$8 opening forecast may be on the cards

Westpac is forecasting an $8/kgMS opening forecast and ASB has boosted its opening forecast by 20c to $7.50/kgMS.

With five weeks left to run, the 2020-21 season is wrapping up and the next two Global Dairy Trade (GDT) auctions are likely to have little impact on this season's farmgate milk price.

Last week's GDT auction saw a 0.4% rise in whole milk powder prices. Dairy prices are holding most of their gains from earlier in the year and remain remarkably high, a good omen for the coming season.

Westpac senior agri economist Nathan Penny points out that, if realised, an $8 milk price would be the second highest on record.

Penny says he now expects dairy prices to start the 2021-22 season firmly on the front foot.

He points out that in milk price terms, last week's GDT auction and NZ dollar rate equated to a milk price of over $9/kgMS.

Since March, Penny has lowered the bank's NZD/USD forecasts by around two cents over the season, adding further upward impetus to milk price forecasts in NZ dollar terms.

"From the stronger starting point, we have built in a moderation of global dairy prices over the New Zealand dairy season.

"Specifically, we forecast whole milk powder prices (WMP) to fall by 18% over the season.

"In other words, we have built in a supply response to the higher milk price."

Another factor that could keep milk prices high is a very modest supply response to the high milk price by historical standards.

"As such we expect that dairy prices will remain stronger for longer," says Penny.

He notes that in New Zealand, dairy supply is constrained for a range of reasons, including environmental constraints, limits on fertiliser usage and higher compliance costs.

"As a result, we expect modest production growth next season of 2%.

"While this would be in addition to the 1% growth we expect this season, it is modest given the very healthy milk price. Indeed, following the record milk price in 2013/14, production grew a whopping 10% over the season."

Global dairy supply is similarly constrained.

Europe and the US are forecasting relatively modest growth over 2021 of 1% and 2%, respectively.

"Weighting those production forecasts by export shares sees production in the three major dairy exporters forecast to be up just 1.6% over 2021, compared to 1.2% increase over 2020," Penny says.

"The constraints that New Zealand farmers are facing are similar to those facing European and American farmers.

"However, in the short term, northern farmers are also battling very high grain feed prices. When combined with somewhat subdued milk prices, US and EU farmers have little incentive to increase production beyond what is currently forecast."

On the demand side, Penny expects robust demand to continue.

"As we have noted over recent months, strong Chinese and South-Eas Asian demand is underpinning the price strength and we expect this to be ongoing through 2021. Notably, we expect the Chinese economy to expand by 10% over 2021."

ASB economist Nat Keall says last week's auction saw China retake the driver's seat after it's conspicuous absence last auction.

After a string of auctions were marked by aggressive purchases, the April 6th auction saw China recede and other regions take the front foot.

Keall says that looks to have been a blip, with China returning to its dominant position this auction, particularly for WMP. "The vast majority of product on offer was captured by the 'North Asia' region, with other parts of the globe taking lower volumes than at the last auction.

"Another bearish sign we saw last time around also reversed itself. At the last auction, not all WMP product was sold, and we noted at the time that this suggested short-term demand is already being met. That development also proved short lived with 99% of product on offer sold this time."

Keall is also confident of prices holding in the new season.

"The shape of the contract curve suggests prices maintain momentum heading into next season.

"The further-dated contracts (for shipment in August-October) continue to trade at a modest premium over those nearer. The shape continues to suggest it's not just short-term supply anxieties that are fuelling gains at auction.

"An uncertain outlook for Northern Hemisphere production and rising global consumption should keep prices supported over the medium term."

But Keall says he will add the caveat that it's very, very early days.

He expects Fonterra to open its own 2021-22 forecast at a wide range.

Fonterra is expected to announce its third quarter business update and opening forecast for the new season next month.