Here at Xcheque we have for some time been warning about the pace of growth in global milk production. Year on year Production from the major global exporters increased by more than 4 billion litres in the 7 month period from May to November 2010 (EU27, US, NZ, AUS, ARG).
To put 2010 milk production growth in perspective, average annual milk production growth from 2006 to 2009 was 1.8 billion litres. During the runup of global commodity prices in 2007 the total increase for the year was 3 billion litres. Dairy commodity prices fell steadily from the peak in September / October 2007 and then, with the onset of the global financial crisis, collapsed dramatically in the second half of 2008.
This background provides some explanation of our view that the rate of growth in 2010 was unsustainable and would result in weakening of commodity prices during 2011. Drawing on Xcheque's core values:
In the absence of alternatives, history is our best guide to the future
Respect and study what has gone before you. It may not always make sense but it happened for a reason and most likely can happen again.
You can therefore understand our surprise when prices kicked away again in January and February. Yet again we are reminded of another of our core values:
The market will have the last say
Markets can move in mysterious ways. To try to control it or suggest that you know what will happen with absolute certainty is fraught with danger.
As it turns out we haven't had to wait too long for an explanation for recent commodity price rises. We have all heard about floods in Australia and dry conditions in New Zealand (I can't bring myself to say drought - they don't know what that really means in NZ). As noted before however, Europe and the US have been the major drivers of recent global milk production growth - the world can get along just fine if Oceania stalls a bit.
We get the US milk production results very early from the wonderful USDA data gathering process. Back in January we saw that the US December milk production was slowing down a fraction but still well above the prior year and, more importantly, above their long term trend line.
The all important European production data was finally updated last week and soon after the US January data was posted. The story is now just about complete. Our year on year production chart for the major global dairy traders is shown below, updated with December data. AUS, ARG, EU and US data is official and we have had a bit of a guess at the NZ result based on comments from Fonterra and other quarters.
The chart shows that milk production growth is still in the black but has slowed down dramatically from the trend of prior months. While the US and Argentina appear to have maintained their momentum of growth, drought in NZ, floods in Australia, and a cold European winter appears to have taken a toll.
We will probably need to keep saying this, but a comparison with prior year data can be misleading (see also "US milk production turns the corner" Dr Jon Hauser, Xcheque.com 20 November 2010). The important reference to growth is the comparison to the long term trend. If production in the corresponding month last year was abnormally high or low this can skew the year on year comparison and give a false impression of the trend. None-the-less, a close look at the European and US data shows that global milk production growth has indeed stalled in the past 2 months.
The charts above show the EU and US milk production data corrected for seasonal variation and shown in the context of the long term trend. December EU milk production is above the long term trend line and so there is still some real growth in the system, albeit at a slower rate than prior months (registered users can access the dynamic charts in our chart library).
The slowdown in US milk production was small in December but January data shows a big reduction in seasonally adjusted terms. The January increase of more than 2%, relative to last year, is therefore deceptive - it is an artefact of low milk production at the start of 2010.
The US market has demonstrated an ongoing demand and supply growth equivalent to about 1% per year. This is mostly for domestic consumption but in the past few years has also fed into increased export sales. With export demand running on growth path, the slowdown in the supply side has a quick effect and that is perhaps what we have seen in the US commodities market during January and February.
So with 20:20 hindsight, we can see that recent rise in dairy commodity prices appears to be due to a slowdown in the supply side. This has arisen because of the combination of unfavourable climatic conditions in Australia, New Zealand and Europe, plus either climate or feed price effects in the US (the US slowdown is due to lower milk production per cow).
The recent commodity price history shows just how finely tuned the global dairy market has become. With very little government stock to buffer supply, prices can rise very quickly - just as we saw in 2007. The caution is of course that markets can fall just as readily. Furthermore, the price drops in 01/02 and 08/09 show they can fall a long way. But I'm not going to leave you with that thought this week. It's time to get out there and sell the dairy industry! ... well to Oceania farmers at least.
Not so long ago I made the point that we have seen a huge shift in the economics and politics of the global dairy industry ("The global dairy industry's paradigm shift" Dr Jon Hauser, Xcheque.com 12 November 2011). It is indeed scary that the US and EU can ramp up milk production so quickly. If supply overshoots demand then prices will fall. The good news for Oceania is the EU and US governments have systematically reduced export subsidies and lowered the price point at which they will intervene in the market. The trigger point at which EU and US farmers start to feel a world of economic pain is now well above the point of government intervention, and well above the current cost of production in Oceania.
So yes, the US and Europe can kill a market run by quickly increasing production and taking up the available opportunity. Just as importantly, the US and Europe can and will quickly slow down the supply side when commodity prices fall. A small turn of the feed dial is all that is required and supply resets to balance demand. They also have every incentive to do so with their expensive high variable cost feed supply.
Here's the underlying message Oceania - as long as you always remember that cost is king in commodity markets (it's part of the Second law of Economic gravity):
Get your motor running
Head out on the highway
Looking for adventure
And whatever comes our way
Yeah darling, gonna make it happen
Take the world in a love embrace
Fire all of your guns at once
And explode into space
Steppenwolf "Born to be wild" 1968
Postscript: Believe it or not - I did write this before the announcement of the Fonterra price rise.