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Dairy Demand Drives Price Volatility

May 29, 2020

We have seen some truly monumental volatility in the dairy markets during the covid-19 pandemic.

On March 18th, 40 pound blocks of cheese were trading for $1.87 per pound before plunging to $1.00 with headlines about restaurant sales being down 79% and farmers dumping milk on the ground. But a month later, May 20th, cheese was trading for $1.92, which was higher than it was prior to the pandemic. It looks to me like the market overshot prices on the downside, and now the market has overshot on the upside; we should steady out around $1.50 in coming months.

The major driver in the market has been the demand side. It has been hard to track all the different and dramatic changes in dairy demand as retail sales are running well above last year while foodservice and the movement of milk and dairy products through schools have dropped dramatically. We’ve put in a lot of work to figure out how dairy sales through all these different channels work back to total demand so that we can use weekly data on foodservice and retail sales to get a near real time view of dairy demand.

Our weekly demand index lines up well with the anecdotal reports that we’ve heard as we’ve moved through the pandemic. First the surge in retail sales as consumers went into lockdown more than offset the decline in foodservice sales. But then retail sales stabilized while foodservice sales hit their low point in late March, which marked the low point for our demand index which was down about 13% from the previous year. Since late March, foodservice sales have been improving. They bottomed out at 79% below year ago levels, but have bounced back to 40% below year ago in early May. Retail sales remain strong, up about 17% on a volume basis in early May, but they have slowed a little from the 20% growth that we saw on average in April. When we net it all out, demand has been improving and was only down 6% from last year in the first week of May.

So, demand is improving, but consumption is probably still down from last year, so what explains the rally in prices? A large increase in government purchases, primarily for the Food Box program has pushed this market dramatically higher. The process the USDA uses to buy commodities is typically very transparent with plenty of time for companies to put together their bids and delivery of the product often happens one to six months into the future. The new Food Box program was conceived, birthed and kicked out into the real world with $3 billion dollars in its pocket in a matter of weeks. The USDA had indicated that initially the plan was to buy about $100 million dollars of dairy products per month through this program, but when the announced the results from the first round of bidding, they decided to spend more than $200 million per month for May and June. We don’t know the exact volume of dairy products (or even the exact mix of dairy products) that will be purchased and donated to food banks and other non-profits through this program, but it could be around 60 million pounds of cheese in May/June and 53 million gallons of bottled milk. We think the Food Box purchases, along with other USDA purchases are going to add up to about 5% of production for June, July and August.

Food service sales should continue to improve as states lift stay at home orders and some people go back to working outside the home, but it’s unlikely that foodservice sales will completely recover this year. Retail sales should continue to soften, but stay above last year. The way we see it playing out will leave commercial dairy consumption down somewhere between 1 and 3% from last year. So long as the government is purchasing 3 to 5% of dairy production, the market will be in relative balance assuming we don’t get much growth in milk production and dairy exports don’t change too much.

It looks like the USDA can continue the current pace of purchases through August or maybe September before the Food Box program will run out of money. There are other programs that they are using to fund purchases, but they are aren’t as big as the Food Box program. However, the current administration (and Congress) has not been shy about spending money so it is possible they could allocate new money to purchase programs if commodity prices fall sharply later this month.

To fully explain the rally that we’ve seen in the market we need to touch on two other things. The first is exports. While weak global economic growth is expected to put a dent in global import demand this year, US cheese prices were falling much faster than prices in Oceania and Europe were during March and April. That allowed US cheese makers to book some large exports for May and June which have contributed to the tightness in the cheese market at the same time the USDA surprised us with some large purchases.

The second item, and it’s a big one, is milk production. Back in March (when prices started falling), US milk production was up 2.8% from the previous year. By April that had slowed to 1.4% growth and it was likely flat or down slightly from year ago levels in May. So the combination of improving foodservice sales, strong short-term exports, a large and unexpected increase in government purchases and a dramatic slowdown in milk production growth have all contributed to the rebound in cheese prices. But the strong exports won’t last. Milk prices are back to profitable levels for farmers, so milk production growth should improve. Foodservice sales probably won’t fully recover and the government is going to run out of cash for their purchasing programs. That should allow cheese prices to pull back toward the middle of their recent range.



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