Blimling and Associates Blog

On Tuesday, the US Dairy Export Council issued an alert that Mexico had announced it would impose tariffs on US cheese in retaliation for US non-compliance on certain NAFTA obligations - specifically Mexico's cross-border trucking access.  Retaliatory tariffs from 20-25% could begin being imposed as early as today.  According to USDEC, it appears that most cheese exports to Mexico would be impacted, a significant point of concern given Mexico's position as the primary destination of US cheese exports, having claimed about 30% of US export volume YTD through June (53 million pounds), according to USITC.

Cheese was not alone on the retaliation list.  Pork, apples and California oranges were also on the list, leading some to believe that Mexico is hoping the lobbying bodies - and lawmakers from key states - will get involved and put pressure on the Obama administration to resolve the long-standing trucking issues.

Hot or Not?

July was hot enough to crimp milk production and rouse the cheese market to new heights.  But, where weather has been cutting into production, long-term effects are less certain.  In fact, the June USDA/NASS Milk Production report showed output up 2.4% year-over-year and the national herd expanding for a sixth consecutive month.  It can be dangerous to get sucked into an exclusively supply-side view or one that ignores milk production conditions elsewhere in the world, but for now, global demand conditions remain little changed and are not likely to change much over the next six months.  We lay out our views on price prospects for the coming months.

What If Grain Prices Move Sharply Higher?

Returns to dairymen have stabilized over the last several months and while current margins are far short of the levels necessary to repair the damage done to balance sheets in 2009, most US producers are covering or are close to covering cash production costs.  The benefits of the current environment are not shared equally across all regions, however, just as the damage sustained last year varied from place to place.  What happens if grain prices rally and milk prices stagnate or decline? 

Developed Verus Developing: The Trial Continues

For the past three years, two ongoing epic trials have been prominent in global economic affairs.  At every turn we find factors that contribute evidence for either Developed Economies v Developing Economies or its sister case, Inflation v Deflation.  Over the past two weeks, global markets have been captivated and catapulted by corporate earnings reports as well as a sense that values for “materials” have bottomed…reversed, even.  We take a look at the evidence building in these cases to see what the copper, crude oil and Baltic Dry Index have to say about global commodity supply and demand.

As efforts to again extend unemployment benefits remain stalled in Congress, a dispatch in yesterday's editions of The Wall Street Journal highlighted the struggle some states are having with a surge in fraudulent claims. Seems as though some folks continue to report themselves as jobless even after they have found a new engagement:

Nearly $3 billion was likely lost to unemployment-insurance fraud nationwide in 2009, more than double the 2008 figure, according to early estimates from the U.S. Labor Department..In the most common type of fraud, formerly unemployed people continue to collect checks after finding work. On other occasions, fraud rings bilk the system out of tens of thousands of dollars at a time.The temptation to continue to collect checks after finding a job can be high. Many newly re-employed people accumulated debts during unemployment and took lower-paying jobs than they once had, said Ohio fraud investigator Mickey Ford, tempting them to supplement their incomes with an unemployment check. Potential fraudsters have also been lured by the larger potential take made possible by extended unemployment benefits, which until last month could be collected for up to 99 weeks, said Gary Burtless, an economist for the Brookings Institution. Last month, Park Forest, Ill., resident Reuvean Day admitted she collected $25,398 in benefits while employed as an administrative-support specialist a couple of years ago. Ms. Day was one of 11 people charged in May with taking $255,000 from Illinois's unemployment insurance fund.

Stories along these lines will only add heat to an already hot debate about the pros and cons of extending benefits. Proponents say that beyond the obvious help benefits deliver, the payments are good for the economy because they largely maintain consumer spending potential. Indeed, last week Speaker of the House Nancy Pelosi said that the unemployment benefits program "injects demand into the economy" and "creates jobs faster than almost any other initiative you can name." Opponents cite the need for fiscal restraint at the Federal level and, in some cases, say that by essentially rewarding joblessness you get...joblessness.

