Markets' eyes on Fonterra auction result

World dairy markets will be studying closely the results of Fonterra's globalDairyTrade internet auction this morning, after speculation the strength of recovery in global dairy prices might not be sustainable.

Specialist rural bank Rabobank has raised such concerns, warning continued price increases at current levels, through which whole milk powder prices reached a 16-month high in December, could create another boom and bust cycle.

"Strange as it may seem, exporters and their suppliers may well be best served if the market at least started to stabilise now," the bank said in its latest Australia and New Zealand Agribusiness review.

"Each further increase in commodity pricing from here will only increase the prospect of another steep boom and bust cycle, which is not likely to serve anyone's interest well."

The rapid market recovery has been driven by a shortage of supply and has pushed global dairy prices above the long-term average.

But the bank described demand as "at best gradual, and still distinctly fragile".

It based this assumption on "sluggish" improvement in economic activity, "the skittishness" of financial markets and anecdotal evidence that wholesalers have replenished stocks.

"Commodity spot market prices have now pushed up to levels which, if they held, would translate through to profitable milk pricing, not just for southern hemisphere farmers, but also for those in the United States.

A supply response is thus not a question of if, but when, and how strong."

Milk production has fallen around the world, except for Europe, where it increased 1.1% in the last three months of 2009, and New Zealand, where it increased 0.5% in the six months to November.

At current pricing, Rabobank warned of a consumer reaction as higher raw material prices translated to higher product prices.

Fonterra was offering 25,000 tonnes of whole milk powder and 3600 tonnes of anhydrous milk fat on its monthly globalDairyTrade internet auction, which will give the sector a lead on how strong the market recovery has been.

Prices for whole milk powder at the December auction were 3.6% higher than November, but 95% higher than last July's auction.

Another factor which could affect the market was the 300,000 to 400,000 tonnes of stockpiled butter and skim milk powder in Europe and the United States.

It represented 40% of product that was stockpiled earlier in the decade, but analysts have warned it could still dampen prices.

Westpac rural economist Doug Steel said demand for dairy products was outstripping supply, but it was also being driven by urbanisation and westernisation of the middle class, especially in China and also other parts of Asia.

Fonterra has already responded to improved global prices by increasing its payout to suppliers from $5.10 a kg of milksolids (kg/ms) in September to $6.05 kg/ms.

Mr Steel said predicting future payouts was difficult given the fluctuating currency and weather.

"We have some confidence regarding the fundamentals of tightening supply now and ongoing solid demand growth out of Asia, but growth in western nations, which also has a big influence on commodity prices, is more precarious."

He suggested farmers budget on a milk price of $5.70 kg/ms for next season and a five-year average of $5.40kg/ms.

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