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Got Milk

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la4angus

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Got milk?

You may want to butter up your portfolio

By Thomas Kostigen, CBS.MarketWatch.com
Last Update: 8:38 PM ET Apr 12, 2004

SANTA MONICA, Calif. (CBS.MW) -- The price of milk is expected to reach record highs this year, increasing about 50 cents per gallon by as soon as next month, according to some analysts.

The price for a gallon of milk already shot through the three dollar mark this month, up from $2.85 in March.

The Department of Agriculture predicts higher raw milk prices will create an increase of between four percent to six percent in retail prices for all dairy products this year. Dairy product prices typically increase between just one percent to two percent per year, according to the USDA.

Mad cow disease, fewer growth hormones and higher feed prices are behind the price jump. Last year, milk prices had been on the downswing , hitting record lows.

Dairy-futures traders are having a field day.

"We've been hitting records," says a spokesman for the Chicago Mercantile Exchange. Open-interest volume in dairy product futures has already doubled from last month's levels and is up fivefold from the same period last year, according to the CME.

Trading in dairy-product futures is relatively new, beginning in the late 1990s. The most actively traded contracts are Class III milk futures, according to the CME. That's cheese.

The CME trades contracts in four different dairy products: Class III milk (cheese), Class IV milk (skim milk and cream), nonfat dry milk and butter. These contracts provide price indicators for retail products in months to come. However, because volume and trading has been inconsistent in the fresh market, price indicators aren't as reliable as other commodity futures (i.e. crude oil), analysts note.

The translation into retail product prices includes a great range of factors, of which commodity futures pricing is just one. For example, one analyst says the reason milk prices have held steady until now (even though raw milk prices dipped last year) is that milk wholesalers "kept their prices the same, so they had some cushion."

Dairy-product prices beef up

Still, prices on all dairy products are expected to rise, along with other commodities for the rest of this year, analysts predict.

"It's really economics 101," says Peter Vitaliano, vice president of economic policy and market research for the National Milk Producers Federation. "There was an excess supply and softening demand situation following 9/11.That resulted in... 25-year low levels."

Farmers then cut back on production, he says. When demand picked up again last year, farmers were behind on production, but fell further behind when access to dairy cows from Canada was shut off due to mad cow findings in that country. Additionally, Monsanto (MON), which supplies a key growth hormone to dairy farmers to increase per-cow production, this year announced a 50 percent rationing of the product due production problems at one its plants.

The confluence of events will put dairy prices at new highs, with peak months being May and June, according to Vitaliano, before prices moderate as production capacity increases.

While, "you can't turn cows on and off like water," as Vitaliano notes, farmers can milk them more and import dairy cows from other countries besides Canada. "It will all work out when new cows are added," he says.

Not for everybody

Direct trading of commodities futures contracts may be outside the realm of most investors. (Commodities contracts are complex and extremely volatile.) But hedge funds and managed futures accounts are more retail-oriented products that allow investors to access the commodities markets with professional oversight.

Still, the perceived risk and volatility of the commodities markets is often too much for the average investor to bear.

"We invested our clients in a pooled commodity account four years ago," says veteran financial planner Jack Blankinship at Blankinship & Foster in Del Mar, CA. "Most of them would just as soon not have it as part of their portfolio."

He says, "we thought at the beginning of an economic recovery that commodities would be better performing. Turns out we were right, but our clients still aren't comfortable with them." He says they don't understand futures contracts, and are uneasy with the associated risk.

In any case, commodities should comprise at most between five and 10 percent of a portfolio, according to financial planning models.

For those wagering investments in the asset class, there are a plethora of choices. The USDA keeps tally on these products and sets a calendar of reports on its Web site.

With the basics like milk and gas prices pushing through new price levels, it begs the question of what will be next. Bread and water?
 

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