It’s a traditionally slow month for the dairy industry, so Ted and T3 take a whirlwind tour of the state of the industry. Topics include potentially bad crop yields, slowing milk production, the trade situation with China and a dose of market psychology.
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Anna: Welcome to The Milk Check, a podcast from T.C. Jacoby & Co., where we share market analysis and insights with dairy farmers in mind. It’s early August and things are slow in the dairy industry. We’re taking a step back to look at markets as they stand today and discuss where things might go from here.
We’ll start by discussing feed. You don’t need to be a feed expert to know it’s been a hard year. T3, what’s your understanding of the feed situation? And how might this year’s issues affect milk production?
T3: You know, my understanding of the issues with feed are, you know, we’ve had a lot of rain, the corn that’s in the ground is, for the most part, running behind and in some cases, we’ll probably never catch up, they’re just gonna run out of time.
Ted: It’s running behind, the question is where it’s running behind.
T3: Absolutely. You know, where we live in, in St. Louis and in the parts of Missouri and Illinois down by us is actually in pretty good shape. We’re hearing that there are parts of Illinois that are not in as good as shape but the fields that I’ve seen are in good shape around here.
A couple of weeks ago though, I was up in Wisconsin, eastern side of Wisconsin between Madison and the lake and I saw a lot of really bad fields that were just in bad shape for, you know, for the second to last week in July, they weren’t even up to my waist yet and they certainly weren’t anywhere near getting ready to tassel.
Ted: Michigan is the same way. Northern Ohio, same way. Northern Indiana, same way.
T3: And I’m hearing Minnesota is the same way too. I’m hearing that northern Iowa might be struggling a little bit, but southern Iowa was in pretty decent shape. Here’s where I’m going with that discussion. You know, a lot of the corn that turns into being feed for dairy cows is actually silage. What I’m actually hearing is the silage is not gonna be a problem, the dairy farmers are gonna have enough silage, and also due to tariffs and other things, brewer’s grains and some of the other things that dairy farmers feed their cows, there’s also gonna be an ample supply of.
And so, ironically, even though the corn is not looking good, the corn directly is not gonna be the problem, the problem is going to be that the same weather that’s caused the corn to be behind has caused the pasture, whether it’s hay or alfalfa or whatnot, is a major problem. That whether they’re gonna get one or two fewer cuttings this year, and the quality of the cuttings they do get, it’s a pretty big problem. And so it’s very safe to say that feed quality is going to be an issue but the issues probably gonna be more an issue of feed quality than feed price.
You know, the basis has gone up and so maybe the feed costs a little bit more in various places but the bigger issue for the dairy farmer is gonna be feed quality in most parts of the country.
Ted: Well, that’s a price-related factor.
T3: So that eventually will have a negative effect on milk production per cow. And so you’ve got cow numbers down, you know, I’m not ready to say milk production per cow is gonna be down because it’s usually up a little bit every year but heifer numbers are down. We know that a lot of dairy farmers are breeding with Angus and other beef cows rather than Holsteins or Jerseys. The sense I get is that there’s more, they’re replacing out the Holsteins much more than they’re replacing out the Jerseys.
Ultimately, you’re gonna have a smaller number of heifers in the pipeline to eventually go into their first lactation. So between poor feed quality, fewer milking cows, lighter heifer pipeline, there’s reason to believe that milk production is gonna stay relatively flat to maybe even slightly negative for some time even if the milk price goes up.
Ted: And then in addition to that you have an economy which is doing pretty well, promising to stay well.
T3: I’ll debate you a little bit on the economy, not that I think it’s going bad but the fact that the Fed lowered interest rates by a quarter percent, you know, because they see some rain clouds on the horizon bears watching. I’m not gonna assume the Fed is wrong if they’re reacting now to something in the future.
Ted: Well, I agree with that too but the trade issue and so on, I think as far as the dairy industry is concerned is overblown a little bit. You know, it hasn’t really affected our cheese sales into places like Mexico which is our biggest customer and if there is an effect, it’s marginal. And China isn’t a big buyer of cheese anyway, even though that’s the biggest trade issue we got right now. They buy a lot of whey, they buy permeate to feed pigs and swine flu is more of an issue with China than anything else.
T3: The African swine fever has hurt our exports to China probably more than any tariff issues. And I will also say that I get the distinct sense that the Chinese economy is not doing well at all, not just because the tariffs are hurting them but they’ve got their own internal problems. Just talking to some of our contacts around the world who may be sell dairy products into China from Europe or from Oceana, they’re not bullish on the Chinese economy right now, they’re bearish on it.
The Chinese raise and have raised tariffs on various U.S. dairy products, on a certain level it’s just a game of musical chairs. Somebody else gets the Chinese business and then the U.S. gets the business into that country that is ordering from the U.S. because where they were getting it from Europe is now going to China.
