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Hackett Advisors in the News

Milk Prices Likely to Rise in 2016 

By Simon Constable - October 3, 2015 8:40 AM ET

The recent drop in prices isn’t expected to last much longer as farmers start to thin their herds. Traders could profit.

It could soon be time to lay off the latte and, for that matter, grilled cheese sandwiches, too. Why? Because milk prices are set to rally next year. In case you forgot, cheese is made from milk.

Recently plummeting U.S. milk prices mean it doesn’t pay for farmers to maintain the highest quality milk production of their dairy herds. As a result, herd size is set to drop and production with it. It’s a problem that could take years to work out. Still, there’s a chance for traders to profit.

November-dated futures prices for class III milk have been sliding for much of the year, trading Friday on the CME at $15.61 per hundred pounds, down from more than $17 in early June. Class III milk is primarily used in the manufacture of cheese, according to the U.S. Department of Agriculture. In 2014, prices were in excess of $20 per hundred pounds for the first 11 months of the year, says the USDA.



It’s that dramatic drop in revenue for selling milk that’s making the maintenance of the cow herd unprofitable, says Shawn Hackett, author of the Hackett Money Flow Commodity Report. He predicts that the U.S. herd will start to fall around January of next year.

Already, the growth rate in milk production is slowing. For the year through August, production has inched up by 1.4%, compared with a 2.4% rise during all of last year, according to Barron’s analysis of USDA data. In other words, production growth is off about 40% from 2014’s rate.

SLOWING GROWTH OBVIOUSLY is not the same as declining output. We get from slowing to declining through farm economics. It works like this: Farmers make decisions on adding cows to the herd based on whether it pays to do so. Unfortunately, the economics argue against the heifers. Cow prices have jumped after a drought a few years ago led to declining herds. Meanwhile milk prices have fallen. The price of a replacement cow was $1,970 during the second quarter, versus $1,440 in the first quarter of 2014, according to the USDA. Or, put another way, the farmer must pay a third more for a cow that will provide a lot less revenue. That may not make sense for some farmers. On top of not adding to the herd, cows that cease to produce milk may simply be sold off and not replaced at all. Ultimately, the result will be a lower herd size and declining production. At that point, milk prices could rise again and traders can make a profit.

Although prices for cows were high in the second quarter, coming figures will probably show they have retreated. Cow prices are related to prices for the live cattle traded on futures exchanges. The good news for farmers is that futures prices for the latter have dropped about 20% since early July. It means the economics will start to improve. But as Hackett says, “Nothing happens overnight with live animals.” Just because cow prices have dropped doesn’t guarantee we’ll see an instant increase in the herd size.

Hackett says it could take two years to see an expansion of the U.S. herd. In the meantime, milk prices could rally as early as next year to as high as $18 per hundred pounds, or about 15% above recent prices, which Hackett says is workable for producers and consumers alike. Maybe not for latte lovers, though.

 

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