July 8, 2015
More beef, less milk in your future?
Dairy returns are back to their pre-2006 levels as supplies expand and demand growth tapers off. Will farms shift back towards beef cattle ranching?
By Eric J. BROOKS
An eFeedLink Hot Topic

Although the dairy market downturn started a year and a half ago, the downtrend's market shaking gravity only became apparent during the last four months. After a sharp first quarter rally lifted prices by 30% in three months, rising New Zealand output was coincided with EU dairy liberalization. Prices then went into an even steeper tailspin than their initial 2014 slump -and made producers understand that the good times are really over.
Even at their 2014 peak, prices were still 10% below their 2007 all-time high. With early July's dairy prices slumped 59% below their early 2014 peaks, no protein line has seen its returns take as steep a tumble as the dairy sector. While prices are now as they were in 2009 after the financial market crash, the market is, if anything, weaker now than it was back then.
This can be seen in the fact that as of mid-year, the dairy market is trading approximately 17% lower than it was in mid-2005 before its historic rally began -and nearly 50% lower if the price level is adjusted for ten years of inflation. Indeed, when inflation is factored in, dairy prices are lower now than they were after the 2009 recession.
Weather, EU deregulation extend price slump
Although returns have retreated back to the levels they were at before the dairy boom started, a confluence of legal changes and southern hemisphere rainfall has postponed the market's recovery into late 2015.
According to Rabobank's Q2 Dairy Quarterly, "EU producers took advantage of the final removal of quotas, while improved weather saw New Zealand, Argentina and Uruguay return to year-on-year growth." Even before deregulation took effect in April, the EU's Q1 milk production was up 5% from the previous year but demand typically rises by less than 1.5% annually. Moreover, with EU producers expanding their herds in anticipation of this year's output deregulation, there is built-in inertia for European dairy output -and the exportable EU surplus- to rise higher later this year.
Similarly, New Zealand, which supplies 40% of the world market, saw 2014-15 output and exports both increase by 3% from a year earlier -with abundant rainfall bloating its April 2015 output to 8.5% above April 2014 levels. Amid relatively flat domestic dairy demand and aggressive cow culling, pasture-friendly precipitation pushed Australian milk production 2.7% in the year to May, with February to April output up 4.6% from the same period of a year earlier.
While America's rising fluid milk production was counterbalanced by rising domestic consumption, "most other surplus regions saw their production rising faster than local demand growth." With supplies staying abundant in the face of flattening demand, a new round of price deflation was triggered.
Emerging market downturn dents WMP, SMP prices

Dominant importer China saw its H1 2015 fluid milk output rise by a Rabobank estimated 5% while demand for it increased only 1%. As a result, with imports of imported milk powder being partly replaced by domestic supplies, China's re-entry into the world dairy has been postponed from the middle of this year to late 2015.
Even when it resumes importing, there's more trouble ahead: China's domestic milk output outracing demand for the first time since 2008's melamine contamination scandal is dovetailing with a long-term slowdown in its economic growth rate. Even after its economy rebounds from its recession, China is expected to grow only half the 10% to 12% annual rates it did a decade ago. Going forward, China's neighbours in Southeast Asia account for the second largest import market and they too seem to be headed for an economic slowdown.
The slowdown in emerging market demand can also be seen in the relative performance of dairy product lines: Cheese and butter, which are mostly used by western importers, remain more expensive than ten years ago. On the other hand, dairy powders such as SMP, WMP and whey are back at price levels last seen in the mid-2000s, prior to the dairy boom.
This was also reflected in July Global Dairy Trade auctions, where butter, butter milk and cheese stayed flat or increased in prices, but the overall market was swamped by much steeper declines in the cost of WMP and SMP. Even in the one market where supplies are growing with demand, mid-year saw domestic American cheese and butter prices not just maintain their premium over their world market cost but rise further -even as the country's WMP and SMP prices followed the world market in a downward direction.

For the next two quarters, the only chance of this happening is at the mercy of equatorial Pacific Ocean currents: The ongoing El Nino is expected to persist throughout the rest of this year. It traditionally brings rainfall to South America and drought to Australia and New Zealand. During the third quarter southern hemisphere spring season, that could reduce Australia and New Zealand combined exportable surplus by more than it increases dairy supplies from Brazil, Argentina and Uruguay. That would be especially true if drought hits Oceania on this occasion, as both Australian and New Zealand farmers are taking advantage of high cattle prices to cull their herds.
Nonetheless, with Southeast Asian buyers having restocked inventories earlier in the year and China's recessionary economy extending the time it requires to run down bloated inventories, the market is poised for at least another six months where exportable supplies collide with slack or declining import demand. The extent and duration of market softness will be determined by whether the ongoing El Nino ocean conditions result in an unusually dry Australian and New Zealand spring times.
More beef, less milk in your future

Two factors make the above coincidence interesting: First, the increase in beef prices is even higher and price declines are even lower when they are priced in southern hemisphere currencies such as the Brazilian real or Australian dollar -countries from which most future output increases have to come from. Second, how many have noted that while China's import demand for beef has skyrocketed even as its appetite for imported dairy products has soured?
Conclusion: We are probably in the early stages of a market shift where, for over the next ten years, beef prices stay high, dairy prices languish at low levels -and some of the acreage transferred from beef cattle to dairy farming is again goes back to making red meat.
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