AgriHQ hails dairy market 'turning a corner'; Westpac increases farm gate milk price forecast to $5; ANZ sees challenges remaining for dairying

Big price rises in the latest fortnightly GlobalDairyTrade auction bring good news for New Zealand dairy farmers, but some economists are still preaching caution for the beleaguered sector.

Overall, prices were up 12.7% in US dollar terms, and up 11.9% in NZ dollar terms. Even better, the key wholemilk powder price (WMP) was up 18.9% to US$2,695/tonne, which is the highest WMP has been since October 2015.

Off the back of the latest auction results, Westpac senior economist Anne Boniface has increased her Fonterra farm gate milk price forecast by 40 cents to $5 per kg/MS. However, Boniface also continues to sound a note of caution, as do ANZ's economists. Meanwhile, BNZ senior economist Doug Steel says BNZ has increased its 2016/17 milk price forecast to $5.30 from $4.60 per kg/MS.

Dairy farmers are currently facing three consecutive seasons with payouts below breakeven for the average farmer. DairyNZ estimates the break-even milk income required for the average farmer in the current 2016/17 season is $5.05 per kg/MS. Fonterra is forecasting a $4.25 milk price for the current dairy season.

Here's what some of the economists and analysts are saying:

Here's BNZ's Doug Steel

Dairy prices zipped 12.7% higher, on average, at the GDT auction overnight. There were great expectations heading into this event and even those were surpassed. Comprehensively. This was an extremely strong result. 

Sure the indicators were pointing sharply higher but it is always better to see it in physical pricing. The latter is what drives milk price and there is now clear and present upside to Fonterra’s forecast of $4.25 per kilogram of milksolids. If dairy product prices maintain these levels, and the NZD doesn’t push materially higher, then the milk price would likely be over $5. 

To date, international prices are tracking closer to the upside scenario we outlined in our note back in June and above our central view. On the back of the strengthening international prices we have lifted our 2016/17 milk price forecast to $5.30 from $4.60. As usual, at this early stage of the season, we continue to emphasise the wide error bounds around any point forecast. 

Still something in the ballpark of $5.30 would be above current breakeven estimates for the current season on a headline basis. While cashflow will not recover as quickly as the headline, it is important to see improvement is in the pipeline. 

We sense this auction result has a bit of panic buying in it. Unsatisfied bidders had been a bit elevated of late (and lifted further at this event). The 6.6% price rise at the previous auction likely generated some fear of missing out at this event. This adds to price supportive developments on the supply side like falling EU milk production and expected production declines in Australia and NZ this season. Meanwhile, Chinese import demand has been firmer in 2016 and oil prices have bounced off recent lows. 

We suspect the market is now factoring in a sizeable decline in NZ milk production. This no doubt added to the massive 18.9% lift in wholemilk powder prices to an average of US$2,695/T. Our current forecasts have a relatively mild production decline of 2%. As usual, the weather will be crucial (the recent snow and too much rain in parts have been unhelpful, but it’s early days). Production may be lower than we anticipate and thus prices firmer than we forecast. All eyes now on the early season NZ milk flow. It is one of many moving parts. 

Large price gains were widespread at this auction with butter +14.1%, cheese +8.9%, and AMF +8.4%. The 3% gain in skimmilk powder was relatively soft. The weaker SMP performance is likely to reflect the influence of the very large EU stockpile of that product. We also note that international grain prices remain low and will be some sort of restraint on dairy prices over the coming year or two. So it might not quite be all go on the indicator front for dairy prices, but there has been a clear jump off the lows and that’s encouraging.

ASB rural economist Nathan Penny

•  After a prolonged slump, global dairy prices have corrected higher.

• Driven higher by a similar correction in global supply.

• We expect the auction price lift over August will be sustained and built upon over the remainder of the season.

Summary

The dairy cycle. The hog cycle. Supply correction. Behavioural change. Whatever you call it, it is here, and dairy markets have pushed dairy prices higher as a result.

