When Fonterra executives and New Zealand farmers checked their Lotto tickets on Wednesday last week they had a very pleasant surprise. Overnight the value of powder and butter oil had jumped more than 20% on Fonterra's globalDairyTrade auction. What the .... ??  we all said.

It's something of mystery to everyone except the buyers and Fonterra - and perhaps even they are wondering.

Just to add to the drama, the unexpected rise comes just as the Fonterra auction price is being put forward as the basis for NZX's proposed dairy future's trade.

It all deserves closer inspection and so here are my thoughts on the subject.

At Xcheque we are a bit of a fan of the Fonterra Auction. It has brought a level of transparency to the industry that has been lacking in this part of the world. Real buyers (we presume) buying real product for the current and future needs, at a public price. We don't for a minute believe that the Auction in itself is driving the overall market price up or down.  It is very clear for example that the price crash in 2008 was lead by collapsing international demand and surplus production from the US and Europe. Take a close look at the WMP price chart and others on our site if you don't believe us.

To us the auction is very important information but it is not the market. Our observations over time are that Australian market prices tend to be lower than the Auction, even in the month after the Auction result comes out. The real market is more sluggish - both on the upside and the downside. That may well be the nature of the data gathering but we don't think so. Face to face negotiation does not generate the same results as an auction. The emotional dynamics are just so very different.

One of our contacts (a trader) has repeatedly claimed that the Auction is a manipulated price because Fonterra control what volume of product goes on to the market and when. I suspect there might be just a touch of sour grapes there - secrecy and misinformation is a trader's stock in trade. The Auction has opened the door of dairy commodity trading to the public - including a vast array of previously ignorant dairy commodity buyers. In this month's result however, there may be some truth in the comments. The Auction appears to be defying our pet topic of economic gravity (yes I will finish that series of articles).

There is no question that right at the moment Oceania is sold out of product. Australia's export and ingredient production heartland of Victoria has suffered a dramatic fall in production this past year - a direct effect of the 2008/2009 price crash and very low opening milk prices. The Fonterra Auction therefore does make sense, in a regional context at least.

We would also acknowledge that in the case of butteroil this is not a regional issue - there is a global shortage relative to demand.  It will be interesting to see how that plays out. To make butter and butteroil you also need to make skim powder, and right now there is quite a lot of that in EU and US storage.

Notwithstanding the validity of the current Auction prices, the real story on global dairy prices is contained in our Weekly Bulletin from this week. I won't go into detail here - there is plenty of evidence in the articles on EU and US production and markets - the bubble can't last, there is just too much weight on the downside. As soon as we move fully into the northern hemisphere summer, and as soon as Oceania cranks up in spring, it will all come down with a thud.

Which brings us back to our issue of transparency and futures. It is in fact the lack of transparency in the rest of the Oceania market that makes the Auction result seem so strange. Fonterra puts 10 - 20% of their product on-line. What about the rest of Fonterra and New Zealands product?  What about the 6 billion litres of milk from Australia that goes into ingredient markets? The underlying data shows that pricing is much more closely aligned with Global trends. That data is available but it is very hard to get at and so everyone is focused on that small piece of the jigsaw that is the Fonterra Auction.

If and when the Fonterra Auction represents 40 - 60% of Oceania product then I might get excited about using it as the basis for a futures price. Even so, there is quite a bit more data on production and stocks that needs to be brought to the table before you could say that an Oceania future's market has validity. We have a long way to go before we catch up to the quality of data and information coming from the US market. I'm not so sure that there is even the will and capability within the private and public sector to get there. In the absence of a truly transparent market (here and overseas), just don't go there - it will all end in tears.

You might also ask why am I so keen on a transparent market? Well because I believe it is the lack of transparency that drives the extreme volatility of the market, and that volatility is not good for anybody. The extremes of supply and demand and the associated price fluctuations come from uncertainty and lack of information. For most of the year in Oceania dairy farmers get up at 5 in the morning to milk their cows and have no idea how much they are getting paid to do this work. It is not a sustainable model and our crusade at Xcheque is to agitate and open the door just a little wider each day. That might not make us very popular with processors and traders but we think there might be a legion of farmers, buyers of product, and suppliers to the industry who are standing behind us (looks around .... yep there they are ... back behind the hedge ... about a mile away ... no the other hedge ... well I think that's them ...)