Strong supply, weak demand soften prices

Last week's Global Dairy Trade (GDT) auction saw prices drop across the board, with butter and skim milk powder recording slumps of 10% and 6% respectively. WMP price was down 0.4% to US$3,149/MT.

ASB economist Nat Keall notes that dairy prices are back to three-year lows on the back of three factors: a lack of strong demand from China for milk powder imports, weaker dairy demand in most other parts of the world, and comparatively better-supplied market than last season.

"Not much has changed of late to dissuade us of our long-held conservative view on dairy prices," says Keall.

He says the bank's below-market $7.25/kgMS milk price forecast has rested on three legs, all of which are still in play.

"For the last six months or so, GDT prices have largely travelled in line with, or perhaps even slightly below, our forecast track.

"Of note, China continues to be largely absent from recent auctions. 'North Asia' took just 15% of the WMP sold at this auction, which by our count looks to be its lowest proportion in nearly a decade.

"As we've noted in earlier reports, Chinese WMP production remains strong at the same moment that domestic consumption is still soft."

With recent Chinese economic data underperforming, Keall isn't envisaging a big change to this story on the demand side here.

"Additionaly monetary stimulus has been signalled, but nothing dramatic, and with consumer confidence weak, there's a risk that households simply horde cash in the event of interest rate cuts.

"For now, Southeast Asia is helping prop up demand, though the economic outlook isn't rosy there either. And finally, broad strength in the USD continues to make things tricky for many dairy importers."

ASB economist Nat Keall.

The supply-side story is much the same too. European production closes its peak period with decent year-on-year growth. NZ production experienced a record May with milk production jumping 8% year-on-year and while climate indicators are looking mixed for later in the season, output starts with a bit of momentum behind it, notes Keall.

"Softer WMP prices for contracts two and three suggest that buyers are feeling comfortable with the supply outlook for NZ's peak production months."

A weaker New Zealand dollar future may offer some respite.

Keall says Fonterra will end up with a more favourable exchange rate than anticipated when the season began, but that's comparatively small fry compared with the underlying weakness in prices.

"What's more, there will be progressively less scope for further weakness in the Kiwi to lift our forecast as the season wears on."

Westpac economist Paul Clark notes that last week's GDT results does little in terms of setting the direction for prices over coming months.

"For now, still soft global dairy demand and soft global dairy production are weighing on prices," says Clark.

"That said, an expected rebound in Chinese demand later in the year will hopefully provide some price support."

Westpac is forecasting a milk price of $8.90/kgMS for the season.