January 24, 2020
After nearly five years of a range-bound trade, the dairy market has experienced a dramatic increase in volatility. In a few short weeks, the barrel market managed to climb to a record-setting premium to the block market. On average the cheese price at the CME traded up to a high of $2.27 per lb., a price that has not been seen since 2014. What goes up must come down though. Setting another record, the barrel in a single week broke down by 53.25 cents. Within a three-week period, the barrel market alone went from trading at nearly $2.30 per lb. to $1.60 per lb. By mid-January blocks climbed towards $2.00 per lb. while barrels lagged in the mid $1.50s per lb. After a few years of sideways price action volatility in dairy market has made a comeback.
So far, the front portion of the 2020 futures curve for both Class 3 and Class 4 have shown a significant increase when compared to 2019. Looking at months like January and February Class 3, prices are trading at nearly $3.50 higher. Currently the futures market is showing a relatively flat curve with the spread between April and December being only four cents wide. That said there are both domestic and global events that are developing which could impact the future of dairy. Multiple trade agreements are in the works that can be beneficial to prices for all dairy commodities.
Between the recent signing of the Phase One China Trade agreement along with the USMCA, we are positioning ourselves domestically to increase our export abilities. Recent export data shows that even without these deals in place the U.S. had strong exports to round out 2019. November export data showed us that total dairy exports were up 13.1% YOY with Nonfat dry milk up 41% YOY along with cheese up 7.3% YOY. Look for the export market armed with these new trade agreements to be a key factor for supportive prices for the entire dairy complex.
Domestically milk production will be front and center. This past year we started to see a stagnation in growth. With export demand climbing the ability to satisfy that demand will be something that plays a role. Assuming we see a continued stagnation in growth of milk production we could simply see demand outstrip supply not just in the United States, but around the world. When looking at what hedges to consider for the 2020 calendar year, we are entering what is seasonally a lull in demand. For the remainder of the 1st quarter in Class 3, for a producer hedge using the CME futures (as opposed to options) to hedge flat price may be something to consider. When considering the balance of the futures curve in Class 3, I would consider either buying put options through either the CME or using the recently released Dairy Revenue Protection program, DRP. For those that have Class 4 exposure, I would simply consider buying puts on the CME or using DRP to put floors in place rather than using any kind of flat price hedge via the futures market.
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