May 21, 2020
Anna-Lisa Laca
The past several weeks milk markets have enjoyed a significant rally in prices, driven largely by a surge in demand and curbed milk production. While it’s encouraging to see prices moving in a positive direction, economists warn a push to the upside is unlikely to last. In fact, they say producers should use this opportunity to manage price risk for what will be several months of extreme volatility, the likes of which we haven’t seen in years.
“[The rally is] a combination of starting to see some demand start to pick up from a number of factors,” explains Ben Laine an economist with Rabobank. “From the USDA purchases to food service starting to open back up slowly we’re starting to see more demand for milk again, so that's helped relieve some of that pressure. We also did see some response from some of the calls for reduced milk production. We saw producers reduce milkings or change rations and other things. We saw high slaughter rates on a weekly basis through April. So, all of those factors helped reduce supply a little bit at the same time that we're seeing sort of this sudden pickup in demand.”
In the beginning of April, Rabobank economists believed there was roughly 10% more milk than processing capacity but a combination of factors including farmers slowing production has meant the supply has tightened. So much so, Laine says, that they’re starting to see private processors remove production restrictions in parts of the country. Meanwhile, most cooperatives still have their base or excess programs in place and could keep them engaged through the remainder of the year.
“Everybody was designing their supply management systems to be flexible so they could respond to improving markets,” says Marin Bozic, a University of Minnesota economist. “I would anticipate that people will adjust their planned production accordingly so this market rally will be stimulative off the of the supply response.”
According to Laine, it’s likely cooperatives will take a wait and see approach when determining when to take off production restrictions because, in a lot of cases, there’s not a specifically set discount. Instead, the penalty is determined by what the market can bear which means there won’t necessarily be a penalty for producers even if those programs are in place.
Laine and Bozic agree the current strength in the market is merited, given the surge in demand for products to be included in USDA’s food box program. However, Bozic says the fundamentals for the last quarter of the year and into 2021 don’t support long-term price strength. Similarly, Laine says the market will have to deal with some level of recession regardless of government programs which shrinks his long-term optimism.
“Right now, the strength that we're seeing is justified given the amount of purchases from the USDA and some of the other factors like the strong demand for the initial refilling of the pipelines and food service,” Laine says. “But we need to remember that as we go forward this isn't going to be sustained. Those USDA purchases are slated to be delivered between now and the end of June, and we can't expect that to go on forever. It's an immediate demand surge, but long-term we are going to be entering an economic recession. There's going to be slower demand, there's going to be slower worldwide demand so exports could suffer. There's going to be a lot of factors going forward that are going to drag on this still.”
There’s reason for near-term optimism, but Laine looks at the next few months with caution as markets could cool off from where they are at substantially. Not only is it hard for Laine to imagine food service demand returning to the level it was pre-COVID, but he says the food box program will likely shift demand and won’t necessarily create it.
“The food box program is a benefit in terms of providing food to those in need and a challenging time, but there's the risk that these will to some extent just be displacing some normal retail sales,” he says. “It's not necessarily meaning that when we purchase $317 million of dairy products all of a sudden, it doesn't mean that that's product that wouldn't have naturally sold anyway. It's just kind of shuffling things around a little bit. I think there will be some benefit, there's an immediate benefit in the sudden surge in demand. But realistically, we're not generating new demand through that.”
Over the next six to 12 months the broader economic situation in the U.S. and around the world will be the driving market factor, he adds. Reaching a breakeven level of $16 Class III milk by the end of the year is not out of the question, he says; however, it will come with extreme volatility.
“I think that the environment that we're entering into, is going to be a lot more volatile than we've seen in the last few years,” he says. “There's going to be big swings to the upside and big swings back to the downside. There are strong cases to be made for a really strong prices right now, and there are strong cases to be made that we're going to be in a period of weaker prices through this recession. Any sign or data releases that indicate one way or the other can make pretty big swings.”
He says large price swings can provide a good opportunity for producers who maybe came into this black swan event without the risk management plan they might have hoped for.
“There could be opportunities now to look at preparing for more swings in the future,” he says.
Bozic agrees wholeheartedly and advises farmers to use the recent price rally to start covering milk into 2021.
“I guess the decision point that producers should take now is whether they use this rally to lock in some higher floors for the fourth quarter of this year, in the first three quarters of 2021 or do they wait?” he says. “I would say, don't make it a binary shoot. Don't make it all in or no go. At least do some action and then maybe next week, you do a little more, and then week after you do a little more to slowly build it up.”
Fight the urge to make this one big decision that can result in a mental block.
“Big decisions mean the opportunity for big mistakes, but smaller decisions mean smaller mistakes,” Bozic says. “Get yourself in a mood where you feel internal permission to act.”
dairyherd.com
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