Blimling and Associates Blog

Is it just us or is it remarkable that the corn market has continued to hang on? Current crop size estimates range from large to huge, yet the market has managed to stay above $3.00/bu (December basis). Harvest is not over yet and some respected analysts still have $2.70/bu pegged as a downside target. But it has not happened yet. Dairy production costs may be as low as they can go for a while, even with sizable crops set for harvest.

Bloomberg runs an article this morning looking at the run-up in whole milk powder prices. Commentary from Fonterra executive Kelvin Wickham is interesting and perhaps telling:

Milk Rally May Stall Without Further Demand Lift, Fonterra Says

Sept. 11 (Bloomberg) -- A rally in world milk powder prices may stall without evidence of a sustained improvement in demand or a tightening in supply, according to New Zealand’s Fonterra Cooperative Group Ltd., the world’s largest dairy exporter.

An 55 percent jump in whole milk powder prices to $2,872 a metric ton in the past two months was driven by improved demand, slow New Zealand production, a weaker dollar and concern that an El Nino weather pattern may reduce supply, said Kelvin Wickham, managing director of Fonterra’s global trade unit. “Not a lot of business is being done” at current prices about $3,000, he said.

“Everyone is out there trying to test those higher price points,” Wickham said in a telephone interview from Auckland. “But to go much beyond where we are today, the fundamentals don’t support it yet.”

Milk powder prices slumped to a five-year low in July as consumer spending slowed faster than producers could reduce output and the U.S. and Europe offered subsidies to help their farmers export surplus product.

Fonterra accounts for about 40 percent of the global trade in butter, milk powder and cheese. The company’s shipments for August and probably September would be down from last year and supplies remain “hand to mouth,” Wickham said.

Prices had fallen too far and recent gains were not a “bubble,” he added.

Still, recent rain and mild weather means New Zealand output is getting back on track and supplies will increase as the season progresses. Traders are also waiting to see what the European Union does, now that prices are high enough for its farmers to export without subsidies, he said.

France and Germany, Europe’s biggest milk producers, are pressing the union to increase export subsidies and intervention payments in the domestic market. French farmers yesterday called for a strike in protest at falling prices, AFP reported.

Intervention payments, in which the union buys butter and skimmed milk powder for domestic stockpiles, resumed in March and are likely to continue through 2010. The European Union could trim export subsidies without harming the competitiveness of their farmers, Wickham said.

 "Can they be bold enough to maybe reduce the subsidies by a nominal amount?” he said. “That might be very helpful in helping firm prices and would also be a strong signal to the world not to just expect subsidies to continue and prices to be depressed accordingly.”

Over the past few weeks the energy markets have been occasionally roiled by stories about prospective defaults on derivative contracts by some Chinese entities. Seems as though a group of companies find themselves on the "wrong" side of some energy hedge contracts with foreign banks. Published reports suggest the losses among a group of airlines add up to $2 billion. Reportedly, several companies sent letters to their counterparties suggesting that their contracts may be "void, invalid or unenforceable." The Wall Street Journal offers some wisdom on the matter today:

Beijing needs to clarify whether a contract is a contract, and fast. Recent suggestions that the government might allow or even encourage companies to challenge derivatives contracts that went against them send a bad signal to foreign companies and countries doing business with China... China has been down this road before, pushing foreign counterparties several times over the past decade to back down from derivatives contracts that had turned against a Chinese company. In those cases, the companies or the government variously argued that the firms had been illegally speculating or had not understood the risks they were taking—or even that the people signing the papers on behalf of the Chinese companies hadn't been authorized to do so. It's hard to see how such arguments could apply to the kind of bread-and-butter fuel hedging at issue here... But this kind of bullying is not free. Most immediately, hedging is a risk-management tool that many Chinese companies can't afford to live without. It works on trust between counterparties that each side will hold up its end of the bargain. Already banks reportedly are demanding higher collateral for derivatives contracts like those at issue here to compensate for the loss of trust. That's an added cost of doing business not faced by other airlines that take their lumps when hedges go wrong, like Hong Kong's Cathay Pacific or America's United.

Hedging is hedging. Speculating is speculating. A contract is a contract. Any questions?

China's equity markets bounced back some overnight, but the uptrend line has been broken. The concern: China led the way down in 2008 and has led the way back up in 2009...and now China seems to be faltering anew. If we read things correctly, this mini-meltdown is a key factor behind slippage in the US equity and commodity markets this week.

When milk prices were $20/cwt and hay was fetching north of $200/ton there was concern about what would happen when milk prices declined. Combinations of $15/cwt milk and $200/ton hay or $12/cwt milk and $200/ton hay would have been unpalatable. At the time, however, we figured that hay prices would have to come down in concert with milk prices. If producers cashing $12/cwt or $11/cwt milk checks couldn’t afford $200/ton the price would have to come down. After all: who else is going to buy a lot of hay? Dairy farmers’ peers in the livestock industry – the only real competition – have not exactly been flush, either.

The latest USDA/NASS Agricultural Prices report shows that, indeed, hay prices have continued to collapse as the best customers struggle to make ends meet. In fact, the price for a ton of alfalfa hay in California was below $100/ton for the first time since February 2004. Our rough math shows that the reduction in hay prices from August 2008 ($214/ton) to August 2009 ($99/ton) has reduced the cost of feed by about $1 per hundredweight of milk produced. While that certainly does not spell prosperity in a $12/cwt milk environment it has likely relieved some pressure or slowed the pace of financial devastation.