Thursday, April 23, 2009

Is Milk Pricing Really Tied to Cheese Prices?

In the April 7 post, the mathematical equations for calculation of Class III milk prices were discussed. The fundamental equations for Class III pricing come down to the following:

Class III Milk Price = 9.6 x Cheese Price + 5.9 x Dry Whey Price + 0.4 x Butter Price - $3.20

That means that when Cheese prices move, there is a 9.6x impact on the Class III price. However, when butter prices move there is only a .4x impact. While the dry whey price has a 5.9x impact, the value of whey is small enough that the impact is minimal. The whey supply is obviously tied to cheese production, but the demand side can be very different.

I've had a few comments on this questioning whether cheese prices can really have this big an impact on a dairy producer's economic health, so I've developed a few charts to substantiate this relationship.

The first chart shows the correlation between cheese prices and the Class III milk price. I have used the National Agricultural Statistical Service (NASS) market survey price for cheese, not the Chicago Mercantile Exchange (CME) cheese pricing (see April 2 post).

The correlation is almost 100%. This is in spite of changes in the "make allowance" for cheese over this period of time. The 98% correlation means that 98% of the change in Class III milk prices can be predicted by changes in the cheese price - a very strong correlation?

The chart below goes one step further and tests the correlation between all Federal Milk Marketing Order (FMMO) milk prices and the NASS cheese price. This FMMO pricing includes those orders paying on skim and butterfat and well as the component pricing orders which dominate the FMMOs.

Again, the correlation is very strong. This is partly because the component payment milk orders are such a large part of the overall FMMO's milk volume.

Numbers don't lie. Cheese prices really control the financial health of the U.S. dairy industry.

More on this in upcoming posts

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