September 23, 2020
 
Understanding the world dairy market and COVID-19's impact - Part 2

Falling tops, rising bottoms, accelerated convergence and fast-forwarded deflation - why a new dairy price cycle is on the horizon.
 
By Eric J. Brooks
 
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Global Dairy Trade's (GDT's) early August auction saw the overall index tumble to 3,004, down 6.4% from mid-July's 3,209.

On one hand, this snaps three months of aggressive gains: After falling 17.4% in three months, from a January 21  peak of US$3,434/tonne to US$2,836/tonne on April 21, the GDT index rallied back 12.8% in early July. It then plateaued at this level for nearly a month before falling back to just above US$3,000/tonne in late-August.

On the other hand, while this is 7.7% lower than it was in August 2019, it is a strong performance at a time when COVID-19 lockdowns made many commodities fall by 20% to 50% on-year.

The GDT index continues to sell in the same 35% to 45% discount to its February 2014 market peak that it has traded since mid-2018  –long before COVID-19 devastated the world economy.

As you can see in the attached graph, every post-2016 GDT price peak has been lower than the previous one. After Q3 2018, a pattern was also established where each price bottom was higher than the previous ones. Most of the time, new market rallies begin where the slopes of descending price peaks and rising price bottoms intersect. As mentioned in Part 1, this pattern of falling price peaks and rising price bottoms has coincided with an ongoing narrowing of the formerly widespread between the price of fatty dairy goods and powders.

COVID-19 deflation did not break this bear market pattern of rising price bottoms and falling peaks. Nor did it stop the narrowing spread between more expensive fatty dairy goods and that cost of WMP and SMP.

There are several conclusions to be drawn from this. First, from over US$1,800/tonne in Q3 2019 and US$1,490/tonne in Q1 2020, the price gap between the most expensive fatty butter and the cheapest dairy powder (SMP) has narrowed to just US$834/tonne as of mid-August 2020. –This is the smallest price gap since the dairy market crashed.
 

Second, if anything, COVID-19's price deflation accelerated both the ongoing price convergence between fatty goods and dairy powders, as well as the current, deflationary bear market cycle. Third, by undercutting dairy farming returns and destroying market confidence, COVID-19's price deflation and global recession reduced the time required to wind down global surplus dairy inventories by six months to a year.

As the attached graph shows, the market price trend usually changes direction when slopes that connect price tops and price bottoms intersect. Without COVID-19, the GDT index was poised to make several successive, gradually lower market tops, bottoming out near $3,000/tonne to $3,100/tonne in late 2021 or early 2022.

By increasing the bear market downtrend's steepness, COVID-19 accelerated supply-side adjustment crucial to ending this deflationary phase. Pushed along by COVID-19 deflation, the upcoming GDT price bottom will constrain production in western dairy exporters – but China and other top East Asian importers will see their demand recover faster than the rest of the world economy.

As the graph's converging lines show, the GDT index is on track to bottom out slightly below $3,000.  This is the lower end of the $3,250/tonne ±13% price band it has fluctuated in since its first post-recovery peak in late 2016. Barring any further unexpected macroeconomic shocks, expect a three to four year sustained, across-all-dairy-commodities upturn to begin sometime in Q2 2021, exceeding previous market tops by the mid-2020s.
 


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