Moreover, the supply correction is large. The reduction in the NZ dairy herd is big and unprecedented. The estimated 5% or circa 300,000 head reduction in the herd is the largest on record. Also, it comes on top of last season’s 3% fall. Indeed a back-to-back fall in the NZ dairy herd is also a first.

The supply correction is also irreversible. Once farmers cull at this level, there is no going back. Dairy production will fall, with the question turning to “by how much?”

These factors give us confidence that the auction price lift over August will be sustained and built upon over season. Other factors like weather, currencies will come into the price mix at the edges. All up though, our view is that dairy prices have corrected higher for the season. Accordingly, we reaffirm our 2016/17 milk price forecast of $6.00/kg.

AgriHQ

Another huge leap in dairy commodity prices was recorded overnight at the latest Global Dairy Trade (GDT) event. 

The overall GDT Price Index lifted 12.7%. The average price was US$2731/t. 

AgriHQ analyst Susan Kilsby comments, "It was a stunning result and it couldn't have come at a better time for our farmers. I think it is now safe to say the market has turned a corner." 

Whole milk powder (WMP) lifted a massive 18.9%, to an average selling price of US$2695/t. At close last night the Derivatives market had anticipated a lift of 11.5% or US$250/t from the US$2175/t achieved for C2 regular grade WMP at the August 2 auction. The physical market blew this out of the water, with this price lifting US$440/t to US$2615/t - a 20% gain. This is an impressive result, given Fonterra offer volumes of WMP are at their highest level for the season, at 21,500t. WMP prices are now 45% above year ago levels. 

Both butter and anhydrous milkfat (AMF) also lifted more than the Derivatives market anticipated. The Derivatives market expected a lift of 4.8% in the C2 regular grade AMF price and an 8.9% lift in the Fonterra C2 unsalted butter price. The relevant AMF price lifted 6.7% to US$3995/t and the butter price 14.8% to US$3215/t. The Butter Price Index lifted 14.1% and the AMF Price Index 8.4%. 

Skim milk powder (SMP) prices lifted a little less than anticipated by the Derivatives market last night. The Derivatives market had anticipated a lift of US$90/t for C2 medium heat NZ-sourced SMP. This price lifted US$60/t to US$1995/t. The average price achieved for SMP was US$2028/t. The SMP Price Index lifted 3%. The entire SMP curve remains very flat, as the European intervention price (equivalent to about US$1890/t) for SMP continues to suppress global SMP prices. The average price for SMP in C1 was US$2030/t, lifting to US$2105/t for C6. 

Butter milk powder (BMP) also saw a huge lift in percentage terms, with this price index up 18.1%. The average price for BMP was US$1983/t.

There was strong buying activity out of China and South East Asia at this auction, driving the lift in prices. Kilsby says "Last year we saw a similar result with prices lifting at this time of the season only to fall away again in October. This season I am more confident that prices will be able to hold up as global milk supply is now retracting rather than growing." 

There were 37,766 tonnes of product sold at this event. 177 bidders participated, with 119 bidders winning their bid. The event took 2 hours and 36 minutes.

ANZ economists

WOW: Dairy prices rallied an impressive 12.7% overnight with wholemilk powder prices leading the charge, up 18.9%. As we’ve said the spark has been slowing supply across major Southern Hemisphere exporters and now Europe; China buying for the preferential free-trade window from November to January; other buyers hopping on board to extend their hedging into 2017; and low New Zealand inventory levels directing more demand toward the GDT platform (as opposed to other sale channels).

The trick for farm-gate returns will be whether or not these gains can be held on to post the preferential free-trade window with China closing around October. There are many other indicators that still look challenging for dairying such as low global grain and energy prices and an overhang of skim milk powder.

Post October much is likely to depend on how the New Zealand season starts. If it stays cool and wet, it will be a slow start. If the sun emerges, it could well be a fast start. So all eyes will be on the weather and pasture covers.

