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Economists say further dairy supply cutbacks and increased demand from China are needed to pull prices out of the dumps; ASB calls for Fonterra to provide evidence it's cutting production

Economists say further dairy supply cutbacks and increased demand from China are needed to pull prices out of the dumps; ASB calls for Fonterra to provide evidence it's cutting production

Fonterra reducing supply to the GlobalDairyTrade (GDT) auction is helping pull prices out of the dumps… just.

The latest fortnightly GDT auction overnight saw the GDT trade weighted index rise an impressive 14.8% to US$1,974 per tonne.

The price increase is the first since the March 3 auction, and breaks a 10-auction falling streak.

The price of New Zealand’s key export, whole milk powder (WMP), rose 19.1%, while skim milk powder (SMP) rose 8.5%. Anhydrous milk fat rose most significantly by 26.6%.

A matter of supply/demand

ANZ Agri Economist Con Williams says, “Fonterra’s strategy of changing its product mix and constraining supply sold via GDT seems to have at last found some price traction”.

He says lower supply, as well as increased purchasing from China, are key to driving prices back up.

“Both have shown tentative signs of heading in the right direction in recent weeks, but further movement will be required to provide a sustained rally”, he says.

Fonterra has decrease its total WMP supply for the next 12 months by 19% (91,400 tonnes) over the last two auctions, with much of the recent reduction front-loaded.

“To provide perspective the change is equivalent to nearly twice the US annual exports and one quarter of Europe’s”, says Williams.

Fonterra last week announced it would cut the amount of WMP it sells on the GDT by a third over the next year.

The NZX’s AgriHQ dairy analyst Susan Kilsby recognises this reduction was the trigger required to turn market sentiment, but says global dairy markets remain over supplied.

“Until global milk supply slows the market will remain very volatile”, she says.

What’s really happening with production?

For this reason, ASB rural economist Nathan Penny says we need to see evidence production is heading down, before we can be confident prices will keep inching up.

He says we need to see hard data from Fonterra, affirming it is in fact tracking to reduce production by 2% this season. ASB maintains the drop will realistically be closer to 1%.

“Expectations and forecasts only go so far – we need to see less milk on the ground here in NZ”, Penny says.

“Farmers have culled stock heavily so far this year, and are poised to cull further over the next few months, which 'should' translate into lower milk production particularly from later in spring.”

Agreeing with Kilsby, Penny says we need to see broader production falls globally.

“Often NZ farmers respond faster than their global counterparts. European production is down 0.6% so far this year compared to last, but the recent quota removal means further falls are not guaranteed.”

Where to from here?

Last night’s auction results have sparked economists to change their forecast milk prices for the season.

AgriHQ has increased its 2015-16 Farmgate Milk Price to $3.85/kg of milk solids (MS), in line with Fonterra’s 2015-16 milk price forecast.

Kilsby says, “Fonterra’s milk price forecast is now looking achievable. Dairy commodity prices need to continue to track upwards in line with NZX Dairy Derivatives market projections in order to reach the current forecast price.”

The NZX Dairy Derivatives market indicates whole milk powder prices will increase by a further 45% by the end of the season. This price projection is built into the AgriHQ 2015-16 Farmgate Milk Price of $3.85/kg MS.

ASB has stuck with what it acknowledges is a “relatively optimistic” forecast of $4.50/kg MS.

However Penny notes this doesn’t alter the medium-term picture materially, as ASB now expects a more gradual recovery and has lowered its 2016/17 forecast to $6.50/kg MS.

“We expect the prices to recover much of the preceding three auction’s lost ground. But from there, further lifts become more difficult,” he says.

ANZ says last night’s price rebound reduces the downside risk to Fonterra’s latest milk price forecast.

It has accordingly removed the downside risk to its 2015/16 milk price forecast, moving back to a $3.75-$4.00/kg MS range.

Williams says milk powder prices need to head back toward US$2,200/t to deliver Fonterra’s $3.85/kg MS.

Futures market activity

Westpac senior market strategist, Imre Speizer, notes futures markets in particular, had pre-empted a positive auction result.

“Contracts started rising after the Fonterra volume announcement, and closed yesterday implying gains of between 8% and 34% across the future delivery months”, he says.

“If anything, futures markets appeared to under-predict the nearby months and over-predict the more distant months."

“The futures market is expecting another strong result at the next auction on 1 September.”

