While milk prices have rebounded strongly over the past two months, recovering 63% at GlobalDairyTrade from their August lows, Rabobank cautioned against expecting an extension to the strong recovery.
The recent rally represented a correction, after an «overshoot on the way down».
«It is difficult to see any tectonic shift in the market fundamentals that explains the sharp improvement in dairy commodity prices from mid-August to late September,» the bank said.
Weak demand
Milk production has «continued to outpace weak consumption growth», said Rabobank.
Milk output is slowing in New Zealand, with the bank forecasting a 7-10% decline, a steeper drop than estimated by Bank of New Zealand last week, and foreseen by Fonterra, the Auckland-based dairy giant.
«A contraction of milk production of this magnitude would reduce New Zealand milk exports by around 10%—wiping around 1.5bn litres of product off the international market in a 12-month period,» Rabobank said.
But supplies from other regions have remained strong, particularly in Europe where the end of milk quotas supported production.
Chinese inventories
Meanwhile on the demand side, dairy markets are still working through the repercussions of a Chinese buying spree in 2013, which created a backlog of milk powder still being worked through.
Import demand has also been undermined by strong domestic mill production growth, which Rabobank pegged at 5.5% in the first half of 2015, up from a previous forecast of 4%, and compared with demand growth of 2%
«Despite reduced imports, Chinese processors appear to have made few inroads into reducing stocks,» Rabobank said.
Indeed, even in the first half of 2016, China’s imports «will only stabilise, not increase.»
‘Mountain of milk’
The dynamics imply a market in which a «rebalancing of fundamentals… is now almost at hand».
However, before prices stage a substantial recovery «the world must first consume the proverbial mountain of milk, notably milk powder, that has been accumulated during the market downturn.»
The bank forecast that «pricing pressure will build as the first half of 2016 progresses – from modest in the later stages of the January-to-March quarter, to significant late in the April-to-June quarter».
Even so, the price recovery, on a 12-month horizon, will be limited by factors including China’s «less prominent» buying, and the strength of the dollar, which reduces the affordability of dollar-denominated assets such as dairy commodities.
The bank, which had in June forecast prices recovering in «late 2015-early 2016», trimmed its forecasts for values of major diary commodities for the first half of next year.
Key catalyst
Earlier this week, Macquaire also said that Chinese stocks were still weighing on prices.
«The key catalyst for whole milk powder prices in the near term will be the clearing of inventory in China,» the bank said.
Macquarie estimated Chinese whole milk powder reserves at around 300,000 tonnes, or around 3-4 months of supply.
«China has also had a very strong production season themselves, providing plenty of liquid milk to meet consumption and processing requirements and less requirement to draw on the mound of whole milk powder inventory.»
Macquarie also warned that although domestic product was considerable more expensive than imported supplies, there might be political support for dairy self-sufficiency «which may create additional barriers to exit for farmers».
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