Dairy futures prices discounted

Whole milk powder prices - which make up about 75 per cent of Fonterra's farmgate milkprice - dropped by 13.1 per cent to an average US$1,848 a tonne at Thursday morning's auction. Photo / Bloomberg

NZX dairy futures prices are trading at a discount to the physical market and traders predict further falls over the coming months in the aftermath of this week's worse-than-expected GlobalDairyTrade auction.

In whole milk powder, the August NZX futures contract is now priced at US$1570 a tonne, September US$1580/tonne and October US$1630/tonne - all at a big discount to physical market, Nigel Brunel.

Auction volumes are set to considerably increase over next three months and given some volume on Thursday's GlobalDairyTrade auction may have gone unsold, Nigel Brunel, director financial markets at OMFinancial, said.

"As prices did not clear reserve prices, it is hard to be bullish on the dairy front at the moment," Brunel said in a commentary.

Traders continue to price in substantial declines in dairy prices with production numbers in dairy being up in many regions around the world.

Whole milk powder prices - which make up about 75 per cent of Fonterra's farmgate milkprice - dropped by 13.1 per cent to an average US$1,848 a tonne at Thursday morning's auction - well short of the US$3,500 a tonne required for the co-co to meet its current 5.25 per kg of milksolids forecast.

Fonterra's board will consider forecast at its next meeting on August 7.

The farmer-funded Dairy NZ estimates $5.70 a kg to be the break-even point for most farmers.

Prices, after a steep decline in 2014, bounced back in February this year but have been falling ever since.

Oversupply, slack demand from the world's biggest dairy importer - China - Russia's import ban, the removal of dairy production quotas in Europe and higher production arising from cheaper feed costs have all acted to depress dairy prices.

Economists expect prices to stay low this year before the balance between supply and demands starts to improve next year.

The Reserve Bank has flagged a weak dairy sector as one of three key risks to the nation's financial stability, saying about a quarter of farmers were operating in negative cash flow.

The bank cut its official cash rate by 25 basis points to 3.25 per cent on June 11 and financial markets are pricing in two more cuts by the year's end.

New Zealand - the world's biggest dairy exporter - has contributed in no small way to the oversupply.

Domestic milk production, despite low prices, the drought early this year and high cow cull rates, reached a record for the season ended at 1.883b kg of milksolids, up from 1.712bn kg in 2014 - a 3.6 per cent improvement.

ASB estimated that for Fonterra, the lift was more like 2 per cent as it continued to lose share to other dairy companies.

The bank expects production to finally come off the boil this year. If production increased for a third year, then its $5.00/kg forecast would be at risk, the bank said.