Source: The Wall Street Journal

Not Limping, Not Speeding

Summer has arrived, but not much has changed in the dairy markets – there are a few bright spots, a few areas of softness, and a lot of angst about the world around us.  Butter remains the only compelling act with depleted stocks, solid exports and a firm global market.  Beyond the next 60 days, however, the picture for  butter could be entirely different as a variety of forces take hold. The cheese market still seems hopelessly range-bound. As for powder, there is a sense that front-loading chickens are coming home to roost. Turning our forecasting attention to 2011, we find numbers that look a lot like those for 2010, at least on an aggregated basis.

In the On-Deck Circle: New Zealand

When the New Zealand Ministry of Agriculture and Forestry released its milk production forecast for the upcoming season – an increase of 14% year-over-year – it created a distinct buzz.  With clients asking the impact on the US market should such an occurrence come to pass, we thought it would be helpful to put the estimates in context – particularly in light of the fact that it was a 10% surge in New Zealand production in 2008-2009 that played a key role in driving US prices from the 2008 highs to the 2009 lows.  Even if the 14% increase doesn’t come to pass but instead the gains are in the 8-9% area, New Zealand production still represents a significant headwind to meaningful price recovery in the US.

Little Fun Here…Even Less With Hugo

The slog continues: an economy with unemployment stubbornly near 10%, ballooning government balance sheets and pervasive unease.    From a consumer – and by extension dairy product demand standpoint, little has changed.  It is still all about cautious spending, heightened price sensitivity, and slow, uneven growth.  It was once believed that lower gas prices would amount to a tax break and result in increased spending in other areas, but that has clearly not been the case.  Against this backdrop, it is not surprising to see that restaurant spending continues to be lethargic – with ongoing implications for dairy product demand.  And then, just when all seems on the path to lost, a comparison to what real trouble looks like – Hugo Chávez’s Venezuela.

Stocks Matter…

The April Milk Production report pointed out that there is  more milk around than many expected and it increasingly seems that more heavy lifting will be needed to get the markets really rocking. Along the way, markets are coming to grips with the fact that stocks matter – be they commercial or government, visible or off the radar, widely available or tightly held. The recent decision by the EU to put some of its powder back in circulation has brought that reality sharply into focus and had a cooling effect on markets.  Cheese has its own inventory issues with total cheese stocks at an all-time record high of 1.01 billion pounds in April.  Something is going to have to change in a big way to alter the cheese mountain phenomenon that is casting a shadow over the market. The butter market does not lack for heartburn-inducing qualities .  A month ago the butter market seemed capable of over-heating but has since gone through two modest cool-downs.  Even so, plenty of upside potential remains as the bid side of the market has reawakened.  

Implied Margins Clarify Milk Production Picture

Entering 2010, the prevailing outlook in most published forecasts was for the sharp milk production declines of 2009 to continue, the thought being that lingering effects from low milk prices and associated damage to producer balance sheets would create impetus for further production weakness.  The April 2010 milk production data clearly calls those expectations into question, however, as output was up 1.5% year-over-year.  Rebounding milk production may seem confounding, but it is not entirely surprising when one focuses on measures of dairy producer health.  Implied margin over feed calculations indicate dramatically improved conditions, particularly in Western states.

Economic Jitters Return

Economic conditions have become more turbulent in recent weeks, with unrest centered on sovereign debt issues.  For now, the headline problems are in the EU.  But there are lurking troubles here, and the rising government share of personal income seems incompatible with keeping those trouble forever at bay.  In California, a state in the grips of a budget crisis not unlike that faced by Greece, restaurant performance figures highlight the challenges which, quite naturally, hit on dairy product consumption.  Is the US economy - and dairy product consumption - headed for more trouble?  We are not facing another 2008-esque calamity, but a "slow down" seems possible - on a global scale. 

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So-called strategic defaults by homeowners have been a source of stealth stimulus. That is not really breaking news -- stories along those lines have been in print for several months. But the phenomenon doesn't cease to amaze...or outrage. So when a new story is published -- especially in the venerable New York Times -- we read it. In part to stay up on the trend. In part to see how high it can drive our blood pressure.