But for now it’s looking like it could be a slow start to the season. This, combined with Fonterra having low inventory and other higher-performing product streams has seen a further rationing of the amount of WMP to be sold through the GDT platform (annual forecast down -2.9% or 10,022 MT) providing price support.

For now we maintain our high-$4/kg MS milk price forecast for 2016/17. We would need to see the price gains achieved so far held onto post October, and the NZD/USD to behave, to change this view. 

Westpac senior economist Anne Boniface 

Dairy prices posted another solid performance in last night’s GlobalDairyTrade auction. And while this good news will certainly bring a smile to the dial of many beleaguered dairy farmers, we would continue to sound a note of caution. While the fundamentals of supply and, more recently, demand certainly appear to be moving in a more favourable direction, we’re still wary that we might see a partial retracement of the recent lift in prices. Despite this, stronger than expected developments have led us to upgrade our farm gate milk price forecast for this season to $5. 

It was a gold medal winning performance by whole milk powder prices in last night’s global dairy trade auction. The headline GDT index was up an impressive 12.7%, led by a whopping 18.9% surge in whole milk powder (WMP) prices to $US 2,695/tonne - an even stronger outturn than had been signalled by futures markets. Prices for other products on offer also rose, albeit more modestly. Skim milk powder was up 3% to $US 2,028. AMF was up 8.4% to $4,148.

Last night’s result follows another strong outturn two weeks ago and means WMP prices have risen almost 30% in the last month, and are now back to levels last seen in October last year. 

While the recent strength in prices is a welcome development, we’d continue to sound a note of caution. We have seen periods of strong gains in dairy prices followed by partial retracement. A year ago we saw solid price gains through August/September 2015 which partially retracted later in the season (in part as fears of an el Niño induced sharp drop in New Zealand production reversed later in the season). 

That said, while we continue to tread cautiously, the fundamentals certainly appear to finally be shifting in favour of dairy producers more quickly than we had anticipated. A core tenement of the outlook for improving dairy prices over the course of the 2016/17 season has long been our view that global growth in supply would slow in response to very weak prices. And this is increasingly happening, most notably in Europe. After storming ahead following the abolition of milk production quotas in Europe in April 2015, in recent months, production has started to slow. EU milk collection increased 0.8% in May compared to a year earlier. That’s well down from almost 10% annual growth back in February. Milk production has slowed most sharply in the UK, Croatia and Portugal, who have now produced less in the five months to May 2016 than they did in same period the year before. 

But it’s not just Europe where low milk prices are starting to bite. In Australia, milk production was down 2% in the 2015/16 season (which finished at the end of June) compared to 2014/15, with a particularly sharp contraction over the latter months of the season. In New Zealand, full season milk production for 2015/16 was down 1.6% on a year earlier with Fonterra expecting another 3% fall this season. 

Of the ‘big four’ global dairy exporters, the only one bucking the trend of late has been the US. But even in the US, there are signs softer prices are likely to weigh on future production. Most recent US Department of Agriculture forecasts for milk production for the remainder of 2016 have been pared back on expected lower yield per cow (although we would also note milk production forecasts for 2017 have been upgraded, based on expected higher milk prices and lower feed costs). But while milk production in the US hasn’t fallen as sharply as in some other parts of the world, the strong US dollar is making US dairy exports relatively less attractive. The USDEC notes that over the first half of this year, US dairy exports were equivalent to 13.3% of US milk solids, down from 14.5% in the first half of 2015. 

Of course, the supply side of the global dairy market is only half the story. Equally important is what’s happening on the demand front. There are signs that the recent step up in prices has coincided with improved demand from China. If sustained, this would clearly be a positive for New Zealand exporters. 

Even with a relatively cautious interpretation of the lift in dairy prices over the last month, prices to date have been stronger than expected. Consequently, we have revised up our milk price forecast for this season from $4.60 to $5. We will be watching forthcoming GlobalDairyTrade auctions closely, and are conscious of upside risk to this forecast if there is no retracement in prices from current levels.