GDT 182 - hold your breath!

The following blog is from JT Macfarlane who I introduced two weeks ago.  JT is keenly interested (and qualified) in commodity markets and is providing the below as a commentary on GDT; his motivation I think is mainly as a dairy farmer himself but is also as a Director of MyFarm....

GDT auction 181 held on 7 February provided a positive surprise to myself and most market observers.  My expectation (from my note of 5 February) was for a fall in the GDT Index of 1-2% but I flagged that I thought the risk was of a larger fall given market weakness in some products in overseas markets (specifically skim milk powder - SMP), uncertainty around Mexican demand for US product and the flow on impact of US exports to other markets. I also noted improving supply dynamics in both NZ and Europe.

However, the auction result surprised across the board with the GDT index recording a 1.3% rise, WMP a 1% rise and SMP a small 0.1% rise but an average price of $2,608/t. The auction surprised not just local analysts but feedback from offshore was similar.

News Flow:

A review of the news flow over the last 2 weeks doesn’t instil much confidence for a repeat performance in tonight’s auction:

  • Fonterra reported better than expected milk collections for January (-2.9% in NI, +0.7% in SI) and revised up its season collection estimate from -7% to -5% (currently sitting at -4.9% YTD)
  • As a result of the above it added 5,000 t to whole milk powder (WMP) auction volumes over the next 4 months and 5050 t to SMP volumes over the same period (small volumes were also added to butter milk powder (BMP)
  • European SMP stocks remain an overhang and the authorities have had no success in clearing those. Since auction 181, a number of sources have reported SMP contracts being completed at or close to $2,000/t. To state the obvious, this is a significant discount to the $2,608/t at the last tender [note that as of this morning the Feb SMP contract on the NZX is still quoted at $2570/2630 and there are bids at $2,400/t across the curve out to October 2017]
  • Prices for other products (AMF, butter) have generally eased since the last auction.
  • Notwithstanding storms in California, the US market is generally reporting increased production, as is Europe as we head into northern hemisphere spring (although it remains to be seen what this will look like on a year on year basis in a couple of months).
  • Mexico remains the US market’s largest export destination and the continued rhetoric out of Trump, combined with some key Mexico contract losses by the US to Europe has impacted US sentiment.

Price Implications:  

  • As it stands, near contract WMP prices are off about 2.5% and SMP prices off anything from 2.5% to 7% depending upon contract and category (eg. medium heat)
  • This weakness in WMP and SMP should feed through to the GDT index and we are expecting (again) a fall of 3% - 5% but hoping to be wrong again!
  • The NZ milk price futures have been subdued. The 2016/17 contract which was trading at $6.20/kgMS into the last auction has weakened a little to $6.17/kgMS and 2017/18 which was quoted at $6.30/35 before the auction 2 weeks ago is now $6.20/25/kgMS [last at $6.25/kgMS]
  • With Synlait guidance at $6.25/kgMS for the current season, an update from Fonterra is expected shortly and the industry is generally expecting an increase in guidance to similar levels, notwithstanding the above price action.

Conclusion:

Price action in the market ahead of the last auction was poor but the result of GDT 181 was robust. Price action since that outcome has been similarly poor. How should we interpret this?

Jon Spainhour from Rice Dairies provided the following commentary on the North American NDFM market and I apologise if I am extending his commentary beyond the intended market but I sense it sums up what we are seeing most succinctly.

“…as bearish as all the news is, I think it is worth pointing out a few counter points. As far as we can tell, many of the spot sales at lowr levels appear to be coming out of the trader / distributor level. The manufacturing level still seems hesitant to get too aggressive. Several have claimed they are well sold through the end of the quarter due to sales done at the end of last year. They simply don’t have massive spot sales to make, at least for now. This can go two ways: the market rallies and manufacturers are the only one with product or the manufacturers will have to come to the market and look for bids in a market that has already been sold. Last year it was the latter and most people expect the same thing will happen this year. I’ve been around long enough to know we never see the same movie twice in this industry, so I am sceptical of a massive price break like we saw last year.”

If Jon is correct, we may see some near term price weakness and volatility but hopefully it will not be a rerun of the $600/t fall in WMP prices we saw in January 2016!

A couple of positive notes to finish:

Firstly, an update on the Fonterra share price! I won’t provide a lengthy commentary other than to note that, as of this morning, FSF has attained my first “technical” target price of $6.35. It will do some work here but ultimate target is $6.75!

Secondly,  I try not to be too “microscopically” focused on dairy so I also offer you the following chart to put you in a positive frame of mind! The “I” in my “MILO” analysis is of course iron ore. Iron ore prices staged a major recovery last year and finished the year at $80/t (more than double their lows). Supply dynamics (increased supply) suggest that prices should weaken through 2017 and in my January Outlook I projected a volatile year for iron ore prices with a price range of $50 -$95/t and a closing price of $65/t. This is more optimistic than most industry analysts who are forecasting $50 - $60/tonne.

In this context it is worth having a look at the chart below provided yesterday by John Horner from Deutsche Bank.  The chart plots Chinese steel prices (green line) against iron prices (orange line) and the AUD (yellow line). Iron ore prices continue to surprise on the upside (currently above $90 / tonne) and the chart below suggests further upside based upon Chinese steel prices (as it does for the AUD). China is definitively the biggest player in the iron ore market and while there are questions about the sustainability of the demand picture in China, the current situation looks relatively robust. 

Whilst Iron Ore isn't milk, this is just a reminder that the broader commodity complexes look very different to 12 months ago and while weakness in specific markets can be expected, there is also a good deal of white noise! An eye on the fundamentals is important and supply – demand dynamics in many of these markets remain more positive than 12 months ago. Arguably, iron ore is one market with quite negative supply – demand dynamics and yet it is surprising on the upside!!

Auction 182 - Brace yourself but don't get too negative.