Throughout the first half of 2022, both Class III and IV milk futures soared on tighter U.S. milk production, high feed costs, declining cow numbers, and multi-year highs on their underlying by-products, cheese and butter. Class III milk hit a new record high of $25.60 while Class IV milk rallied up to its new high of $26.30. As of the end of August, Class IV milk has continued its strong rally. In contrast, Class III milk, while still strong, has weakened. Why? Clearly, many of the fundamentals across Class III and Class IV have remained the same, such as tighter milk production and higher feed costs.

What has diverged, and quite starkly, are the fundamentals of Class III and Class IV underlying products. More specifically, spot butter, a by-product of Class IV milk, has continued to achieve new all-time highs almost weekly while U.S. spot cheese, a by-product of Class III milk, has fallen about 25% from its May peak. Understanding what is driving those fundamentals is essential to setting and adjusting your own pricing strategies.

 

Butter Inventories Are Declining as Exports Increase

 

Class IV milk futures have been strongly supported by supply shortages in U.S. butter. More specifically, U.S. butter inventories have declined 32% from their peak of 414.654 million pounds at the end of June 2021 to 282.598 million pounds as of August 2022.

Two factors are driving this significant reduction in inventory. First, butter production in the U.S. has declined on a year-over-year basis in eight out of the last 12 months, reflecting reports on both the East and West Coasts that cream is very tight right now. Indeed, a few butter producers have cited that cream cheese demand is especially strong and that cream is being diverted into that and other products. Secondly, U.S. export demand has taken a large bite out of U.S. inventory with a 67% jump in U.S. butter exports in the last 12 months versus the 12 months prior as of July. To sum it up, tighter inventories and lower production are keeping the butter market bullish.

 

Rising Export Demand Cannot Keep Pace with Roaring Cheese Production

 

In contrast to Class IV milk futures, Class III milk futures are being weighed down (relatively speaking) by an oversupply of its by-product, cheese. In July 2022, U.S. total natural cheese inventories set a new record high at 1.522 billion pounds, up 5% from the same month last year.

As inventories have remained strong, production output is showing no signs of slowing down. Over the last 12 months, 2.45% more cheese was produced than in the prior 12-month period, while U.S. cheese production has grown on a year-over-year basis in 12 out of the last 12 months. In the meantime, regional cheese publications report that cheese facilities are running full schedules and that milk inventories are readily available for cheesemakers. While U.S. cheese exports are up 19% over the last 12 months compared to the 12 months prior (as of July), demand hasn’t been able to put a dent in record inventories.

 

Keep an Eye Out for Fundamentals of Milk and its Underlying By-Products

 

With a bullish butter market and a bearish cheese market, dairy fundamentals are extremely mixed at this time. The good news for dairy farmers is that Class III and IV milk futures remain elevated at strong, profitable levels. However, it’s important to pay attention to Class III and IV milk prices as well as the fundamentals of its underlying products to understand price movements and what they mean to your overall strategy.

Dairy farmers have a lot of great tools available to them to hedge these prices and to protect their risk. It is more important than ever to have a plan in place and to be ready to execute when the time is right. At Total Farm Marketing, we have decades of experience understanding all aspects of the milk market. Look to us to help you as you make pricing decisions to help your operation grow and prosper.

 

 

If you have questions, reach out to one of our consultants at

800.334.9779 or visit us at TotalFarmMarketing.com.

 

 

 

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