Westpac Institutional Bank Team
Westpac Institutional Bank
The dairy sector’s sigh of relief has continued, with yet another sharp increase in the GlobalDairyTrade (GDT) auction price last week. Dairy prices have risen a stunning 63% in two months, and some products are now trading at prices that we regard as above the long-run sustainable level.
Clearly, the worst has been avoided for dairy farmers. We are now forecasting a farmgate milk price for the current season of $5.30 per kg of milksolids for Fonterra suppliers. That is still not a great number – it is roughly the break-even mark for an average farm, and will still leave some in the red. But the situation is a whole lot more manageable than a milk price below four dollars would have been.
One probable reason for the sudden lift in milk prices is concern about the supply of milk coming out of New Zealand. Fonterra has forecast that milk collections will be 5% down this season compared to last, mainly because farmers have reacted to low milk prices by culling cows among other volume-reducing measures. Now we have meteorologists saying that an El Niño weather pattern this summer is a near-certainty, meaning a high risk of drought that could further curtail milk production.
We are wary of extrapolating too far from the current high level of global dairy prices. New Zealand farmers may start to make more generous decisions about feed intensity and the like now that payout forecasts are higher, which could boost milk production relative to forecast. Any drought premium in the current price must eventually unwind. And dairy prices are starting to look anomalous against the backdrop of lacklustre global commodity prices more generally.
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