Given that a majority of dairy producers are losing a substantial amount of money right now on every pound of milk they produce, the majority of the news stories you read are overwhelmingly negative. In fact, we tracked stories that are written in the dairy news media and found 80 to 90 percent of this year’s stories focused on negative aspects of the dairy sector economy.

We acknowledge that things don’t look very good right now, but focusing on the negative certainly won’t do anything to keep you in business tomorrow. Let’s focus on where prices will be, where the opportunities are and how you can best position your business as we welcome 2010.

While it is painful right now, the good news is that all this unprofitability is leading to reduced cow numbers. We’ve already taken 144,000 head out of the herd, and it is very likely that by year-end, that number could grow to between 220,000 and 250,000. This number is a bit short of some earlier projections of 300,000 or more coming out of the herd.

Yet, in our estimation, the reduction in herd numbers, along with other global factors, are coming together to lay the foundation for bullish prices ahead. We may, in reality, not need to liquidate 300,000 head to see prices move back to profitable levels. We are projecting the average price for milk for 2010 to fall between $14.70 and $16.74.

Oftentimes, when coming up with a projected range of prices such as this, a person might be inclined to assume the mid-point would be a reasonable number to expect. We are more optimistic than that. We believe that $14.70, the bottom of our projected range, is really the worst-case scenario and is almost unlikely.

The $16.74 number looks almost probable to us. We even wouldn’t be surprised to see $18 at some point. That $18 price won’t be around for a long time, but we could at least touch it. We know that any number in that $18 range would be very welcomed, as it would bring back the black ink and stop the flow of red ink on your balance sheet.

Let’s look at some history to help put things into perspective. First, Figure 1* shows the year-to-year change in the calendar average milk price. As you can see, it clearly illustrates the painful increase in volatility that milk prices have been going through over the last decade or so.

If you feel like your milk marketing challenge has gone up exponentially, this chart supports those feelings! This chart also shows the historical extreme of the downside prices we are experiencing, compared to previous years.

Figure 2* illustrates the same extremes. You can see that in past years, when milk prices have gotten into the area they are now, they typically don’t stay there for long, and they very often have a substantial recovery.

Here’s the key thing to remember about market trends and psychology: When prices are down at historically low levels, and profitability is non-existent, and nearly everything written in the media is about how bad things are, and it seems it is going to stay that way forever, and everyone gives up all hope, then, typically, that is exactly the time that most markets bottom and prices turn higher.

Don’t allow your planning and attitudes to be influenced by the herd mentality of negativity. You need to be a bit of a contrarian when it comes to markets. When everyone else is giving up hope, you need to be optimistic and move forward in a positive way.

The monthly chart alone should show you that now is the time to be patient and optimistic, not the time to panic and think the world’s coming to an end. Because in fact, that has already happened.

There is much evidence to support an optimistic outlook for the future.

• Cow numbers
As stated previously, the herd is down. In fact, they are down (March to March) over year-ago levels. Historically, that is the leading indicator of an upturn in prices, typically within three to four months. That time is upon us.

• Milk production
In the past, we have seen that when January milk production is 2 percent or less above the previous January’s milk production, it historically has indicated a coming bull market.

• Global economic upturn
It is a bit tenuous and it certainly isn’t going to be straight up every day, but the worst of the global economic downturn should be behind us, and we should see an improvement in demand from all sectors.

• Commercial cheese disappearance is up
Everyone has been so focused on the bearish aspects of this market that this has gone all but unnoticed. Not only is disappearance up over year-ago levels, but it is also above the five-year average. Yes, exports are way off, but domestic consumption has stabilized and is recovering.

Figure 3* tells both a very positive and a very painful story: the milk-to-feed ratio. The purple line through the center of chart represents the running average milk-to-feed price ratio, while the more volatile blue line represents the monthly actual milk-to-feed price ratio.

As you can see, going back over 20 years, the ratio of milk prices never has been so unfavorable relative to feed costs. In some ways this ratio is very, very bad news and it is certainly the root cause of so much pain in the dairy industry.

On the other hand, the laws of economics have not changed. Unprofitability leads to reduced production, which leads to future profitability. So yes, it is painful in the short run, but in the long run, it is a sign of good things to come, because it will change. If you look back over time, the milk-to-feed price ratio line seldom has spent more than 18 to 20 months without returning back to its historical running average line.

Based on our positive projections for recovering milk prices, in addition to the fact that we believe feed input costs are highly likely to decline, we think it is very reasonable to expect the milk-to-feed price ratio to recover back to the 2.90 to 3.00 range. In other words, a return to profitability. Odds are great that grain prices will decline into harvest and that milk prices will recover into 2010. The combination of these two events should dramatically change the profitability situation on dairy farms across the country.

So how do you best respond to these market trends?
• Don’t panic. Don’t make decisions based on your most recent experiences.
• When milk prices start going up a little bit, don’t rush into pricing. We know you have been unprofitable and we know you are desperate to ensure future profitability. But don’t be so desperate that you lock in very small margins when better margins are possible. The trend for milk prices should be higher. Let it run its course. Don’t be in a hurry to sell.
• Just like you shouldn’t be overly bearish now, when milk gets back to $17 or $18, don’t start thinking that it’s going back to $25 or $30. Things haven’t changed that much that fast. While we are optimistic, we do not see $20-plus milk prices in the immediate future.
• On the feed side, the trend is currently down. Possibly toward fall or early 2010, grain prices could be back at levels that represent good value, and that may be a time to aggressively forward-price feed before the next swing-up in feed costs occurs. However, the trend will be down for some time and don’t get in too big of a hurry to price. Allow the market to stabilize and only start to buy if an uptrend starts to be re-established.
• The bottom line: Be optimistic for the future, plan for a return to profitability, and position yourself to aggressively price when milk prices reach into the upper teens. I wish you all the best in 2010! PD

*Figures omitted but are available upon request to editor@progressivedairy.com

Scott Stewart
President and CEO
Stewart-Peterson
scotts@stewart-peterson.com