Signs look good for a further rise in global dairy prices - and maybe a return to profit

Dairy product prices are expected to rise again at next week's GlobalDairyTrade auction, as signs keep pointing to a recovery and a return to profitability for farmers after two years of losses.

Futures trading indicates that prices for whole milk powder - which have the greatest bearing on Fonterra's farmgate milk price - will rise by 5 to 10 per cent, building on an 18.9 per cent gain at the previous sale on August 17 and a 9.9 per cent improvement in the one before that.

Some confidence has been drawn from the strength of prices further out, although the market had lost some of its lustre by the week's end.

Yet futures prices for the peak months of October and November, when Fonterra's factories will be running at full tilt, still point to a whole milk powder price of just under US$3000 a tonne - seen as near to break-even for farmers.


Low farmgate prices over the past two seasons have resulted in burgeoning farm debt, a huge cow cull and severely curtailed the use of supplementary feed.

Cash-strapped farmers took some confidence from the latest GlobalDairyTrade (GDT) price lifts but they remain cautious after a short-lived spike this time last year.

New Zealand's biggest dairy co-operative, Fonterra last month raised its farmgate milk price forecast to $4.75/kg of milksolids, from $4.25, while the second biggest co-op, Westland Milk, raised its payout to $4.55-$4.95/kg.

Fonterra's milk price came to $3.90/kg in 2015-16, $4.40 in 2014-15, and a record of $8.40 in 2013-14. The updated milk prices compare with DairyNZ's break-even estimate of $5.05/kg.

Next Wednesday's auction will take place three weeks after the last sale, compared with the usual two-week gap, which may play into the hands of the dairy suppliers because of pent-up demand over the period.

The durability of the turnaround over the past month rests on production over the next few peak months. New Zealand is the world's biggest dairy exporter, so production trends here have a big influence on world prices.

The big question is the extent to which production has been affected by the cow cull and less supplementary feed.

There is a big hole in their balance sheets to fix given what has happened over the last two years.


The season has so far offered few clues, but Australian production is in decline and there has been an encouraging slowdown in production growth in the European Union.

At the same time, demand from the world's biggest dairy importer, China, is improving.

Latest Dairy Companies Association of NZ data showed local production in the June-July seasonal lull was up 0.4 per cent over the same period last year.

The real test will lie in the spring months, but in the meantime the market has seized on Fonterra chairman John Wilson's comment last month that the co-op's milk collection is so far about 4 per cent down on this time last year.

"The key thing to watch is what happens to New Zealand production through the spring flush because I think some of the price gains to date have been predicated on a reasonable pullback in production," said BNZ senior economist Doug Steel.

The danger is that we do squeeze higher in September and then come off at a rate of knots when the buyers say that's too high.


"If you see New Zealand production holding up better than expected, then you can expect to see some price retracement.

"On the other side of the coin, if production does get hit pretty hard via the cow cull, reduced use of supplements, and perhaps through the weather, who is to say that prices can't keep advancing higher?"

After two successive seasons of losses, Steel said farmer cashflows would start improving in 2017. "But there is a big hole in their balance sheets to fix given what has happened over the last two years," he said.

ANZ Bank rural economist Con Williams said the proof of the improving price trend would be in the next few months. "The market is starting to get a bit nervous about pricing things too much higher beyond $3000 a tonne in the futures.

"The danger is that we do squeeze higher in September and then come off at a rate of knots when the buyers say that's too high."

Wholemilk powder shot up to US$2824 a tonne around this time last year, before slumping to US$2148/tonne in just one month. "We could easily see that again," Williams said. "I hope we don't."