This week my travels brought me to Ireland and with it came the chance to catch up on all the news of the past month. And what news there is! You turn your back for 5 seconds and find that the world is going to hell in a hay cart ... again.
But what does it all mean for the wide world of Global Dairy Trade (GDT), and what excuse can I give for coming to Ireland to find out? Well, inspired by a pint or two of Guinness, I'll have a shot at this interesting conundrum.
Don't worry, I'll get back to Ireland before too long but before I do let's take a look at the international litmus test of GDT - Fonterra's New Zealand farmer payout.
First the good news. Sir Henry and his merry men at Fonterra are currently telling us that we are in the middle of boom times again. The projected 09/10 milk payout has risen to the giddy heights of $NZ 6.45 / kg MS. The forecast for 10/11 is for a payout of around $NZ 7.00 / kg MS and it could even go up to $ 8.00 !! ("Fonterra tips milk price of up to $8/kg", Paul McBeth, Scoop.co.nz 25 May 2010) . And Fonterra, who command 40% or more of global dairy commodity trade, should know - right? Well - umm - maybe.
Whilst forecasting a payout of up to $8.00 a quite different message was given in the same Fonterra press release, and also a few weeks ago ("Fonterra boss warns farmers of 'volatile world'", Susie Nordqvist, The New Zealand Herald, 5 May 2010) . The recommendation is: 'farmers doing their budgets for the coming season should base their planning around a payout broadly in line with this year.'
So what's it to be Henry - $6.00, $7.00, or $8.00 ??? Methinks you should be in Politics with that sort of a message. Oh, sorry, you already are? I keep forgetting that Fonterra and the NZ dairy industry is an undeclared portfolio of the New Zealand Economy and Government.
I think that was the good news. Now what does the data say.
Like all good dairy consultancies, Xcheque has an index for international dairy commodity prices linked to the Fonterra NZ payout. We like to work with real money rather than this % index or commodity basket nonsense. What you are seeing here is an index of the NZ milk payout in $NZ / Kg MS overlaid with the actual final Fonterra payout (includes the value add component). Also shown is the progressive Fonterra forecast from recent years - that is, what they forecast at the start of the year and how that changed through the year. We'll go out on a limb here and suggest that the current forecast for the 09/10 payout is pretty close to the final declaration. You can draw your own conclusions from the chart but what this tells me is:
- The index is a reasonable guide to the final payout
- Fonterra's opening forecast of the past 3 years has been a long way out
- Fonterra's progressive forecast simply follows the market direction - up and down
- Market conditions need to improve further to achieve Fonterra's 10/11 forecast
The chart is even more compelling when you look at it as a weighted average prediction and in US dollars and Euros but that is a story for another day.
The bottom line for me is that Fonterra are simply guessing - 'If everything stays the same as it is now this is what will happen'. But things are not going to stay the same are they? The world has changed. Stability is out and volatility is in. I can show you a hundred charts that demonstrate this and the latest economic news is just more evidence that.
Which brings us to Ireland
A wise Irish gentleman told me this week (I paraphrase) 'I've got data and charts coming out my ears - tell me what it means and more importantly tell me what the chart is going to look like in 6 - 12 months'. The real question on everyone's mind is not where we are today but where we are going. What is actually going to happen with commodity prices and currency. Before I have a go at that question, here's a postcard of from Ireland
In the Irish newspapers this week:
- 'Farmers back in the frame as speculators desert land market'
- 'Banks are driving Ag contractors to the wall'
- 'Dairy fears grow amid intervention releases'
- 'China an export opportunity for Irish dairy'
- 'Settled views on grassland management are changing'
- 'Country enters stage five of economic grief'
- 'Boom to bust enquiry will be forced to dig deep for truth'
The item on grassland management was an interesting insight into the importance of pasture harvest in Ireland and this was reinforced by an investigation of the milk production curve. Ireland is much closer to New Zealand and Australia than most of Europe in terms of farm practice, and processing. There is very seasonal milk production with the majority of milk going into commodity products. Unlike Aus and NZ, Ireland has the benefit of access to European markets and market prices but milk price is none-the-less closely linked to the European and global commodity market.
The last two items point to the current economic problems in Ireland, one of the so-called 'Piigs' of Europe. Ireland is deep in recession with 8 consecutive quarters of negative GDP and a 13.4% unemployment rate. Being part of the Euro currency system they can't quickly deflate their currency (like NZ and Australia) to export their way out of trouble. It takes real deflation to bring costs to a point where product and service supply is competitive, and that is extremely painful for the entire country. Ireland, Italy, Greece, Spain and Portugal, are definitely in crisis. 24 billion Euro of public sector cuts announced in Italy this week. 15 Billion in Spain.
There is no short term fix and for Ireland it is not going to come from my favourite impression of the week. 'Paddy Power' is a betting agency. It will do nothing for the economy (it's all about wealth transfer) but it speaks volumes to my personal heritage and the infusion of Irish culture of Australia. Amongst many other allusions is our quintessential carry over, 'She'll be right mate'. Along these lines, here's another wonderful reference I found this week "Ireland (is) a mentality, and not a physical place"1.
Getting back to dairy trade, the question is: "where is the market going?". As noted above, if you look closely at the chart, Fonterra is forecasting that market conditions are going to get even better than they are now. That has to come from either further increases in commodity product prices or further devaluation of the NZ dollar. The latter option may fix Fonterra's payout problem but it's not of much interest to the rest of the world. Most buyers and sellers are asking what is the commodity price outlook in terms of the more mainstream currencies of the USD and the Euro.
At the most recent NZD / USD exchange rate (28 May: 1 NZD = 0.68 USD), the $7.00 / kg MS forecast looks to us to be suggesting a further improvement on current commodity prices (as per the Fonterra May Auction). We haven't got long to wait - the next Fonterra Auction is a few days away. It is the first auction since the announcement of the release of EU intervention SMP and Butter stock and also the first auction since the recent fall in just about all commodity and economic market indicators. I'm not a betting man but if Paddy Power were prepared to give me reasonable odds on a June fall in Fonterra Auction prices I might just break that rule.
European and Oceania dairy commodity prices have had a short run in the sun while Oceania is short of product and the EU has had a relatively slow winter and early spring. The US has only seen glimpses of this sunshine with their market recovery faltering in the face of a quick return to maximum milk production. It is significant that another round of CWT cow culling has been announced. That wouldn't be happening if there was confidence in future US dairy market demand. Likewise, these travels in Europe, and especially Italy and Ireland, give me absolutely no confidence that the European economy is on the mend. Unemployment and forced government austerity will keep demand weak, buyers frugal, and suppliers desperate to sell.
With that background firmly in mind, my humble view is that the EU / Oceania dairy commodity market is currently overcooked and heading for a downturn of 10 - 20%. We'll see US and EU dairy export prices coming closer into alignment - particularly on the staples of SMP and butter. For Australia and New Zealand weaker currencies may mitigate that but watch out if the EU sees the need to subsidise exports again.
And, because I control this website and can make my predictions disappear if I get it wrong, here's the prediction for the Oceania milk price in 10/11:
$US 3.50 - 4.00 / Kg MS or ? 2.80 - 3.30 / Kg MS
I'll let somebody else have a go at predicting the NZ and AUS exchange rates to the USD and Euro. It's a complete mystery to me.
1 "The Confusion", Neal Stephenson, Arrow Books, 2004