Milk story may be turning sour

New Zealand Digest: Milk story may be turning sour

- Dairy prices fell sharply in the past six months (-40%), largely reflecting an apparent ramp-up in Chinese milk powder inventories last year, which is now being run down

- Although we expect the inventory downswing has a bit further to run, we expect prices to stabilise in coming quarters, supported by strong medium-term dairy demand

- Falling dairy prices are likely to be a drag on New Zealand’s income growth, although we still expect strong construction and immigration to support above-trend GDP growth in 2014

Dairy price decline to drag on income growth
Dairy prices have fallen sharply in recent months, taking some of the shine off New Zealand’s strong growth story. According to the GlobalDairyTrade Index, dairy prices are 40% below their February peak and are now a touch below their post-2000 average. The dairy price fall has been dramatic and is a timely reminder of the volatile forces that large commodity producers can face and need to manage.

Nonetheless, we remain optimistic about New Zealand’s overall growth prospects, as dairy is only one part of the strong growth story. Growth is still expected to be supported by the substantial and on-going post-earthquake rebuild in Canterbury, a strong upswing in residential construction in Auckland, and rapid net inward migration. Consumer and business confidence remain at levels consistent with above-trend growth in 2014.

Although the data are limited, it appears that the fall in dairy prices largely reflects a cycle in Chinese dairy inventories. Available trade data suggest there was a substantial rise in Chinese dairy imports in late 2013, which has largely retraced in recent months. Imports had ramped up well ahead of previous trends, suggesting that significant inventories are likely to have been accumulated, which are now being run down.

At the same time, however, near-term supply is set to continue to be supported by better weather in New Zealand and Europe. In 2015, the removal of European milk quotas could also see an increase in the supply of traded dairy products. We see the price cycle over the past year as a result of temporary demand and supply imbalances and an inventory cycle. We expect medium-term demand for dairy products to remain strong as Asia’s middle class incomes rise and their diets change. Dairy prices should stabilise in coming quarters, although they seem unlikely to return to their recent peaks in the near term.

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