Today's dispatch in the Times comes under the headline "Owners Stop Paying Mortgages and Stop Fretting" and, from the start, it does not disappoint:

For Alex Pemberton and Susan Reboyras, foreclosure is becoming a way of life — something they did not want but are in no hurry to get out of.

Foreclosure has allowed them to stabilize the family business. Go to Outback occasionally for a steak. Take their gas-guzzling airboat out for the weekend. Visit the Hard Rock Casino.

“Instead of the house dragging us down, it’s become a life raft,” said Mr. Pemberton, who stopped paying the mortgage on their house here last summer. “It’s really been a blessing.”

To be fair, the banks are apparently so busy with foreclosures that the process has been significantly lengthened. According to the story,

The average borrower in foreclosure has been delinquent for 438 days before actually being evicted, up from 251 days in January 2008, according to LPS Applied Analytics.

In essence, lenders are helping float the life rafts. In a sense, the borrowers cannot be faulted for grabbing hold. They are basically being incentivized to do so. At the same time, there is hanging on and there is hanging out. It would be one thing for people to take the gift they have been given and sock away money for a fresh start or the next time. It seems like something altogether different to go out for a steak or to the casino (or, in the now infamous rendering by The Wall Street Journal late last year, buying a season pass for Disneyland). As other commentators have pointed out, when the banks are painted as the bad guys, it is less difficult to feel moral compunction about spending the mortgage money elsewhere.

Perhaps this is good for the economy over the short run. But someone, of course, is going to pay -- namely, all borrowers in the future. It may not be a sign of the apocalypse. But neither is it one of our proudest moments.

The Euro got roughed up again yesterday as currency markets continue to assess the potential fallout from last weekend's nearly $1 trillion "bailout" package for struggling member states. The reaction in those member states? Hardly enthusiastic. Indeed, The Financial Times is reporting that unions in Spain are planning large-scale strikes. From the dispatch:

“The government has decided to sacrifice the purchasing power of public sector workers and pensioners to the dictates of the financial markets,” Cándido Méndez, UGT leader, said in an article in the El País newspaper. “And it’s very likely that it will be a pointless sacrifice.”

[Finance Minister Elena] Salgado said it was hard to disagree with the unions about the effect of the cuts on growth but made it clear that the government had no choice other than to reduce salaries.

“We would never have started them there, the cuts?.?.?.?We’re a socialist government and therefore cutting salaries and freezing pensions is something we only do because we have to. There is a moment when you have to do it and we did it.”

More than one story in recent weeks has noted the similarities between Greece or Spain and some US states confronting serious fiscal issues and large public-sector workforces -- California being the most commonly referenced. George F. Will, for one, offers up his perspective under the headline "Greece and GM: Too Weak To Fail" in the Washington Post.

The general sense is that it is not too late, too far gone for the US. But it is not easy to stay out in front of the issue -- austerity is a bitter pill to swallow here, too. Consider what is happening in New Jersey, where a new governor, Republican Chris Christie, is trying to tackle fiscal issues with alacrity. From "New Jersey Governor Sets The Tone for the US" in The Hill:

Upon taking office Christie declared a state of emergency, signing an executive order that froze spending, and then, in eight weeks, cutting $13 billion in spending. In March he presented to the Legislature his first budget, which cuts 9 percent of spending, including more than $800 million in education funding; seeks to privatize numerous government functions; projects 1,300 layoffs; and caps tax increases. 

Teachers unions are incensed, fighting Christie’s proposal that — in order to avoid cuts to education — teachers accept a one-year wage freeze and contribute 1.5 percent to the generous-by-every-standard healthcare plans they now enjoy for free. New Jersey, which has the highest unemployment in the region and highest taxes in the country, lost 121,000 jobs in the private sector in 2009 while adding 11,300 new education jobs. During the last eight years, K-12 enrollment rose just 3 percent while education jobs increased more than 16 percent. 

Today it is the Euro's turn to earn the forex market's scorn. Who's next?

As people who are inclined to obsess about demand-side issues, we marvel at how often market participants and analysts forget that price matters in the consumption equation. This was plenty ignored -- with major consequences -- in the global commodity price rally that took the world by storm in 2007 and 2008. 

