Just when you thought it was safe to venture into the dairy market, prices drop by 8.8 per cent.

Last week's 1080 threat aside, the latest auction was about prices coming back down to earth after a couple of big gains in February.

Back then, it looked like production was going to be hit hard by the drought, so up they went.

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It's happened before. The size, scale and duration of the last drought had a big bearing on prices going ballistic last season.

At the margin, last week's threatened contamination may have been a factor, but the rules of supply and demand were more likely to have been at play.

In its latest update, Fonterra stuck by its prediction that production would fall by a chunky 3.3 per cent compared with last season but the market is sceptical.

Going on season to date data, production in the nine months to February 28 was running 1.5 per cent higher than the same period a year earlier, which means supply is going to have to drop like a stone for that kind of contraction to take place.

In the futures market, which in the lead-up to the latest sale has been an accurate predictor of the physical market, prices have been falling thanks to Fonterra putting more product up for sale via the GDT platform. The auction was about the market coming to the realisation that more supply is around than was previously thought. On the demand side, the situation is still not clear.

These wild swings in dairy prices - 50 per cent down last year - look like becoming a permanent part of the commodities landscape.

Dairy has for decades gone from strength to strength. Broadly, it is estimated to represent something like 10 per cent of GDP and is by a country mile New Zealand's biggest export.

Last week's 1080 scare brought the country momentarily to a standstill, with good reason. Previous food safety scares have had serious ramifications.


The current pullback in prices, while temporary, will doubtless make its presence felt in the terms of the trade. Despite dairy's spectacular performance, the events of the last few days serve as a reminder that the economy has a soft underbelly.