We are playing by pandemic rules. Unfortunately, those rules are not clearly spelled out and there are no referees to guide us. But one of the rules seems to be “keep people fed”. By our estimates, the U.S. government bought about $1.3 billion worth of dairy products in 2020 with most of the products distributed to people in need through food banks and nonprofits. Many in the industry believed a Democratic administration would favor increased SNAP benefits to help people in need, and that has been a priority for the Biden administration, but it looks like the direct purchases are going to continue and we could see government purchases of dairy hit $1.5 billion this year.
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Market Demand is Weak, Plenty of Milk
Without government purchases, the dairy market is bearish. Even with the large government purchases, domestic cheese disappearance was only up 0.1% from May through December compared to 2019. If you net out the government purchases, domestic commercial demand was down about 2.2%. Commercial demand probably isn’t going to get back to “normal” until most people feel comfortable going out to restaurants, students are back in schools, and the unemployment situation improves. We could be most of the way back to normal by September, but even that might be too optimistic.
So, demand is weak, but what about the supply situation? Milk production was up 3.0% during the fourth quarter, compared to the previous year. Thanks to the record high cheese prices in the second half of 2020, and direct payments from the government, milk production was very profitable and farmers have expanded their herds and boosted production per cow. Given the imbalance between supply and demand, milk buyers and cooperatives could start to discourage production by passing lower prices back to farmers or putting other supply controls into place like they did in April/May last year. But without direct action by milk buyers or co-operatives we are likely looking at strong milk production growth for at least the first half of 2020.
Dairy prices could stay volatile. At times, the over supply is going to drive prices lower, but with the government still committed to spending billions on direct commodity purchases we could go through periods where the government purchases temporarily tighten the market and drive prices higher. We also have some risk that supply tightens faster than expected, especially when you factor in the large increase in feed costs that we’ve seen over the past six months. We also have the possibility that commercial demand will recover faster than expected, and if the government is still buying large quantities we could end up with very strong demand.
We are playing by pandemic rules, which are being written while the game is being played. If large fluctuations in dairy commodity prices cause problems for your company StoneX offers tools like futures, options and over the counter contracts that can smooth your prices or set ceiling or floor prices. If you want to learn more, feel free to reach out to us.
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Editor’s note: The author is the Director of Dairy Market Insight at StoneX Financial Inc. and has been applying his interest in large complicated systems and statistical analysis to the international and U.S. dairy markets since 2005. As a consultant, he has worked with clients at all levels of the dairy marketing chain from the farm level up to processors and packaged foods companies, food distributors and restaurants as well as connected industries like banks, private equity groups, government agencies, and industry associations. Through ongoing reports or one-off client specific projects, he helps them understand the short and long-term trends and the underlying relationships driving the market and what that means to their businesses.