Cheese Inventories May Hinder Recovery
In my previous article I indicated that World dairy prices are showing some good sings that higher prices are on the way. U.S. prices have moved to a level at which we may be move competitive opening up the way for improving exports. However, U.S. dairy market fundamentals have change very little. We continue to see strong milk output and higher inventory.
USDA released the September Cold Storage report last week which showed the usual trend of declining inventory the this time of year with the exception of American cheese. Inventory for American cheese showed a surprising and unusual increase of inventory. There have been only 2 other years since 1980 that have shown an increase of inventory of American cheese. These years were 2010 and 1983. This does not bode well for this category through the end of the year. That is the cheese that is traded on the dairy spot CME market. Inventory is 6% above a year ago and will have a difficult time eliminating that 6% over the next three months. In fact, all categories are now expected to end the year higher than last year. We could see record high inventories of total cheese for the month of December is this pattern continues. Total cheese inventory was at another record high for the month of September even though there was a decline with that decline only being 3.1 million pounds.
USDA had announced the purchase of another $20 million of cheese and is specifically purchasing cheddar cheese which should help provide some support. This was possibly one reason cheese prices showed the largest one day price increase since January 8, 2014 last week. Fortunately, this increase was not just a flash in the pan and did not fall back immediately. However, cheese prices have been slowly eroding since then facing the possibility of declining back to the previous levels.
Milk production continues to remain strong and above last year providing sufficient milk for both bottling and manufacturing. There are no concerns over a shortage of supply. The manufacturing of dairy products is not outpacing demand with the exception of American cheese during September as inventory has been dipped into to supplement fresh production to meet demand. The concern is of the amount of supply we will end the year with. Inventory seasonally begins to grow during the first half of the year. If we end the year with inventory above the previous year, it means we may begin adding to that inventory.
Demand will need to improve to reduce supply. Yes, it certainly was good that USDA is purchasing $40 million of cheese for food banks and to distribute to those in need. However, there is some question as to whether this will be additional purchases over and above their usual purchases for these programs or if some of this purchase will offset some of the usual amount that would be purchased minimizing the overall impact to the market. There is no definite answer to this at present.
So what is there that can be done. There is the potential for milk prices to follow the pattern of earlier this year and that needs to be avoided. I continue to recommend put options and put option spreads to provide downside protection through the first half of 2017. Straight put options for the closest 2-3 contract months and put spreads for the later months with the spread difference being $1.25. These can be done for 45-50 cents. These strategies leave you upside completely open to take a higher milk price if one develops while providing downside protection to some degree depending on which strategy is used. Risk needs to be managed for the business and not be embraced as part of the business.
- September Agricultural Prices report on October 31
- California October 4a & 4b prices on November 1
- October Federal Order class prices on November 2
- September Dairy Products report on November 3