INVESTOR EDUCATION – Dairy In Depth
Global Dairy Trade prices slipped again at their most recent auction this week, falling
a further 2.9%. Both the key Skim Milk Price (SMP) -2.5% and Whole Milk Price -0.8%
dragged on the overall dairy price index.
Dairy prices remain under pressure as Europe continues to pump supply into an
already saturated market. The EU has seen growth in milk production in each of the
eight months following the removal of quotas on 1 April 2015.
Simple demand & supply dynamics dictated that an increase in supply without a
corresponding equal increase in demand leads to lower prices all else held equal.
Adding further price pressure to the mix is both China and Russia, two of the biggest
consumers, had cut their buying of dairy recently.
New Zealand continues to respond to lower prices with reductions to their output.
Milk production in the year to December reached 22 million tonnes of liquid milk,
down 1% compared to the same period the previous year.
Further, milk production for the remainder of the season will continue to be
influenced by changes in farming systems, such as decreased stocking rates and
supplementary feeding, as farmers respond to the low milk price environment.
Both Australia and the USA have also slowed their rate of production although total
production is still up from a year earlier.
Europe continues to be the major driver of increase dairy volumes on the open
market. November production increased 5% compared to the same month the
previous year. The EU now has seen growth in milk production in each of the eight
months following the removal of quotas on 1 April 2015.
Demand
The chart below illustrates graphically the material decline in the number of bidders
in the dairy action. This has corresponded to a decline in dairy prices.
Asia (excluding China) and Latam (Latin America) continue to their solid growth.
Latin America imports in the year to October have increased 12% with WMP up 50%,
SMP up 28%, cheese up 13% and infant formula up 8%.
Asia (excluding China) imports in the year to October remain strong, increasing 8%
compared to the same period the previous year. This is due to increases across most
major dairy categories including SMP up 14%, cheese up 13%, WMP up 8% and fluid
and fresh dairy up 7%.
China demand has been somewhat volatile, but appears to be settling and continuing
on its upward demand trajectory. Demand increased 46% in December compared to
the same month the previous year. Fluid and fresh dairy and infant formula were
both up over 100%, and whey powder up 22%.
However, imports in the year to December are still down 6% led by reductions in
demand from SMP (down 21%) and WMP (down 49%). We are however observing
significant increases in infant formula (up 46%) and fresh dairy (up 43%)
Most market analysts agree that the current milk prices are unsustainable over the
longer term. As in other commodity markets (iron ore, oil) we are likely to observe
some industry consolidation with farmers electing to cease dairy production given the
low prices. This should led to lower supply over time and a recovery in prices. Less
efficient diary producers will be the first to exit and consequently the industry will be
left with the most efficient low cost farmers.
It is clear that demand for protein and dairy are set to experience significant
increases in demand. With the gentrification of the Asian market, wealthier Asians
are demanding larger amounts of protein, of which diary is a major source. Over time
we expect prices to stabilise and continue on a longer term upward trajectory.
Unfortunately there is a mismatch in timing. Supply has pre-emptied the increase in
demand. The additional supply is forcing the market price lower in the interim.
It’s not all bad news however. Lower dairy prices today will attract larger amounts of
new customers and consequently develop larger long term demand for the product.
As the Asian market becomes more accustom to dairy and their bi-products we expect to see further increases in demand. Typically once a customer is familiar with the product, they tend to be sticky and continue to demand dairy.
The weakness in the GDT prices has led Fonterra to lower its predicted payout to
farmers once again. Fonterra now predicts a pay out between $4.35-$4.45 per kg of
milk solid after already been cut as recently as January this year. It is estimated that
the payout cut is likely to knock about $400 million from farmers’ incomes this
season.
Dairy farm debt has reached $38 billion and a recent Federated Farmers poll found
more than one in 10 are already under pressure from banks over their mortgage.
Dairy prices are volatile and therefore difficult to predict with any certainty. do
believe that prices are nearing a bottom and therefore remain positive over the
longer term outlook.
Although the current Fonterra payout is historically low, we do expect a bounce back
in dairy over the medium term and consequently a corresponding increase in the
diary payout.
The stress on farmers has led the RBNZ to cut interest rates twice recently. It is
predicted that the cash rate could go as low as 1.75%, although ’s base case is
that 2.00% will be the low.
With the NZD continuing to decline against the USD it is going someway to insult
farmers from the decline in the price in dairy. The NZD and GDT are very highly
correlated.
Explains the GDT mechanism HERE members can log in and find out the exact
workings and the most important features of the GDT Index.
’s education article HERE explains why a low GDT Index isn’t bad for all agriculture
stocks