, and a lot of people were really bearish to the cheese market. The other thing that was happening was Europe was not having a very good milk production year, and we were starting to sell a lot of cheese internationally, and by a lot I mean we were making deals to sell cheese internationally beyond what we could reasonably make and still supply our domestic market as well. It was driven by international demand. It was driven by export sales of cheese, and all these sales happened without the domestic market being taken care of first.
I’ll never forget New Year’s Eve at the end of 2013, the day before it became 2014. All of a sudden, I realized no one had any cheese for sale, no one in the industry. And not surprisingly, in January and February, this market went straight to the moon, and it stayed there for most of the year. But the difference between what’s happening today as we transition from 2021 to 2022, and what happened eight years ago, is I’m not as confident we are making the size of the export orders this year for cheese that we did then, and I’m not as confident for multiple reasons.
The first reason is, I will continue to say, I am not the only one that is really pessimistic about our ability to actually get that cheese on containers and get it to the destination. Yes, export numbers have been good, but export numbers could have been great this year if the logistics were even halfway decent. The other thing that was happening was it was taking four months, five months, to get product to the destination, when in the past it was taking six weeks, and that really changed the dynamic. And there’s a lot of exporters out there that are pretty reluctant on both sides, buyers of American cheese internationally and sellers of American cheese into export.
There’s a reluctance on both sides to commit to sales of US cheese for export because there’s not a lot of confidence in the logistics right now. And I think that’s a pretty serious headwind for cheese exporters, more so than powder exporters. So I’m not of the belief that we’re going to get suddenly caught short of cheese because of the demand-driven scenario like we had in 2014. What we’re having this year is a little bit more of a supply-driven scenario than a demand-driven scenario. So that’s one of the reasons why I’m pessimistic on the Class III side.
The other reason I’m pessimistic on the Class III side is we added some pretty significant cheese capacity in the last year. When we added that capacity, we started producing more cheese, cheddar cheese in particular, than there was actual demand out there. So I think we’re still in a overcapacity scenario when it comes to cheddar cheese, and I think that’s going to have an effect unless we pull a significant amount of milk away from the cheese vat, and I don’t believe we will. I know you do believe we will, and maybe that’s the big difference in our numbers, but I do not believe we’re going to pull that milk away from Class III.
Ted Jr: Well, we’ll see. I know we do have a logistics problem. There’s no denying it. But we also look at the fact that our exports are up what, 15%, 20%. And you can argue, well, we’re looking at last year, which is a bit of an anomaly and then compare to the year before. But even though logistics are a battlefield operation, we’re still getting a lot of it done. And as far as buyers are concerned, I don’t think they’re worried about us reneging on our supply, on our deals. I think they’re more worried about it showing up on time.
T3: Yes, but I think it’s both, and let me push back on you in this way. A lot of exporters agreed to export deals that because of the logistics problems, they didn’t make money exporting. So, they’re building in bigger margins in order to do an export deal this year. It’s not just they’re afraid of the logistics. It’s if they’re going to put in the time, and it was a lot harder this year than in years past, they want to get paid for it, and they want it to be profitable. So I think that you’re going to see a lot of exporters who are going to… They’re going to charge a lot more to do it, and they’re going to make sure that it’s profitable, and if they can’t get it done profitably, they’re not going to get the deal done. So, that’s where the pushback comes from, and the buyers are going to say, “Well, if you can’t get it to me…” We already have this going on. “If you can’t get it to me in two months, then I’m not going to commit to it.”
Ted Jr: We’ve all been there, and I’m sure the buyers are going to say that, but the reality is that everybody’s got a logistic problem. It’s not only the US. It’s not efficient at all as far as logistics are concerned, but you fight your way through it, and the product’s going to show up at the right spot eventually. I mean, we’ve been there, and we’ve done that. It’s amazing. I mean, our people get it done. I’m sure other companies have the same kind of logistics department who are grinding their teeth and working long hours, but they get it done. So, I think that’s a problem, and I think it raises costs, as you say. It doesn’t mean that all of a sudden we’re going to see less demand or less actual business.
T3: I’m going to push back on you on that. I think you’re making a bad assumption, because I’m seeing it. And yes, they are having trouble getting it done, and we are walking away from deals, and other people are walking away from deals, and they’re just throwing up their hands and they’re saying, “This isn’t worth it.” And they’re saying, “Okay, we’re still going to make the offer, but we’re going to make the offer and build in a lot bigger margin than with have in the past because it’s just too hard.”
Ted Jr: You’re undercutting your argument again because the customer is not all of a sudden going to decide he’s going to go out of business. He’s still going to buy the product. He’s just going to buy it with whoever can deliver the good quality product at the right price.
T3: But the thing is the New Zealanders are not having the logistics problems we have. The Europeans are not having the logistics problems we have, so they’re more likely to commit to it. Now, they’ve got milk production issues too, but they’re not having the problems the US is having with logistics. Now, I’m not saying they’re having no problems. I’m just saying their problems are nowhere near as bad as our problems are.
Ted Jr: Alright. I hear you.
T3: I think we need to be really careful about being overly exuberant. One of the things I’ve heard a number of people say lately, and I agree with it, is when everybody in the whole industry is bullish, the question you need to ask is, “What don’t we know?” It usually scares me when the whole room’s bullish. It also means that it’s usually already all priced into the market.
Ted Jr: The market’s only been going now for a couple of months.
T3: It’s been going up since August, so four months.
Ted Jr: Alright, alright. Starting from somewhere in the toilet to where it is now.
T3: Toilets are a relative place when it comes to markets.
Ted Jr: So, we’ll see, and I agree that it’s certainly a very stimulating discussion to talk about it, but I think we’re looking at a lot of the stars lining up for major increases of milk pricing, and that’ll be good. The dairy farmers have had it in the shorts here for several years. And the real good ones do fine, but the ones who muddle along and cash their check at the supermarket are going to have problems with this kind of an environment, I think. So we’ll see how it goes.
Ted Jr: We’re sorry, Anna. We didn’t mean to monopolize the time.
Anna: No, I do not mind at all.
T3: It certainly isn’t the first time that Anna has witnessed my dad and I disagreeing on what the market’s going to do.
Anna: No, definitely not.
Ted Jr: Well, Anna, let me ask you a question. How much business have we lost because of logistical issues?
Anna: I don’t think we’ve lost any, but that’s on the milk side.
Ted Jr: Aha.
T3: I’m going to push back on that one too because to me, on the milk side is where we’ve had the least logistical issues, and I’m not saying we’ve had none, but it’s been the least —
Anna: Definitely not none. It’s the least because you have the drivers that are used to going to the… They’re at those firms every day. Could we have taken more south? Maybe. We’d have to ask Greg and Mary if there was anything that they said no to because of trucking. But we’ve had most of our standard places still ship, and everything’s kind of been going like it usually does.
T3: Look, just talk to Cathy and Julie. They’re the ones who are dealing with spot lanes, and those spot lanes are harder to fill than the regular lanes in the milk group, and so their logistic challenges have been bigger probably than the milk group’s challenges, and then I can say that our international business has been more challenging than our domestic, but our domestics business has had its share of challenges too.
Anna: I would absolutely agree with that.