One a slightly different note, Speizer also points out there was a material increase in the number of participating buyers in last night’s auction, suggesting low prices have prompted some buyers into action.

“Around 29% of 621 qualified bidders participated – the largest proportion since September 2014. And among this auction’s participants, only 77% were successful bidders for product, suggesting stronger competition than at the previous two auctions where 96% and 93% of bids were filled,” he says.

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Does Fonterra sell its milk powder " forward", you know like the Aussies miners sell ore or coal they have not yet extracted from the ground , to be delivered next year ?

I am sure they ( Fonterra) are a professionally managed business , and surely they can take steps with forward contracts to iron out some of these wild market gyrations .

Gold was sold forward for years by miners with gold supplied from central bank vaults, to be returned under contract from yet to be mined gold - it certainly was a strategy to fix future returns but the downward pressure saw costs rise above actual sale prices for harder to reach metal.

I wonder whether the $30million the government gifted Tiwai Point ended up as working capital cover for yet to be processed bauxite. Certainly seems forward paper sales contracts could be contributing to new aluminium price lows. View graph.

Yes. At each auction buyers bid on forward delivery contracts, from 1 to six months in advance. Prices are different for each forward contract. You can find the auction results by following the detail at

What is reported is an index of all those various time-based contracts over all the many product lines that are offered. The detail is intense, but prices acheived are all transparent. Product volume detail however are only reported with a 90 day delay. (Total 'event' volumes are reported immediately however.)

The GDT platform rules are here.

Fonterra's move to cut supply to auction is simply stockpiling in disguise, is it not? Eventually they'll be forced to release the stock pile due to spoil?

They only way to genuinely cut supply is at the farm gate or convert more WMP into value added product?

No. There is nothing to stop Fonterra selling its product off the platform. I am sure most of what it sells is not via the platform even in the best of times. But the auction is a transparent way to determine price, (which is always fraught when there is no transparency in private sales).

In Fonterra's past (and predecessors) there have been many times when they have stored product awaiting better selling conditions. There are famous stories about the value of warehousing in New Zealand from decades ago.

Fortunately, the product stores for years successfully with modern barrier packaging.

Keep an eye on

If milksolids production is up while Fonterra's gDT volume is down, there ought to be some kinda manipulation.

Fonterra is forecasting a 2-3% drop in production this current year

If there are any smarts in the dairying community (and I believe there are) and understand the following link, the reduction in supply will be much greater than 2% or even 3%

And, connect that with the comments below about PK supplementary feed

One would ask the question how much are the supplementary feed companies costing our dairy industry at present? both in high cost supplement relative to forage eaten by cow and the surplus milk that it produces that is driving down the payout price?

Feed companies are a liability to our dairy industry. A lot of farmers have in-shed feed systems and mixer wagons and continue to use them with fixed year contracts on feed, what a risky business they have fallen in to......

10% of Fonterra supply probably comes from Supp feed so just need to encourage farmers to stop over achieving, but all suppliers compete against each other so whether you buy supp or not the feed companies are keeping the payout down

You may want to add to that the price of processing milk produced with PK. Although there's not much change in the ratio of fat to protein there are large changes in the type of fats produced and the subsequent products it can be processed in to. Source is resent research by Fonterra.

Now that is really interesting!

Interesting! Just google "milk from grass fed cows " "butter from grass fed cows " "cheese from from grass fed cows". Dairy from grass fed cows is considered to be super food and you ordinarily pay though the nose for it.

If we simply turned our back on the Walmart/Warehouse side of the food market and became boutique high price, high quality "grass fed/organic" suppliers to the World's luxury "whole food" retailers, we would not have to compete with cheap crap food raised with industrial "feed". in inside cages/crates/stalls. As pharmaceuticals become more unaffordable, smart people (even smart poor people) will happily pay a bit more for food that will support their precious good health.

Fonterra owns 50% of agrifeeds, so I guess you can look at it two ways
by buying supplement feed from them they are giving Fonterra money back
and whatever profit agrifeeds makes will come back to the farmer as share dividends

Dead cat bounce?

Double or nothing

End of NH season (not that they're so seasonal as NZ, but their crops are).
Effect of dumped milk - no advantage to gDT customers to destroy supply.

