Dr. Cameron Thraen, Milk Marketing Specialist, The Ohio State University, Additional milk marketing information by Dr. Thraen
Now that we have passed the nadir of the summer heat, we are entering a period when milk production and component levels rebound across the country. In this column, I will make a departure from past columns and take a look at the milk production - price cycle relationship in the United States dairy industry. This is a dynamic relationship which I find very informative as I look to the future for price direction. This relationship is depicted in a chart that is available on my website and is updated each month on the same day that the USDA releases its Milk Production report. You can get a copy of this chart and my price projections for the milk and dairy product markets by accessing my Ohio Dairy 2006 website at this address: http://aede.osu.edu/programs/ohiodairy/ . Here, you will find a wealth of information on the national, regional, and Ohio dairy industry. Current cash and futures markets charts and data and my 24-week forecast for butter, nonfat dry milk (NDM), cheese, whey, and milk prices.
Dairy production and price cycles
Quite some time ago, when I was a student in an agricultural economics pricing class, I spent a good deal of the time studying the United States hog cycle. The idea was that there where certain dynamics operating with enough regularity that a cycle between production and price was apparent in the U.S. hog industry. At that time, and I will not say how long ago that was for me, there was no discussion of a similar set of dynamic regularities for the milk production and milk price cycle. Now, I believe that there is such a relationship and you can see it in Figure 1.
Figure 1. The milk production and price cycle.
As the title of Figure 1 indicates, you are looking at the percent change in annual milk production calculated as a 12-month rolling average. For those of us who need a little refresher, the 12-month rolling average is calculated each month by taking the current and previous 11 months of milk production, summing this up to get an annual number, and dividing by 12. From this number, we calculated the percent change from one month to the next. For example, beginning with January 2000 and looking at Figure 1, we can see that milk production in the United States was increasing at a rate of 3.2%. This rate of growth continued through August 2000 with a peak of 4.0%. Now looking at Figure 1, you can readily see the milk production cycle. After the August 2000 peak, the rate of increase in U.S. milk production began to slow over the next 15 months. By September 2001, the rate was a negative 1.75%. This pattern appears to have repeated itself two full cycles since 2000 and is now beginning to complete the third cycle in 2006 and 2007.
Now factor in the milk price
Imposed on Figure 1 are the Class 3 milk prices recorded, at specific points in time, over this cyclical pattern. I have indicated both the month for peak growth and the month for the lowest Class 3 milk price. For example, the peak growth of 4.0% occurred in August 2000. By November 2000, the Class 3 price had bottomed out at a record low of $8.57/cwt. Again in December 2002, peak growth occurred at just over 2.5%, and in March 2003, the Class 3 price again bottomed out at a low $9.11/cwt. And again this year, peak growth occurred in March 2006, and the Class 3 reached bottom in May 2006 at $10.83/cwt. What does this tell us about the growth or expansion of milk production and the milk price in the United States? As dairy producers expand milk production relative to demand, the price must drop to clear the markets. This is fundamental economics 101. More milk equals lower prices. Figure 1 shows us this fundamental relationship as faster rate of growth equals lower price. It also shows that the lowest price occurs with a 3 month lag after the rate of growth in milk production peaks.
Of course, this lower price translates to reduced dairy farmer cash income from the sale of milk and a reduced incentive to continue the production expansion. Now look at Figure 1 and observe the production price reaction to a slow down in the growth rate. For example after the August 2000 peak, the rate of growth in milk production slowed to a negative 1.75%. What was the reaction of the Class 3 price to this slowdown? The Class 3 price increased by 86% to $15.90/cwt! How many months did it take to reach this higher price? Fifteen months, if you are counting. Now look at the second complete cycle beginning with January 2002 and ending with May 2004. The rate of growth in milk production picked up steam, fueled by the $15.90/cwt milk price and the expansion continued over the next 13 months. The milk price fell back to $9.11/cwt. This signal to the nation's dairy producers was clear. Over the next 16 months, the rate of growth in U.S. milk production declined. The milk price responded by soaring to a record high Class 3 price of $20.58/cwt! Parenthetically, this high price was aided by some extra-ordinary factors (extreme prolonged western heat, Posilac® (Monsanto Dairy Business, St. Louis, MO) scarcity, and a border closing with Canada), without which I believe the price would have topped out near the $15.00/cwt mark.
The current production - price cycle
Now, we are in the downward side of the third cycle since 2000. Milk production in the United States responded to the record prices of the previous cycle by expanding for a record 20 months. Over this period of expansion, the Class 3 milk price fell by 47% to a low of $10.83/cwt in May 2006. Now, we have to wait to learn how long the down side of this cycle will last before we see milk prices improve. With the past as a general guide, we can expect the down turn to last between 15 and 17 months from the peak. With the peak of the rate of growth turned-in with March 2006, this would put the end of this cycle between June and August 2007. During this slowing of growth phase, we can expect milk prices to steadily increase as we simultaneously slow the positive rate of growth in production and work off already existing product inventories through lower prices. How far milk prices will rise is not an easy question to answer. Looking at the past I would expect to see the Class 3 price move back toward the $14.25 to $15.00/cwt range near the end of this cycle, at which time, we will start all over again.
Updated 24 week price forecast
You can check out my just updated 24-week price forecast available on my website at:
http://aede.osu.edu/programs/ohiodairy/quickchart/nass52.htm. This forecast is based on the assumption that the rate of growth in milk production will continue to decline at a rate sufficient to bring total supply back into balance with demand.