What moves the farm price of milk?
Monday, June 5, 2017
Posted by: Lauren Brey, director of marketing and research
By Andrew M. Novakovic, The E.V. Baker Professor of Agricultural Economics, Cornell University
Economists have a stock answer when they are asked what determines the price of something or why a price moves – “a combination of supply and demand,” including factors like cost of production, yields, family income, prices of alternative goods, etc. All true but not so very helpful. Usually when we ask that question, we are asking either what are the one or two major things moving the price of milk now or perhaps what are the big movers on prices over time.
I was at a meeting recently when someone asked me whether I thought that Bob Cropp’s old rule of thumb was still valid, i.e., when production increases more than 2 percent, milk prices will decline. Less than that and prices will increase. Thumb rules like this are a distillation of complex possibilities that are revealed over time in patterns that analysts can recognize.
This general pattern is indicated in Figure 1 (below), which shows monthly Milk Marketings compared to monthly All Milk Price, both expressed as a year-over-year (YOY) change (e.g., 1.01 is a 1 percent increase, .90 is a 10 percent decrease). From 1996 to 2006, it is pretty clear that increases in milk production coincide with declines in milk price and vice versa.
However, take a look at this same calculation for 2007 to 2017 in Figure 2. Now the relationship is not so straightforward. Indeed, in some years it looks like it works in the opposite direction.
When Bob formulated this old thumb rule, it was in a market environment where sales of dairy products didn’t change much from year to year. The change in marketings, or how much farm milk is sold, moved up and down more than sales of dairy products. So, a 2 percent increase in marketings was very likely to mean supply was increasing faster than demand.
If we look at changes in demand relative to changes in supply over this time period we get a much clearer understanding of what is going on. In Figure 3, we compare the same YOY change in monthly prices with a little more complicated calculation of sales versus marketings. I calculated the YOY changes in monthly marketings and monthly total commercial disappearance (domestic use plus commercial exports). Then I took the difference between those two numbers to get a monthly measure of which was increasing at a faster rate. A positive number means that “demand” is increasing at a faster rate than “supply.” Turns out the dynamics of short-term markets means that this monthly number bounces around quite a bit; so to make it easier to see the effect over time, I calculated a 12-month rolling average of this monthly index. This is what is compared to price in Figure 3.
With rare exception, milk prices rise when Total Commercial Disappearance is increasing at a faster rate than Milk Marketings. It doesn’t matter so much whether either one is rising rapidly or even decreasing a little, what is important is which side of the market is holding stronger than the other. So, it does all come back to supply and demand.
Today, trade is much more important than it was prior to the opening of U.S. markets in 1996 with the Uruguay Agreement on multilateral trade – the agreement that gave us the World Trade Organization. And, trade is much more volatile than domestic sales.
We are going to need some new thumb rules.