Crucial to survive the bad years

Global economist John Macfarlane told Fonterra shareholders last week the key is to survive the worst years.

"The key challenge we have in the volatile market is to survive the bad years; the good years will look after themselves," he says.

Macfarlane and US brokerage firm head Brian Rice were invited by the Fonterra Shareholders Council to speak at eight meetings around the country.

Melbourne-based Macfarlane, who owns dairy farms in the South Island and supplies Fonterra, spoke about the global economic situation and its impact on commodity prices.

He urged farmers to protect their low cost production base and maintain balance sheet strength to ride out the downturn.

He also urged farmers not to rely on what European farmers were doing.

"We can't sit here as farmers and say it's irrational for the Europeans to produce milk at $7/kgMS. Relying on other people to act rationally is not a good strategy."

Macfarlane showed farmers a chart in which global growth had been revised down past two years, important because there is a strong relationship between global growth and demand for commodities.

"It's not a complicated relationship, but a linear [one]," he says.

Economies have grown less quickly and demand for commodities, including dairy products, has waned.

Macfarlane says New Zealand's major dairy trading partners -- China, other Asian markets, Middle East and Latin America -- have all been growing more slowly.

He believes the tightening of fiscal policy in the US is also impacting commodity prices.

Interest rates in the US have been kept at zero since the global financial crisis in 2008-09. Last December the Federal Reserve raised the rates to 0.25%, with more rises to follow.

Macfarlane says according to the Federal Reserve, the rate could go as high as 3.25%. This is important because every time the US Federal Reserve has tightened its fiscal policy there have been "casualties".

In 1990, it triggered the Latin American crisis and Argentina is still struggling to recover; in the 1990s the Asian financial crisis was caused by the US dollar going up, catching many Asian economies off guard. In 2008-09, it triggered the global financial crisis.

Macfarlane says commodity prices may be the first casualty of the latest US Federal Reserve move. In anticipation of rate hikes commodity prices have tumbled.

He says dairy farmers should not feel they have been picked on. "A range of agri commodities, like those traded in the US, have been affected, including soya bean, orange and pork."

China is transitioning from a manufacturing to a service and consumption economy, he says. "What China is attempting to do is incredibly ambitious; as major export partners we should be prepared for accidents along the way."

Macfarlane says demand for dairy products in China remains strong, unlike iron ore which was widely used in infrastructure projects until a few years ago.