July 13, 2020

Unprecedented Volatility

 |  By: Robin Schmahl

Dairy has been a market that is not for the faint of heart. Volatility has been unprecedented so far this year. There have been the most limit up or limit down days ever seen in all categories over the last six months. This has not only been confined to dairy markets, but volatility has been quite high in the financial and energy markets as well. 

The result in dairy has been numerous records being set. The greatest disparity is the block/barrel spread of 59 3/4 cents set on Monday, July 13th. It was just last year in November when there was a record inversion of the block/barrels spread of 37 1/2 cents established on November, 11, 2019. Barrels were then in high demand with a tight supply. The reverse is true as fresh cheese demand is high and buyers were purchasing to fill orders no matter what the cost. There had been a period of time during which cheddar cheese production decreased due to food service demand falling substantially. Cheddar manufacturers reduced production rather than building inventory.

When demand returned as restaurants reopened, fresh cheese was in demand and supply was short. Buyers could not get what they needed through normal supply channels requiring them to come to the CME spot market to find supply. Buyers bid up leap frogging over each other in the attempt to purchase what they could at the best price they could. The result has been an incredible rise to a record block cheese price of $3.00. 

In late April to early June, block cheese increased a record amount in a short period of time moving the price increase between May and June Class III prices to a record $8.90. This caused some real pricing issues between classes of milk. The difference between June Class I and Class III was $9.62 with Class I lower. It also resulted in a large difference between Class III and Class IV of $8.14. This has resulted in some wide price variations on milk checks. 

These wild swings have taken place due to disruption in the supply chain and the changes in areas of demand. Milk was being dumped while retail demand increased substantially. Many plants required patrons to reduce milk production for a period of time in order to compensate for the disruption in the supply chain. Fluid milk demand increased dramatically as schools shut down and milk consumption increased at home with breakfast cereal demand skyrocketing. Fluid milk demand increased significantly as consumers moved to nutritious products for the value compared to alternative drinks that were higher priced. This increase in demand made up for much of the loss from the food service industry finding itself in a tight supply situation as consumers made a run on dairy products.

Most plants have lifted the production restrictions on dairy farms, but now hot weather has had a marked impact on milk output and components. Plant are compensating by adding nonfat dry milk to cheese vats to improve cheese yields, but production has not been able to satisfy demand and limit cheese prices. High prices always cure high prices as demand is eventually reduced or supply increases, but the market has not yet reached that level. We do know that each day moves close to a price correction, but the time of this correction is impossible to predict. The drop of block cheese three weeks ago was thought to have been the top, but that clearly has not been the case. 

Markets will correct and will likely correct with a vengeance as they generally do. This is not the time to be complacent on milk production that has not protected and opportunities are available for those who may have DRP coverage at much lower prices to be able to bridge the gap between those levels and current levels by using options or option spreads.