With that in mind, the latest crude oil demand estimates from the International Energy Association (IEA) caught our eye:

Global oil demand is revised down by 190 kb/d on average for 2009 and 2010, equating to 84.8 mb/d (-1.2 mb/d year-on-year) and 86.4 mb/d (+1.6 mb/d) respectively. Revisions stem largely from changes to non-OECD historical baseline data, as slightly higher GDP prognoses from the IMF are counterbalanced by a higher price assumption.

For several months, we have casually (if inexpertly) asserted that $85 crude oil was perhaps in the "too hot" area. It seems as though IEA analysts see something similar -- a slowdown in demand at the upper-end of the recent price range.

Naturally enough, the market already suspected as much: the crude oil market is down by more than 10% since reaching the $85 mark last month. And, inter-month spreads have widened, suggesting the market is over-supplied on the front-end of the price curve (and willing to pay premiums for storage).

Price does matter.

Over the past week, we have spent a lot of time pondering China's seemingly insatiable appetite for dairy powders. WMP and SMP imports continued to run hot through March. Is it real? Can it continue? What does it mean?

Those questions are difficult to answer without also pondering larger questions about economic health globally and in China. Events over the past week have shaken confidence in a view that all is well (or, at least, all is okay). Robert Samuelson comments on the phenomenon on the Investor's Business Daily website:

The United States and many countries approved "stimulus" programs of tax cuts and additional spending. Panic was halted. A downward spiral of falling private spending and rising unemployment was reversed. The resulting economic slump was awful. But it was not another Great Depression. The worst has passed.

Or has it? Greece's plight challenges this optimistic interpretation. It implies that celebration is premature and that the economic crisis has moved into a new phase: one dominated by the huge debt burdens of governments in advanced societies. Comparisons with the Great Depression remain relevant — and unsettling. Now, as then, we may be prisoners of deep and poorly understood changes to the world economic system.

It should not escape notice that China's equity markets have been under pressure for several weeks. The government seems intent on tightening in an effort to fight inflation. It seems reasonable to wonder about export prospects into a weak Eurozone. More to the point, will fallout from tighter credit conditions or a cooling economy put the brakes on dairy product imports? We don't yet know enough to know for sure...and there are other germane lines of inquiry to explore. At the same time, we get the sense that it would be a mistake to simply assume that everything is okay and conditions tomorrow will resemble those prevailing today or in the first quarter.

As the financial crisis began to spin out of control late in 2008, we occasionally had the feeling that the speed at which markets can be accessed was  contributing factor. In the computerized trading era, people (and firms) can act quickly and, arguably, impulsively in a way that wasn't possible 20 or 30 years go. Long gone are the days where executing a stock or commodity transaction required the involvement of a broker at a desk who would then call a broker on a trading floor. Gone, in other words, are the human circuit breakers. Our sense: at any given time, we could trade ourselves into oblivion. 

Those feelings were reawakened today when seeing US equity markets implode in a 20 minute span -- a downward move of more than 500 points. Within an hour, that ground had been regained. The talking heads on CNBC almost immediately began to speculate that some sort of an error was responsible. Nothing else, it seems, would explain some of the movement (more than a few stocks traded to near zero during the swoon). There was talk about a "fat finger" error -- perhaps some poor soul typing in sell billions in stock value rather than millions. Alternatively, various commentators thought it was possible that an algorithmic/black box type trade went awry -- that an uptick in something here created massive selling there. In any case, there is going to be a lot of talk in the coming days about somehow slowing down the trade execution process. (What kind of speed are we talking about? Legendary fund manager Mark Fisher, in a rare appearance on CNBC's Fast Money, said that in the time it takes someone to "tap your desk" electronic trading systems can initiate 10,000 discrete orders...)

Meanwhile, as everyone sifts through the carnage, the Euro endured another day of ritualistic abuse. Today's low was just over 1.25 versus the US Dollar -- a level not seen since last Spring. In a week, the Euro has lost more than 4% of its value....likely creating some upheaval in the valuation of US dairy commodities in the world markets.