July Class III Price Drops

The July Class and Component Prices were announced July 31.  Butter and cheese prices were down, driving down the milk fat and milk protein prices.  Whey prices did increase giving a slight price boost to "Other Solids," one of the three elements in the Class III price.  The Class III milk price fell to $17.38/cwt. from $18.02/cwt. in June.

The long-terms trends showed a consistent pattern.  Milk protein remains above the long term trend line which will increase the trend line over time.  The protein price would show a steady increase if it were not for the disruptive movement of prices  in the 2008-09 period.

Milk fat prices continue below their long term trends and at $1.57/lb. are near the long-term price of $1.50/lb.

The price of "Other Solids" which are based on the NASS dry whey price continue to be the game changer with a price of $.39/lb.  The demand for whey continues to pressure the supply from cheese manufacturing keeping the price of whey at a level above the historic levels.  This is expected to continue.

The update to the June inventories posted one week ago showed cheese inventories above historical levels.  If this results in a decrease of cheese production as might be expected, it will also reduce whey availability and therefore maintain or increase the price of whey.

The three elements contributing to the Class III milk price remained consistent with the June chart.   Milk fat contributed only 32% of the value in Class III milk.   The remaining 68% came from milk protein and "Other Solids,"  both of which are highly influenced by cheese production levels.

Because the inventory and export levels were updated one week ago in the June blog post they will not be restated there.  The inventories of cheese and butter are too high and this is influencing the price of milk protein and milk fat.  Until the inventory levels are reduced,  milk protein, milk fat, and the Class III price will be negatively influenced.

The remainder of this post will review the tight relationship of cheese prices to the Class III price and the factors that can influence cheese disappearance.

WHAT DRIVES THE CLASS III PRICE?

The cheese price as measured by NASS is linked very closely to the price of Class III milk.  The correlation is a tight 96% as illustrated in the chart below.  The reason for this is that the two are linked mathematically.  The math behind this relationship is explained in the April 23, 2009 post to this blog.

There are only three elements that influence the cheese price:

1. Production
2. Domestic consumption
3. Exports

Production has  increased consistently over time.  There are periodically significant drops in production to correct for high inventory levels.  The current inventories may necessitate  another short term drop to correct for inventories. 

Domestic consumption of cheese has seen a steady increase over 40 years.  Other countries like France still eat a lot more cheese than the U.S., so there is no anticipated ceiling for U.S. cheese consumption.  However, their is a dip in the growth rate in the last four years below.

Cheese like all other foods does have elasticity of demand.  When the prices goes up, consumption goes down.  In the last four years retail prices have increased and while consumption has continued to increase during this period, it has not increased at the pace of the last 40 years.  This has contributed to the current high inventory problem.

Cheese exports increased steadily from 2009 to 2012.  However, exports are not currently increasing.   They are currently tracking at 2012 levels when compared on a month to month basis.  Dairy export news is available at the U.S. Dairy Export Council website.

One of the factors that can significantly impact exports is exchange rates.  When the USD is weak, U.S. cheese is less expensive on the global market than cheese from other countries.  The graph below illustrates this by comparing the exchange USD/NZF rates to U.S. cheese exports. In late 2008 and early 2009, the USD gained strength against the NZD and exports fell significantly.  In 2013 there is a slight strengthening of the USD shown in blue below.  While U.S. Exports have not fallen, they have not increased as they were in the prior four years.

The review above illustrates the problem that is causing decreased Class III milk prices.  Cheese prices are falling and when the prices drop sufficiently, cheese production will be cut.

The NASS cheese prices trail the CME cheese prices by about two weeks.  While the relationship between the CME and NASS prices is not perfect, the CME is a good indicator of where the NASS prices are going.

CME daily cheese prices have risen $.16 or about 10% in the last month

Class III milk futures are reacting to the CME prices with the August Class III prices currently at $17.89/cwt. or about 10% higher the July.  The cheese inventories will continue to be closely monitored.