The sense that I get is China, while they ordered pretty strongly in the first quarter, it’s really dropped off in the second quarter and there’s not a lot of orders in the pipeline for the third quarter which tells me that there’s something going on deeper than just they’re not buying dairy at the moment.
Ted: The object of the trade negotiations such as they are, I think is to get China back to pay attention to the WTO rules.
T3: And maybe to stay out of the South China Sea as well.
Ted: Well, I’m not so sure that it’s that, I think the WTO is the big issue. We backed China’s admission to the WTO 20 years ago and they used trade basically to bring themselves to a first-rate economic power today. But if we let it go forever, where’s it gonna go? So I’m sure that that’s what the major objective is even though there is a military issue involved with the South China Sea.
I don’t think that’s really been discussed very well. They’re talking about trade issues and trade wars and so on. And I don’t think anyone really understands what it’s all about, I don’t think the trade deficit as such is really the issue. I think it’s more an issue of getting them back to conform to WTO rules. So we’ll see how that works out. But in the meantime, I don’t think it affects the dairy industry much. If we get China as a major trading partner 20 years down the road, they’ll be a big cheese user, then the dairy industry will thrive with trade with China. If we can get them on the rails now, we can get to that point later.
T3: I agree with that.
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T3: So we have flat to lower milk production. We have a relatively healthy domestic economy. Prices have come up lately to about $18.00 a hundredweight. It’s a lot better than the $14.00 and $13.00 a hundredweight they were dealing with a year and two years ago especially considering that the basis in places like Michigan and Indiana and in Ohio has also improved and probably will continue to improve, meaning that, you know, instead of getting, you know, $2.00 under the blend price, I have to believe that basis is moving back towards zero. So that’s gonna be pretty helpful for the dairy farmer.
And in theory, you’d expect that if that’s happening that you’re gonna start seeing expansion again. But we suspect that maybe that’s a little bit of a ways off because there’s a couple of headwinds that are gonna make it difficult for milk production to increase in the next 12 months.
Ted: We’ve talked about the cycle that we’ve grown accustomed to. It’s basically 18 months to two years cycle where we have prices go down it takes a while to turn it around and then 18 months later they’re high and then back down again. In my opinion, that cycle has changed. I think sex semen and so on have caused the cycle to extend. Rather than looking at a year and a half, we’re looking at maybe a three-year or four-year cycle because of the difficulty in getting back on the beam to bring a heifer along to get back into the milking herd, you’ve got three years once you decide to do it.
So now we were at $18.00 roughly and so an efficient, well-managed dairyman is probably saying, “Well, maybe it’s time for me to change direction.” Well, so he’s looking at 2023. It’s different than it was, you know, ten or 20 years ago and the consequences are much different.
T3: What that also means is this, and let’s segue into a demand discussion and then segue back to this if you don’t mind. So we’ve risen up to about $18.00 a hundredweight. My gut tells me between, now this is what, August 2 when we’re recording this and the end of the year, we’re gonna have trouble getting much higher. The reason I believe that is because I believe that most of the buyers of dairy products have ample inventory.
There has been a lot of cheese in inventory, there’s been a lot of butter in inventory, there’s been a decent amount of powder in inventory globally, and as a result we’re seeing in our office is a slow-down in the interest of purchasing dairy products even as we’re going into the fall when usually demand picks up.
The reason I think that’s relevant is, and I think it ties in well with what you’re saying about that cycle extending is it seems more likely to me that we’ll struggle to break through that $18.00 range this year but what will happen is demand will continue to be there. You know, milk production will continue to, let’s say be stagnant rather than growing and you’re not gonna build back your inventories. You’ll run them down this year and then you will struggle to build them back next year. And if you’re gonna break out to a higher number, I’m of the belief that’s gonna be 2020. You know, maybe the sooner the better if you’re a dairy farmer, but my gut tells me you are at that point, you know, whether it’s $18.00 Class III milk or it’s a $1.85 cheese, where you’re starting to get a bit of pushback resistance from the consumer that’s buying the products and so you’re gonna have to tighten up further and actually get your inventories to the point where people have to really pay up more for cheese if they really want it. And I just don’t think we’re gonna get there this year even though milk production is running negative.
Ted: Well, I agree but your idea of what constitutes an increase in price, I guess I would think that a push to $20.00 is out. I don’t see that for the reasons that you describe, the Class III I’m thinking of, or a calculated Class IV. But I do see, you know, you have in the cheese industry you have such phenomena as people needing fresh cheese and so on and we see milk tightening up here when schools start and so on and it’ll stay tight for two or three or four months.