Didn't oil cycle up in this fashion recently, with much stock build up before resuming the trend?
What happens when storage is full, and finally the owners of this stock require cash (low interest rates help lower cost of inventory until...).
If you make a 100 widgets, and only sell 80, but at 20% gain, is that not red queen territory...?

I'm surprised they didn't cotton on to this sooner. They copied the model of the way crude oil is sold (at auction) but did not understand that the price was manipulated by limiting the amount available. This creates additional cost through storage issues (in the case of oil, it is just left in the ground) but as Fonterra sold off the technology to produce milk products they lost a large portion of their ability to control and manipulate the market.

Maybe I missed the boat on this one...
If they have reduced volume (e.g. they now sell 7 rather than 10) but the price has increased (e.g. $10 rather than $7) isn't the end result of what they have made in monetary terms the same (e.g. $70) for Fonterra in the auction, but also the same would apply to farmers right? they've reduced stock numbers causing output to decrease so they have less product to sell, but they get a slightly better price for that product....the money they earn is still the same.

Perhaps I'm missing something...or over simplifying...

Anyone else find the knee-jerk reaction of markets and commentators to dairy prices irrational? They appear to react to dairy price fluctuations as reflective of changes in demand. If prices go up because of a reduction in supply, this is confirmation that the dairy sector is going downhill. Basically, a cut in supply at this point is admission that the demand is staying down for the foreseeable future. That's not good news.

Markets are rigged, it's hard to know who to trust, an invisible hand is functioning in the background, behind the curtain.

Agree, the invisible hand looks more like the big US banks manipulating prices. One wonders a) how high or low prices really are manipulated and b) the effects on Main Street (ie us). My suspicion is the effect is quite significant and detrimental.

one of the worst things for Fonterra is the act which states that any farmer that wants to join can and Fonterra have to take his milk.
if they stopped that they could reduce production to a level that would return more for their core suppliers.
the other part is they have to sell raw milk to their competitors (mostly foreign owned) that needs to change as well because that effects the profit for their supplier farmers and transfers it to the companies supplied

They do have to buy shares to be a supplier.

No shares required to supply under My Milk Aj, and you have up to 10years to buy/pay off shares so not the big one off up front cost it used to be.

I have heard farmers in Southland are really questioning the ads currently on the radio there extolling the virtues of becoming a MyMilk supplier. Existing suppliers there are not a happy bunch. Low payouts, slow/negligible grass growth due to prolonged cold and now the company advertising for more milk when there is a glut - almost too much for some of them. Director elections this year could be interesting.

But if that's one of the worst things Fonterra face why do they have Volume as one of their three Vs strategic vision and why do they have MyMilk, a company actively paying to get more milk.
Agreed that the selling of raw milk was just a rort. But a few ex minister did very well out of that.

my feeling with china is that in the last few years it has had a boom based on stimulus spending from borrowing and now they have started to decrease interest rates, creating more liquidity. It's difficult to find numbers on line of china increase in debt without them going on about debt to GDP. GDP is not a profit figure and of course GDP will rise with borrowing and stimulus spending. But is having a high GDP a measure of the health of an economy? I wonder if their economy will bog down as it has done in other countries with low interest rates and too much debt.
The financialisation of the world only sucks everyone dry, there has been no real growth in recent years, we are only looking for new countries who are yet to borrow and consume to their limit.
I believe that percieved values of dairy farms and auckland houses could be "fools gold" because the borrow and consume world has limits.

Fonterra have finally managed to buck the trend at auction - desperate times require desperate measures, and I get that….

However, one immediate thought - how would we feel if we observed ’the banks’ seeking to ’tamper’ with an auction so aggressively to trigger a price response?

We will get some spin from Fonterra that this was always the expectation, etc., etc., but we are a long way yet from a sustainable higher dairy price just yet.
Fonterra have provided very little confidence of having their finger on the pulse of world dairy markets, and it’s a little too soon to recalibrate such a sense…
This was after all, only ever going to be one comprimised season for the milk price, was it not?

The removal of EU quotas on milk production earlier this year was far from timely for a dairy price that was in decline, but what now with any sustained higher price for dairy products?

It will be meet with increased supply like never seen before out of Europe, to participate in that ‘medium term growth’ in China and Africa…

It will be interesting to watch the story unfold accordingly….

I talked to a dairy farmer about the price rebound. He made the point that the price had come up but fonterra didn't have much product at the auction, therefore didn't get that price.