Can commodity prices go higher?

MARKETS depend on a dynamic of supply and demand in order to effectively set prices that clear the supply, writes NICK HOLT-MARTYN, Director, The Dairy Group.
As we have seen recently with milk quota, when there is very little supply or demand markets struggle to operate effectively. A similar position is now being seen with powders where despite good demand there is little available supply to set prices.
The effect is a reported spot skimmed milk powder (SMP) price of more than £2,500/tonne, which is confirmed in reports from Dutch official prices of €3,580/tonne and yet the United Kingdom reported market price is only £2,000/tonne.
This suggests further UK price rises are to come and that the expected switch away from cheese will have started in earnest.
The effect should be commodity prices rising further and, increasingly, a reduction in cheese supply as we enter the autumn. This all points to significant price rises across the whole market in the next six months.
A note of caution for the future is that climate experts are suggesting the possibility of La Nina conditions in the Pacific this autumn, which would provide favourable conditions in Australia allowing a recovery of sorts in their drought damaged industry. A strong recovery could lead to weakening commodities in 2009.
In the meantime, these are excellent market conditions in which to draw up closer ties with customers, markets and production costs. Agreeing smart supply contracts now will help protect against future adverse market conditions.
The Market Price Equivalent (MPE) has rocketed to another new peak due to increases in skim and whole milk powders, while cheese/butter has slipped back due to a fall in whey prices. Returns are now up by 1.95 pence per litre (10 per cent) on May 2006, due to the strength in commodities, but particularly milk powders.
SMP is leading the way, up 47 per cent on the year, whereas mild cheddar is down one per cent, indicating the disparity in returns. With market returns rising, even through the May UK production peak, suggests there should be further price rises as UK production falls from the seasonal peak. The likelihood of cheese production falling over the next six months should strengthen the cheese market and allow an increase in powder production to partially satiate the commodity demand.
The strength in commodity sectors suggests the potential for a 10 per cent rise in the cheese market as milk is switched into commodities. With continued growth in world GDP and adverse weather affecting Australia for at least another production season, prices are set to remain at these high levels until 2009.
The graph of market returns, milk prices and milk deliveries shows that rolling prices are now set to improve for the next 12 months. The rolling weighted average milk price in March was down 0.6 ppl (3.3 per cent) on March 2006, the lowest level since October 2003.
The increase in the farmgate price should feed through as the year progresses, with continual up lifts as the market returns finally benefit dairy farmers. As outlined above, a significant price increase in cheese should be achieved before winter, helping to counter the increase in production costs, particularly energy and feed costs.
The weather has turned again with a wet May leading to a prevention of drought and a continuation of the recovery in production. Grass supplies will now last out June and it seems less likely that drought conditions will hamper UK production until later in the summer at the earliest.
Currently world weather is recovering from El Nino. However, if there is a sharp La Nina in the Pacific we could enter a period of prolonged wet weather similar to 1998-2003 which lead to increased world production and lower commodity values. The current commodity highs do not mean an end to volatility, only that we are on an upward price curve, the end of which we cannot yet foresee.
o The MPE is calculated from the weighted actual wholesale prices for liquid milk, cheese, butter and powders after the normal processing costs. The MPE accounts for 90 per cent of the UK market utilisation of milk.
The MPE is calculated from wholesale market values, whereas IMPE (Intervention Milk Price Equivalent) accounts for just 11 per cent of UK milk production and is effectively determined by the Council of Ministers and the prevailing exchange rate. The MPE provides a far superior indicator of the wholesale value of milk and therefore the likely market returns available to the dairy farmer.

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