You already got a cheese block market that’s up in the 180s. It wouldn’t take much to see that block market up another ten or 15 cents. And that I think is what you’re probably looking at is some marginal tightening between now and the end of the year, and then it’ll back off next year for the first half and then the phenomena is they’ve worked down the inventories and so on, the phenomena that you’re talking about in the second half of 2020 is very likely. And then that same thing would go on for another two or three years. I don’t see a major explosion a la 2014. I don’t see that at all.
T3: We’re in a 100% agreement there, I don’t see it either. Let’s talk a little bit about market psychology because I think this $18.00 point is in my belief, a classic market psychology point. From the perspective of the dairy producer, they’re like, “Hey, great, we’ve gotten to $18.00, we’re getting back to the point where maybe we’re making a little bit of money, but hey, milk production is still negative, we can keep going higher, you know, what’s another ten to 15 cents cheese or $1.00, $1.50 a hundredweight milk?”
But the buyer has kinda got a different point of view. Keep in mind, the cheese buyer has been, you know, 2015, 2016, 2017, 2018, now you’re getting into 2019, for five years, price hasn’t gone much higher than $1.80. It hasn’t really gone much higher than $1.70. And so they’re reacting to it as, I can’t promote anymore because my cheese price is the highest it’s been in five years, so I’m gonna run less promotions in the fall.
You know, price of cheese is really high, maybe I shouldn’t be putting two slices of cheddar on my burger or two slices of American cheese on my burger. This is that point where because they’re not used to the prices this high, their attitude is if it goes any higher, I’m gonna make changes in the way that I use my cheese or the way that I buy my cheese. It’s the psychology of that price point that’s new.
In today’s day and age, five years is an eternity. And so you’ve hit that point where we’re sitting right now in price where anything higher is gonna have a demand response. You know, could we go up to $1.95 for a month? Yes. Well, then I guarantee you this, in our office where everybody calls when things get long, our cheese desk, is the phone’s gonna start ringing with all these people looking to sell cheese. And we’re gonna call them back and say, “Nobody’s buying.” And so I think it’s gonna be difficult to get us too far above $18.00 a hundredweight milk, a $1.85 cheese and and have it stay there for any length of time, that’s where the tipping point is right now. And the only you get through that point and stay through that point is if you don’t have any inventory to draw on.
Ted: Well, I’m gonna disagree a little bit. In today’s market that people who buy cheese to put on burgers have already got their cheese priced and budgeted for the next 12 months.
T3: They don’t have their promotions priced yet though.
Ted: Okay. If you want to split that hair, that’s fine, but they already have their pricing locked in on the futures market for whatever they are gonna need on a regular basis. And if you want to say that they’re gonna save a small portion of it for the spot market, I’ll concede the point. But I don’t think $1.80 is a psychological point, I think $2.00 is a psychological point. And that I think will cause major resistance in the cash market when they get to two bucks.
I’m gonna be a little bit more bullish from that standpoint and even though you’re the cheese seller, I’m gonna say that all the people in the cheese business have pretty much got their budgets in and they already know what their cheese is gonna cost, it’s there. So if the spot market, which we’re involved with, goes from $1.80 up to $1.95, it’s not gonna make any difference to them, they’ve got it hedged anyway.
T3: I’d say for the 60% of the market that’s gonna buy the cheese regardless of the price and so they always hedge it, you’re right. But the tipping point is that last 2% of the market.
Ted: The $2 is the magic number, that’s the big Kahuna.
T3: Two dollars is a bigger magic number than $1.80. But don’t underestimate $1.80.
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T3: Butter, since we’re talking about some of the downstream products from the dairy farmer. Butter market’s been interesting this year. Milk production has particularly shrunk east of the Mississippi and one of the results of that is the cream market, the butterfat market, as opposed to the butter market, has been very tight.
The butter market in the, however, has kind of stayed in its range between about $2.10 and $2.40, you know, for the whole year. Kinda got down to close to $2.10 in January and has slowly climbed up until about $2.40 until about two weeks ago where it suddenly fell out of bed and is moving back down, you know, towards $2.30.
The butter market has been in this $2.10 to $2.40 range for almost five years now. Some of us thought that because milk production was lower, it would get tight enough to break out of that range this year, maybe it will. But I’m starting to believe it won’t for the same reasons when we were talking about cheese, everybody who needs the inventory has the inventory.
Ted: We also have imports.
T3: We have imports and we have fewer exports. And so this butter market just seems to me to be a market that needs more momentum than it has right now if it’s gonna break into a new price range. Any dairy farmer who’s been selling corn over the last 20 years, corn always had a tendency to trade in a certain range for a very long period of time. And as a result, when it broke out of that range, it broke out of that range explosively.
Butter has started taking on that pattern because it’s been in that range for so long. And so the likely scenario with butter is when it does break out of that range, it breaks out explosively and I don’t think that that’s gonna happen this year. And so I think we can expect butter prices to stay about where they are for the remainder of the year, it’s gonna stay within the range.
