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The worm finally turns

3rd December 2015

As we approach Christmas, we can at last talk about a brighter outlook for the global dairy market around the corner. Not the usual promise of “things look great in the long term” which gets overplayed every time the market takes a dip. The market is actually starting to turn; global milk supply is spluttering.

In part of our business, we use a measure of “global market fundamentals”, which is a nerdy way of describing the tension – or lack of it – between the demand and supply of milk at a point in time. When the market is tense, supply is short and demand can’t be satisfied. The market is “loose” when oversupplied – where we’ve been for most of the past two years. The degree of tension – shortages or surpluses in milk availability – over time generally shows up in the size stockpiles of milk powder. Surpluses of milk tend to get stored in the form of the lowest value commodity – skim or whole milk powder. Our tension barometer is a “worm chart”. At present the worm is lying on its side, looking for a way to get up.

This analysis is part of our Global Dairy Directions (GDD), a forward-looking product package available to subscribers aimed at providing time-sensitive input to decision makers on what is likely to develop in world dairy markets.

Our worm peaked in advance of panic Chinese buying of massive tonnages of whole milk powder in the first half 2014, but has been sliding down a hill since.  That’s a long downward slide relative to the recent history of dairy markets, but one we’re probably seeing the bottom of about now.

All the time since that peak, supply has been building faster than demand, building powder stockpiles.  Much of that time China has been digesting the large reserves of milk powders bought in 2014, and this year will buy 40% less powder. The closure of Russia’s cheese and butter market to the West added to the misery, shifting more milk into powder production.

But now NZ milk flow is in decline, and US output has flattened, which combines to provide a large reduction in product supply. NZ’s contraction is not as bad as was first expected – cow culls bit into the size of the herd, but dry conditions and the awful numbers for milk producers thinking about extending their milking season should see many herds dry-off early.

The US meanwhile is a vast land of contrasts. Drought has cut deep into milk flows in the west (and with that milk powder output) yet in the upper mid-west there is too much milk for plants.  In the past few months we’ve seen net national milk growth grind to a halt.

Slowdowns in those two big exporters might have been enough. But the weak market conditions have been extended by the large expansion of milk output in the EU which kicked off when the quota brakes were taken off supply in April this year.

European farmers now hold the key to how quickly our worm chart rises in 2016. As their cows spend more time in barns, output is expected to slow, but a fall in milk supply is not yet on the radar. Milk prices aren’t low enough to speed that up, and feed grain prices are favourable.

Find out more about our Market Tension Index and how it’s relevant to your decision making.

European farmers have been buffered from falls in international commodity prices due to their large and steady home cheese market. Farmgate prices are down just 5% on average since the start of the year, while powder prices are down more than 15% and cheese is down by about half that amount. Hardly a surprise – most big processors are owned by farmers. Rather than send the blunt message that there is too much milk, co-ops are optimising milk prices to cushion the impact.

The current, still viable milk prices coupled with lush grass in front of their cows and the reasonable costs of feed grain have been an incentive to Irish, Dutch, Danish, British and a lot of German farmers to keep the milk coming.  While all other regions have cut prices, French processors have actually increased theirs, basically a political ploy to ensure the government doesn’t re-regulate prices in the wake of EU-wide deregulation. There might be a lot of wasted energy in protesting about the dairy crisis while milk output is still rising, but the French brand of militancy appears to have paid off – at least in the short term.

We’ve seen a couple of false starts to price recovery in the market slide.  Twice this year, the slowing of milk supply in NZ has been spun up as a problem for global product availability. Twice we have seen the GDT rally for several events; only to fall back just as hard as ingredient buyers came to terms with reality. Another rally is probably underway with the results from the early December event.

The worm is not decisively on the upward slope just yet. Demand needs revival. Chinese consumers are pretty gloomy about their economy and demand is weak.  The price of oil is set to stay low well into 2016, affecting the economic health of Russia and the big dairy markets in the Middle East and North Africa.  Economists say the world will be a better place in 2016, with most regions growing faster than in 2015.  Hopefully that converts to higher spending on dairy to reignite some sluggish demand.