February 6, 2015
Global dairy prices firm up, find a market floor
Although late January and early February featured an impressive dairy market upturn, prices remain far below their 2013 highs, and do not have much scope to rise higher.
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It fell more than anyone expected but after several false starts and a Russian boycott, the world dairy market is finally rebounding, if only to form a strong market bottom. Since its late fourth quarter low, the Global Dairy Trade (GDT) index has risen 15.9%, with 9.1% of this total coming in its early February trading session.
WMP leads, cheese trails
Early February's market upturn was supported by whole milk powder (WMP), which jumped 19.2% in that single session. Since its late 2014 low, WMP has jumped 28.9% in price, second only to butter, which is up 51% from its late year bottom. Skim milk powder (SMP), by comparison is up 16.5%, just slightly ahead of the overall index, while cheddar cheese is trading 11.1% under its 2014 low point.
The strong rebound is partly a reaction to the steepness of their fall. On the other hand, cheese, which fell only half as much as butter, WMP or SMP, is the only major product line that continues to fall in price. While other dairy products rallied anywhere from 15% to 51% in two months, cheese entered February 11% below its lowest 2014 price.
At first, the west's steady if unexcitingly slack demand for cheese supported it while WMP and SMP wilted when Chinese purchases, particularly of WMP, almost completely stopped after Q1 2014. However, by late 2014, Russia's ban on EU dairy products began to result in an oversupply of cheese.
What made it worse is that late in the year, Russia's currency crisis forced it to cut cheese imports even from countries not on its boycott list. As a result, cheese, which fell in price the least, is now still the only dairy line still stuck in a deflationary mode. Consequently, EU cheese exports fell by 9% in 2014, with the entire volume drop occurring at a steep double digit rate after Russia's August ban. It went from importing 257,000 tonnes of EU cheese in 2013 to 133,000 tonnes last year.

It should also be said that this price recovery, limited as it may be, is driven more by supply-side concerns than any upturn in demand. Driven in no small part by New Zealand's unexpectedly dry summer, and resulting poor pasture conditions, early 2015's pick up, for now, appears to be more of a market firming even than a return to boom time conditions.
This early year rally still left dairy prices more than 40% below their early 2014 highs. They remain at early 2012 levels, before China's domestic milk shortfalls kicked the market into a one year boom. At this time, however, neither supply nor demand fundamentals favour a return to boom times.
Poor demand forecast limits rally scope
From 2011 to 2014, four consecutive years of Chinese milk output increasing at 4.7% to 6.2% annual rates finally pushed its fluid milk production above 2007, pre-melamine scandal levels. Despite late year difficulties, New Zealand's own 2014 milk production was up 6.1% on-year. In fact, despite 2013's nasty drought, in the five years from 2009 to 2014, New Zealand, which supplies 35% to 40% of dairy exports, increased its fluid milk production 26.3%, from 16.983 million tonnes to 21.450 million.
Incentivized by late 2013 and early 2014's record dairy prices, the surge in New Zealand milk output is one reason why 2014 saw a 4% rise in milk production by top exporters. That was the largest increase since 2007, when a similar price-driven output boom heralded a dairy market crash.
Going forward, Synlait forecasts that Chinese dairy production in the first half of this year may rise by 15% from levels in the first half of 2014. This would minimize China's need for dairy imports.
The USDA also concurs with Synlait's pessimistic forecast. From 10% annual economic growth and 7.4% in 2014, China's GDP is only expected to grow by 6.5% this year. The USDA believes this will result in Chinese WMP imports falling 12%, from 2014's 1,000 tonnes to 880 tonnes this year.
 - And that will happen just in time for the EU to remove its milk production quotas in April. Hence, the world's largest dairy production region will contribute to a looming world market glut.
On the other hand, even if New Zealand's drought breaks, there are economic factors tightening supply-side fundamentals. With Fonterra cutting the average milk solids price paid to New Zealand farmers from NZ$8.40/kg last year to NZ$4.70/kg, the 44% drop in revenue per unit will definitely discourage herd expansion in the world dairy market's largest supplier. Fonterra has already warned that due to drought at the turn of the year, it will be selling less dairy products than at this time last year.
But the reduction in New Zealand supplies is counterweighted by expected higher production in the EU, America, large inventories in China and the prospect of Russia continuing to boycott western cheese, or, if its economy tanks further, being unable to afford far fewer cheese imports than even last year.
Hence, any supply-side reduction from Oceania will be at least partly counterbalanced by expected supply increases elsewhere. This limits the scope for prices to move to move more than 10% higher than it already is. With industry analysts expecting China to require until the late third quarter to run down inventories, prices of most dairy commodities are expected to remain range bound for the next half year.

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