And the reason is because even though butterfat has gotten really tight on the east coast, on the west coast, there’s more than enough inventory. But I will also say this, if you do see butter break out of the range, if you see that butter, it go to $2.50, my guess is it’ll go all the way to $3.00.
Ted: We’ll see. I guess I’m more concerned with the fact that we do have imports coming into the U.S right now and the European price for once for butterfat is quite a bit lower than ours. I think that is probably gonna put a lid on how far we’re gonna go.
Do we want to get into a discussion with regard to the ersatz milk and the effect that it might have?
T3: I think the way you talk about it is like this. So Class I sales have been down at a 4% clip a year over the last, what, three to four years due to a variety of factors. Kids don’t drink milk, they don’t drink or eat cereal like they used to for breakfast like when we were growing up. You have the ersatz milk, you have almond milk, you have soy milk, you have the new oat milk, so people are moving away from dairy and towards those milks. And so Class I milk sales are down, let’s call it 4% to 5%.
And so you have, you know, to kind of bring it all together, you’ve got total milk production in the U.S. let’s say down 0% to 0.4%. You’ve got cheese production generally higher, maybe as much as 1.5% and that’s coming at the…and you probably have Class II utilization up a little bit. And so that increase in Class III production is coming at the expense of Class I and Class 4.
Ted: I’m gonna take a little bit of issue on that, you know, marketing is over half the price of our product. Whether it’s cheese, whether it’s fluid milk, whether it’s yogurt, no matter what it is. And if you look at the marketing plans for some of the major proprietary companies for particularly Class II products, they’re talking about protein-based products as part of their repertoire of products. Now you have to assume that the margin on those products is higher than the milk, otherwise, they wouldn’t be pushing them.
T3: When you talk about protein, are you talking about plant-based protein or dairy protein?
Ted: Plant-based protein.
T3: Okay.
Ted: I’m assuming that the reason that they’re latching onto it, people in particularly the Class II industry, for example, I’m assuming that they’re gonna spend their marketing dollars on marketing-plant based products as opposed to dairy-based products because the margins are bigger so that could cause us a lot of headaches.
T3: I don’t disagree.
Ted: It’s a long-range issue and of course there’s a lot we don’t know about plant-based products. What’s the flavor profile? Has it got to be competitive? Is it gonna be attractive? I assume that if it’s there that they have approved it so there must be something that’s marketable there. What’s the cost to production? If the people that are spending half the value of the product marketing it, are marketing that at the expense of the dairy side, it doesn’t…not good for dairy at all.
If we look at Kraft, has carried the marketing side of our industry for 60, 70 years, they’re gone pretty much. I am expecting as we—to circle back for a moment—that we are looking at a gradually increasing price for the next three years or so. But it’s gonna be a slow pace as we face the problems with imitation products and so on.
T3: What you’re saying is we are gonna see milk prices go up, not in a demand-driven market but in a supply reduction market.
Ted: You’re right. I think that’s gonna be, it’s always supply and demand both but I think the supply side of the industry is gonna suffer.
T3: And I agree. I am not feeling excited about the way the consumer is reacting to dairy at the moment. It’s, you know, in my 30 years of being in this industry, it’s about the worst I’ve ever seen it.
Ted: And maybe that’s the right way to phrase it. The structure of the industry now has reached the point where the people who carry the load for marketing our product, which I’ll point out again repetitiously, it’s 50% of the value, it’s not there anymore. We don’t have the marketing side covered. We market tank loads of fluid milk and cream and truckloads of powder and cheese, but the people who actually take those products that we sell and put it on the grocery store shelf and actually convince the customer to buy the package product are nowhere to be found.
I think we’ve got a problem there. I don’t think that it’s gonna be any sort of collapse, but I do think that when it comes time for our pricing to move forward and up, that’s gonna be an issue. We’ll see how it works out. If the value, the marketing dollars in returns are more favorable to plant-based products, you know, that’s gonna be stiff competition for the dairy industry.
T3: And I agree. And I do agree that the industry’s got a marketing issue right now. I will say this just to give a little bit of a positive spin on it, there are dairy companies out there that I do think are doing a good job. I think Tillamook is doing a really good job out on the west coast, I think Sargento is doing a good job. I think Fairlife has done a good job, Chobani I think has done a good job.
Ted: I agree with you on all of those. But the old stalwarts that we’ve had for all these years are nowhere to be found anymore.
T3: And I agree with that too.
Anna: We welcome your participation in The Milk Check. If you have comments to share or questions you want answered, send an email to podcast@jacoby.com. Our theme music is composed and performed by Phil Keaggy. The Milk Check is a production of T.C. Jacoby & Co.
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