Global dairy prices rose 3.8% in latest auction, but the strong Kiwi dollar again gobbled up most of the gain; key Wholemilk powder prices jumped up 7.5%

By David Hargreaves

Global dairy prices have moved up again, with last night's GlobalDairyTrade auction seeing an overall 3.8% climb, though virtually all of this was neutralised by an again rapidly rising New Zealand dollar, which has pushed up through US70c.

But importantly, in what was the second consecutive auction of rising prices - the first time that's happened this year - the crucial Whole Milk Powder prices gained 7.5%, which will be of encouragement to farmers in the middle of a second bad season in a row. See here for the full dairy payout history.

The WMP average price, at US$2,156 per metric tonne, hit it's highest level since the end of January. This puts the price now 35.6% ahead of last year's low point of US$1590 recorded in August. However, to put it in perspective though, the current WMP price is still 6.4% below where it started this year at, and some 23.7% below where it was in October after what proved a short term rally.

ASB economists are picking an opening milk price forecast of $5 from Fonterra for the next season, with that figure to grow as the season goes on. Westpac economists are more cautious, with a price pick of $4.60 for the next season, though say that last night's auction results suggest "some upside risk" to their forecast.

In terms of the current season, Fonterra's forecasting a full-year dividend of 40c, for the current season/year, which coupled with the present forecast milk price of $3.90, would give its farmers a total payout for the year of $4.30. In 2015 Fonterra paid a dividend of 25c and the milk price was $4.40, giving a total payout of $4.65.

Many farmers will have been operating below breakeven for the past two seasons, which has raised concerns about rising foreclosures and falling dairy farm prices.

ASB rural economist Nathan Penny said dairy prices have taken a "small step towards recovery".

"...And while seasonal factors are in play, the developing trends are consistent with our view of what we expect to see over the new season. Namely, we expect NZ farmers to continue to lead the production response to low milk prices. And as NZ production falls, we expect to see prices for NZ-dominated products to recover first."

Penny said elsewhere globally, the response to low prices is slower, but in places like the EU the response is happening.

"When this slower response does kick in, we expect global prices to get a second wind from higher skim milk powder prices and milk fat prices.

"On this basis, we expect Fonterra’s opening 2016/17 season milk price forecast (announced in late May) to be near $5.00/kg. But as prices rise further during the season, we expect the milk price will ultimately end the season at around $6.00/kg."

ANZ agri economist Con Williams and senior FX strategist Sam Tuck said the push up in WMP prices, with later-delivery contract prices recording even bigger gains than the average 7.5% rise, would provide Fonterra with some comfort that US$2,500/t for WMP by the end of the year is achievable.

"The continued strength of the [New Zealand dollar] will be a concern, but it also needs to be remembered Fonterra will have a significant amount of hedging already done around the mid-0.60s for next season. While we remain cautious, we do think there is a higher chance that WMP will outperform the rest of the dairy complex over 2016/17."

They said the three things they are watching are: New Zealand supply, oil prices and Chinese import demand.

"New Zealand supply is expected to be under further pressure in 2016/17 due to lower cow numbers and farm management/system changes. Oil prices are off their January lows and fundamental drivers (i.e. lower US supply) are pointing to further improvement over the second half of 2016. In China, supply appears to also be easing back as high production costs and falling milk prices squeeze returns to milk producers. Imported WMP is also very attractively priced compared with domestic Chinese product."

Williams and Tuck said they remain "cautious on China as it is still somewhat a black box", but as we move past the seasonal peak in local supply, import demand is expected pick-up.

"The NZX futures curve has been anticipating a further lift and it now looks like the physical market (GDT auction) is starting to reflect similar sentiment. That said, there are still plenty of challenges for the rest of the dairy complex and this will somewhat cap the performance of WMP. After last night’s auction, WMP is now more fairly priced versus buyers using a skim milk powder/milkfat product mix – before it was the cheaper option.

"For SMP, European intervention is anticipated to be full by the middle of the year after its earlier announcement to double the volumes it takes to 218,000MT. This product will need to be re-sold at some point, which is anticipated to cap pricing for some time. Last night’s auction result continued to reflect this."

Westpac senior economist Anne Boniface said while any improvement in dairy prices is good news for the sector, prices remain 12% below where they were a year ago, and more than 30% below a five year average.

"Low dairy prices are starting to dent confidence in both the agricultural sector and beyond. Surveys of business confidence have taken a step down in the first quarter of this year as businesses beyond the agriculture sector contemplate just what the cost cutting on farm and reduced investment might mean for them," she said.

"Our own survey of regional confidence showed distinct differences between downbeat dairy dependent regions and their more diverse neighbours. Even workers have adjusted their outlook. Those in rural centres are noticeably more downbeat about employment prospects than their urban counterparts."

Boniface said Westpac economists expect to see further downward pressure on farm prices, particular dairy farms.

"That’s even taking into account our forecast that dairy prices will gradually improve over the next couple of years."