The authors are with INTL FCStone.
Farm gate margins were very good in the fourth quarter . . . will dairy farmers be quick to boost milk production after a multi-year bearish market that did significant damage to their finances?
It’s usually a good bet that dairy farmers want to make more milk. But there’s a lot on the docket for dairy markets domestically and abroad this year. Some is good, some bad, and some ugly.
The end result?
More market volatility is likely. Let’s dig in.
While dairy futures have taken a hit early in 2020, they are still projecting decently profitable margins through all of 2020. If you combine the past six months of good margins with the next 12 months of futures, the market is predicting an unprecedented period of good returns. These types of global farm gate returns should ultimately accelerate milk production growth during 2020 in the U.S., EU, and New Zealand. In fact, we’ve already started to see the U.S. supply side adjusting higher. The dairy herd is now up 22,000 head from the low point last August.
A typical herd expansion
Once a herd expansion gets going, it tends to last for about 18 months. As for cow numbers, we’ve added 100,000 to 120,000 head during the past three expansions. Even if we stay conservative on this expansion, the herd should be up about 50,000 head by mid-year, which would put it up 0.5% from last year. Good margins typically drive a little better than trend-line growth, but that is probably offset by the feed quality issues.
U.S. milk production in the first quarter of 2020 looks “pretty good” with milk flow shifting up from 0.8% in the fourth quarter of 2019 to an expected 1.1% growth in the first quarter and 1.4% in the second quarter of 2020. That 1.4% still isn’t overly aggressive growth, but it is significantly more than the 0.3% gain we saw in 2019.
Production in Europe looks good. First quarter growth won’t be spectacular, but second quarter is expected be stronger. Australia has its issues, but so far, the fires don’t seem to be having much direct impact on production. The country is getting hit with the remnants of a typhoon, which is actually helping to put out fires today.
New Zealand, the world’s leading dairy exporter, was looking pretty respectable until a month ago when the southern tip of the South Island started experiencing flooding and the North Island began trending dry. As a result, we are ratcheting down our production forecast for the remainder of the season. We’re lapping over poor weather last year in February and March, so we’re probably not going to make a bullish headline like New Zealand production down 5%, but if collections run flat against last year, then total production for the season will only be up a fraction of a percent.
Strong consumer interest
All things considered, demand is strong. We’ve been in a period of good demand, which started back in September, and we expected that to stay good through about February.
We started to see evidence of a demand slowdown a few weeks ago with nonfat dry milk (NFDM) and skim milk powder (SMP) spot prices stalling and weakening second quarter milk powder futures across all the global markets.
Is that normal weakening of demand . . . or is it coronavirus? And there it is: coronavirus. You can’t make it far in any dairy discussion these days without bringing up the virus.
It’s hard to separate the direct (negative) impact the virus is having on consumption from the impact the virus is having on logistics. Then throw in the fear and emotional decisions that are being made in the markets, and things get very confusing.
It’s clear there is going to be a direct negative hit to consumption inside of China. Slower global economic growth will also slightly reduce demand in the rest of the world, too.
Then, there are short-term logistical problems getting products into China, and moving product around within China. Eventually, those issues will get worked out, but it’s hard to tell how much of the current demand weakness is actually tied to consumption versus logistics.
From a broad perspective, global demand in 2020 is, or at least was, looking decent before coronavirus. Leading indicators of economic activity were stabilizing before the outbreak. Trade wars seemed to have a “light at the end of the tunnel” and overall economic conditions were stabilizing, which is what you need to see before an improvement.
What does it all mean?
Now the question is, how much do the exogenous shocks change the base outlook?
Off the bat, we have to look at the current state of coronavirus. By the time this article is printed, there may be some resolution, or it may get a lot worse. We don’t know. The markets like to presume that it is going to continue to spread. The headlines are expected to get worse. The number of cases may not peak for a few more months. Obviously, having entire cities locked down is not great for demand or economic growth.
This is ugly.
It’s possible that if there are enough internal disruptions, they could turn to imports to assure themselves of needed ingredients. But, if internal disruptions are that bad, then economic growth is going to be pretty bad too, and that will trickle out globally.
Looking at various studies on the impact of Severe Acute Respiratory Syndrome (SARS), and some modeling around potential impacts of larger influenza outbreaks, it looks likely that coronavirus is going to knock somewhere between 0.3% and 0.8% off global gross domestic product (GDP) growth. When you work that through the models, it takes average prices down 2% to 10% over the next 12 months from baseline levels. So, it’s not catastrophic, but it isn’t good news either.
On the other hand, China following through with the commitments in the Phase One Trade Deal would be bullish. Also, some resolution to the coronavirus would also be supportive of markets.
Finally, another potential bullish shock would be India coming into the market to buy SMP. If they took 50,000 metric tons, we think it would boost global prices by about 9% or 11 cents per pound from whatever prices would have otherwise been.
When we boil it all down, U.S. dairy farmers ought to do better this year. Tighter than normal supplies weighed against better demand should keep prices trading at higher levels than “normal” for the foreseeable future. But there are still price risks. The question you ought to ask yourself is, what price risks am I willing to live with — and what do I want to do about that?