Weak Demand Will Slow Price Rebound
When it comes to building strong prices, it takes two to tango. A short supply and strong demand makes prices jump. Demand is usually the stronger force, since strong demand can usually at least keep prices stable through periods where of ample supply.
Such has been the case with the dairy industry for many years. Continual production growth has required strong demand to soak the additional milk. While domestic demand was usually adequate to take up the supply, in recent years we’ve relied on global demand to contain the growing production.
Production has continued to grow throughout 2018 but, unfortunately there hasn’t been the support on the global demand side to strengthen prices. According to Nate Donnay, director of dairy market insight at INTL FCStone, the supply side isn’t to blame. He says milk production has been better than expected in New Zealand, but EU production has dropped faster than most thought it would.
“I’m reluctant to blame the price weakness primarily on supply,” Donnay says. Demand hasn’t grown as much as expected, which he says would explain weaker prices despite positive volume activity.
Part of the reason for the shift in demand is slower income growth in major importing countries. The International Monetary Fund (IMF) forecasted income growth in developing countries down by 0.3% for 2018 and 0.4% for 2019.
“Income growth is the biggest demand shifter in our models,” Donnay says. “For every 1% change in gross domestic product (GDP) prices are impacted by about 8.5%. So if everything is constant in the models, the reduced GDP forecasts knock about 2.5 to 3.5% off price forecasts.” That amounts to about $90/MT on whole milk powder and about a nickel per pound on cheese.
Donnay says the more significant pain point is happening in smaller importing countries like Pakistan. While Pakistan does not import much dairy products, it’s other countries like Pakistan—Turkey, Brazil, Egypt and Nigeria—that are suffering economically and accounted for about 7% of global imports in 2015.
Currency value is another driver of demand. In the smaller, emerging countries, currencies have taken a beating, Donnay says. Currency values for the largest importers have been weak against the dollar since 2015 (they are down 5% since the beginning of 2018, according to Donnay), but the currencies of smaller importers are down 38% since 2015 and 7% since the start of 2018.
“Currency-adjusted dairy prices have been at record high levels for the basket of smaller importers, which is having a negative impact on dairy imports,” Donnay says.
While the GDP forecast is bearish, Donnay says there is hope as we get into 2019. GDP growth for emerging countries is forecast at 4.7% for the rest of 2018 and 4.7% for next year, despite a downward revision. The Chinese GDP is expected to slow, but Mexico is expected to accelerate slightly, Donnay says.
Global production is projected to be tight through the end of 2018, which Donnay says will limit downward price pressure. However, he says weaker demand has pulled price forecasts lower for the next six months.
“The lower forecasted milk prices will dent farm level margins in the U.S. and the EU, which is reducing the milk production forecast for 2019,” Donnay says. “We could end up with average 2019 prices that aren’t too far off 2018 levels.”