The global health pandemic has created never-before-seen changes to dairy markets. Let’s discuss these developments . . . through the lens of a psychological bias that has been particularly troublesome in dairy markets. That lens is called the “availability heuristic.”
It is a phenomenon where we overestimate the likelihood of events that we have experienced recently. Because of this bias, people tend to predict the future will look much like the present situation. Regarding dairy markets, I’ve never seen the damage from this psychological bias be as severe as it has been in 2020.
At first, not so bad
For example, go back to when the federal government issued stay-at-home orders on March 14, 2020. As many farmers did, imagine that you predicted milk prices — and made decisions for your business — based on what you were experiencing then. In the week following the shutdown, the CME block Cheddar price traded in the $1.80 per pound range. CME butter was in the $1.70s. You might have concluded that the prices of dairy products were largely unaffected by the impacts of coronavirus. In other words, milk prices in April and May would look like they did in March. This is what the “availability bias” looks like when it is at work.
We know that conclusion was very wrong. The support for dairy markets was caused by a temporary nationwide movement to restock pantries and refrigerators. Commuting employees and students were suddenly working from home and eating patterns evolved quickly. It was as if the entire nation was preparing for a hurricane. A month later, blocks had fallen to $1 per pound, and butter was as low as $1.10 per pound. Class III milk prices were on their way to lows of $12.14 per hundredweight (cwt.) and Class IV to $10.67.
Now, imagine predicting, based on what was happening in April, the shape of the dairy industry at year-end. At that time, Open Table, a company that tracks online restaurant reservations, was reporting full-service restaurant reservations were down 100%. And without any sales to their food service customers, many U.S. milk processors had to scale back production schedules or shut down plants altogether. With the sudden loss of manufacturing capacity, The Wall Street Journal reported cooperatives were dumping 7% of the country’s milk. On Facebook, farmers circulated photos of milk being unloaded into lagoons.
In April, the “availability heuristic” was telling us that 2020 was going to be a disastrous year. Can you remember 2009? Surely, farm-level finances would be much worse than then. Dairy farmers would exit the dairy business like never before. But again, forecasting the future based on the present and the familiar wasn’t just a little inaccurate this year — it was wildly wrong.
Processors and cooperatives decided to implement supply management programs rapidly. Instead of dumping 7% of milk, only 2% to 3% of milk hit the ground during the month. By May, dumping had stopped altogether. The government also decided to get involved in mitigating the financial blow. Dairy farmers were issued Paycheck Protection Program (PPP) checks totaling around $2 per cwt. across milk produced in April and May.
The CARES Act included a grant to farmers equal to as much as $1.54 per cwt. across the entire year’s production. It also allocated billions of dollars to dairy product purchases. Then, restaurants began to reopen and “refill their pipelines.” The fundamentals changed. Dairy product prices shot higher. Just a month later: blocks ended May at $2.23 per pound and butter — as if the coronavirus crisis had hardly happened — finished the month at $1.66 per pound. Average farm balance sheets were still intact.
Then in early June, industry contacts were talking about a “new normal.” Across the supply chain, people were predicting cheese prices would soon fall below $2. They said: “Maybe prices could stay elevated through the beginning of July but certainly no later.” As soon as restaurants restocked, dairy product prices would be back to the levels that they could recall before the coronavirus.
But as we can now recognize, this was the “availability bias” at play again. And, as it had been all year, it provided a particularly inaccurate forecast. As it happened, cheese prices continued to rise during June and set a record high of $2.81 per pound on June 23. At the time of writing this article, block prices are still above the record price levels experienced in 2014.
Demand is evolving
Why has the “availability bias” gotten it so wrong this year? It’s because the demand environment has been changing at record speed. Inherently, the “availability bias” assumes either the supply and demand environment is stable or that we’ve been in this situation before. In 2020, these were both terrible assumptions.
Take, for example, the record growth rates in retail sales of natural cheese. They were up more than 20% year-over-year (YoY) during every week in May and were still up 13% YoY by the end of June. Or retail sales of butter, which rose more than 50% in May and had averaged up 24% in June. If these numbers sound small, consider this: Retail sales growth in June was equal to an additional 63 million pounds of cheese and 16 million pounds of butter.
Instead of relying on the familiar to predict the future, let’s instead attempt to do the opposite. Assume the future will look different from anything we’ve seen before and try to evaluate it based on our best guess of future fundamentals.
Cheese friendly reopening
In that aim . . . as the country has slowly reopened, the remaining coronavirus restrictions have concentrated restaurant spending to limited-service restaurants with drive-thrus or delivery. These establishments also happen to be cheese-friendly. Domino’s reported sales up more than 20% in May, and McDonald’s said its sales recovered to pre-COVID-19 levels by June.
At the same time, full-service restaurants have struggled. These establishments tend to use more butter. In other words, once the country fully reopens, it will likely be price-supportive for butter but price-negative for cheese. Until that full reopening, it will be price-supportive for cheese.
The bottom line: As a forecasting technique, the “availability heuristic” performs most poorly — and should not be relied upon — during unprecedented times. So far, 2020 has undoubtedly been unprecedented. And I do not expect it to return to “normal” anytime soon.