What is it about percentages and ratios that people find so alluring???

The dairy news from the US this week is all over an article from the University of Illinois Department of Agricultural and Consumer Economics - “Livestock/Corn Price Ratios in the New Era”. The article notes that the average milk : corn price ratio from 1985 – 2008 has been 6.0 and in the past few years this has dropped to 4.5. The article goes on to suggest that the milk price needed to restore the average milk : corn price ratio is $24 / cwt. We can hear the cheers from the US dairy lobby all the way over in here Australia.

Unfortunately (if you are a farmer), this type of analysis is just plain misleading. There is nothing about the milk : corn price ratio that says anything about the economics and profitability of farming other than (perhaps) the direction it is heading. To me, analysis of this ratio falls squarely into the basket of lies, damned lies, and statistics.

I have pointed out in a recent article that it is the money that counts in dairy production and not ratios (“US milk production – shouting down the supply chain”, Dr Jon Hauser, Xcheque.com , 1^st April 2011). Farmers respond the amount of cash in their bank. The margin after feed cost is what determines this.

Just to reinforce the point, here are a few more of our charts for your consideration.

The chart above shows the US All Milk price, corn price, and the margin after feed cost from January 1961 to March 2011. You can draw all sorts of lines of best fit to these graphs but the best guide for me is the general trend. This chart tells me:

• Average dairy operating margins after feed cost have been held to an average of $8 - $10 / cwt for 30 years.
• The impact of higher feed prices generates an equivalent incremental increase in milk price, not a proportional increase. In other words the milk price lift is only ever enough to maintain a stable margin after feed cost.

I know that I am going to get howls of protest from dairy farmers who would say that other costs have risen as well. That is correct but dairy, like other agricultural and manufacturing industries, has become much more cost efficient in the past 3 decades. This improvement in productive efficiency has offset cost increases with the effect of stabilising milk prices.

You can see that even more clearly when you adjust the price and margin estimates for inflation. The chart below shows milk price, corn price and margin in today’s dollars. In real terms both milk and corn prices have fallen and along with this the margin over feed cost. To name a few drivers of efficiency gains – scale of operations, technology, genetics and supply chain efficiency have all contributed to farmers producing more from less.

Is any of the real story evident in the milk : corn price ratio, or for that matter the milk : feed price ratio? Well you can draw your own conclusions but I don’t think so.

Reliable milk price forecasts need to come from feed price projections; plus more more detailed analysis of other farm costs; plus projections of efficiency improvement. Supply and demand imbalances will move the actual price around but in the long run it all comes back to dollar margin over cost.

The past and recent history suggests that, at current feed prices, a milk price of about $20 / cwt is required to maintain the slow but steady growth of US milk production. Farmers would love to see $24 / cwt but feed prices need to move quite a bit further before this price is realised. Here’s another way of putting it for cinema fans:

"$24 / cwt milk from from $6 / bushel corn? Tell ‘im ‘es dreamin'.”

To understand that cultural reference better here is the clip from an Australian classic film ‘The Castle’

That’s all for now and I’ll put the article on milk price ratios into the round filing cabinet beside my desk – or more correctly, the desktop icon on my computer screen that says ‘Recycle Bin’.