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With more milk, sluggish prices could be in store

Nate Donnay, Stonex Group Inc.


February 10, 2021



The author is the director of dairy market insight with StoneX Group Inc.

We got bailed out, and then we started drilling holes in our own boat. I wish I could share a more optimistic perspective about the situation, but the recent supply and demand data and mood in the dairy markets has been somber. Milk production in the fourth quarter of 2020 was up 3% from last year, and the dairy cow herd has expanded by 93,000 head in the past six months.


We also ended the year with cheese stocks up 5.7% from the previous year and butter stocks up an astounding 44.4%. Government programs were able to smooth over the underlying demand problems for most of 2020, but strong milk production growth and less government support are driving a more bearish outlook for dairy prices.


The supply picture is straight forward. While a weak Class IV market, negative producer price differentials (PPDs), and base/overbase milk pricing programs limited milk production growth in some parts of the U.S., good farm gate margins, direct payments from the government, and new plant capacity have encouraged farmers in other parts of the country to expand.


Up, up, and up

Farmers added 93,000 milk cows to the herd between June and December. This is the fastest six-month expansion in more than 22 years. The herd is now up 1.1% from year-ago levels. Even if it flattens out near current levels, it will still be running about 1% higher for the first half of 2021 when compared to the same time last year. Milk production per cow has been running around 2% growth in recent months, but I expect it to drop down toward trend-line growth, which would be closer to 1%.


If the herd is up 1% and production per cow is up 1% to 2%, we’re looking at milk production running 2% to 3% above last year for the first half of 2021. Lower milk prices and higher feed costs will likely slow the growth in the second half of the year, but it looks like we will have plenty of supply growth for the next five months.


It is harder to discern the demand situation. With record high cheese prices in 2020, it felt like demand was good. However, if you excluded purchases made through government programs, domestic cheese disappearance was down an estimated 1.9% from May to November. Butter was down an estimated 0.7%, and bottled milk was down an estimated 4.5% over that same period.


Retail sales are still good, but they have stabilized with cheese and butter running about 10% above year-ago levels and bottled milk up about 1%. Retail growth is not making up for other declines, though.


Food service hit hard

Restaurant sales are still running about 12% below last year with month-to-month and regional fluctuations due to lockdowns and weather. We’re estimating the amount of dairy moving through school breakfast and lunch programs is down 38% due to distance and hybrid-learning programs. Food served through workplace cafeterias is probably down 60%. Unfortunately, this all nets out to a drop in dairy consumption in the U.S.


Strong federal intervention

Government purchases were the main driver keeping dairy prices out of the basement during 2020. Between the Farmers to Families Food Box program, Section 32 purchases, Families First Coronavirus Response Act, Coronavirus Aid Relief, and Economic Security Act, and trade mitigation purchases, the USDA likely spent about $1.35 billion buying dairy products in 2020. Those purchases absorbed an estimated 2% of the milk produced from May through December. With milk production up 1.9% during that period, the purchases absorbed most of the new milk produced.


We don’t know all the details on USDA purchases for 2021, but based on the programs that have been announced already, we could see dairy purchases totaling $600 million to $900 million in the first half of the year. They could absorb about 1.8% of milk production. With production growing 2% to 3% and domestic demand down, that still leaves us with an oversupply.


Making sense of it all

The market will probably remain volatile. Government purchasing programs are expected to be active February through April and should absorb most of the milk production gains during those months. We could see prices jump higher during this period, especially if more money for additional purchases are announced. When focus shifts away from the government purchases, this market quickly gets bearish and will reflect the tough underlying fundamentals.


We are probably going to start getting some crazy year-over-year demand numbers, but don’t be confused — these are expected. Due to the tremendous spike in retail sales as states went into lockdown and the massive collapse in food service sales, we expect to see retail sales this year down 15% to 20% in the March and April comparisons, and food service would likely jump 40% to 120%. These are expected shifts, and they don’t change the price outlook.


As for the long-term horizon, it is difficult to see consumption getting back to “normal” until schools and workplaces fully reopen and people feel safe dining in restaurants again. Even at an optimistic pace for vaccinations, that won’t happen until August or September at the earliest. Without a significant slowdown in milk production or additional government purchases, we could end up with weak dairy prices, especially from May through August.


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