Volatility Sign
January 30, 2017

Will Growing Inventory Affect Milk Prices?

 |  By: Robin Schmahl

The recent outlook for milk prices has been a bit more positive than it had been last fall. Milk prices have been improving with December milk prices being the best they had been in 2 years. January’s milk for the Federal Orders is priced and will be formally announced on February 1. Prices will be lower, but still holding well. The question is, “Where do we go from here?” There are analysts on both sides of the market as there always are. A case can be made for strengthening prices as well as a case made for weaker prices that current futures contracts suggest. I think we could follow seasonal movement which would be weakening prices into spring flush and then strengthening prices during the second half of the year if fundamentals remain as they are. Exports interest is increasing providing the potential for strong movement of product to world markets. However, there is concern over U.S. relationships with China and Mexico which could have a substantial impact if disagreements turn into action. It is too early to tell what the outcome will be. Stronger domestic demand could provide strong support for the markets.

There market fundamentals that are bearish as well. The recent milk production and cold storage reports indicated strong milk production and increasing inventory. Even with good demand and demand that has been and is better than expected for this time of year, inventory level increased indicating production exceeded demand. So how usual is it for cheese inventory to increase during the month of December? Total cheese inventory has only declined in December just 7 years since 1980 with most of those years surrounding the Whole Herd Buyout in the mid-1980’s. The most recent year was 2015 where there was a slight decline of around 500,000 pounds. It was somewhat different in the American cheese category. Since 1980, there were 11 years that showed inventory decline in December with the most recent being 2014.

Total cheese inventory set a new record in December with a total of 8 months of new record cheese inventories in 2016. Domestic demand has been steadily improving along with international demand, yet our inventory continues to grow. How long can this be sustained? The current market is not concerned over this and maybe rightly so as the outlook for exports looks positive. Milk production is down in a number of countries increasing the potential for the U.S. to meet demand stemming from the short-fall. A surge of international demand would potentially reduce inventory and support prices.

Butter inventory declined 24 years since 1980 making the increase this year not unusual, but also not usual. Butter production and demand is more variable. Manufacturers many times attempt to keep production close to demand and will sell cream rather than churn. Churning will also be active with good prices and plentiful cream supply such as there currently is. Even though current butter inventory is the largest since 1993, price is high and demand is good. This is expected to continue as buyers remain active purchasing for expected domestic demand and improving exports.

The bottom line is growing inventories cannot continue forever without some sort of reckoning. If we continue this pattern, there may be more difficulty finding storage space for cheese this year. We know there will not be another Whole Herd Buyout or another variation of the CWT Herd Retirement program due to the results of the class action lawsuit and the settlement of $52 million. It will be up to improving demand or the reducing of milk production to limit or reduce inventory growth.

I continue to recommend establishing floor prices for your milk through the middle of the year using put options and put option spreads to leave the upside open. We do not want to look back is prices decline through spring flush saying, “Could have, should have, would have.”