There was a report out yesterday that said milk prices are expected to fall this year and next. The only thing is, the reason they give just do not make a whole lot of sense.

The USDA, in its survey of 30 cities spread across the country, reported an average price in August of $3.87 per gallon of whole milk, an increase of 1.8 % over July’s $3.80. So, what reasons are bring given for the upcoming decline?

Feed

After a rapid rise this year in cattle feed cost due to the cost of corn because of ethanol production, this cost is expected to level out and then begin to ease later this year and next. Why? The demand for corn for ethanol is still increasing and even this year’s crop (the largest in 50 years) did not cause corn prices to fall very much. What would happen if next years crop was a bust? Even if next years crop is just ok, with the built in demand for corn, prices would explode. We just had record corn prices this year and everything went perfectly for the farmers of it. We should not expect these conditions to be the norm. We know that ethanol mandates are going to be increased this fall when congress gets back together so we can bank on an increase in demand from that industry.

Supply

With high prices this year, dairy farmers are working overtime to take advantage of the market and large supply is coming on line. We also have had reports of demand destruction because of the high price currently. If this record supply comes on line and drives down prices, we will see demand pick back up and that should take up slack in the system that would prices down.

Not much is being said about the increasing demand for “organic milk”. Consumers want the product and as more dairy farmers switch to producing an organic product, that in and of itself will decrease the supply of regular milk, driving up the price for it to consumers. The irony here is that this very scenario may cause a decrease in organic milk prices that in most places exceed $5 a gallon.

In short, I think any prediction of milk price significantly receding from the historically high levels are more “hope” than an economically sound argument. When you have a record crop in the main item responsible for the increase (corn) produced under perfect conditions, you must assume some disruption in that paradigm next year. If you are at record high prices under perfect conditions, you must entertain the notion or not a price decrease but an increase if those condition deteriorate.

Recently companies like Starbucks (SBUX), Kraft (KFT) and JM Smucker (SJM) reported earnings and all said raising dairy costs were affecting earnings. I would be extremely hesitant to take any prediction of a price decrease to heart and even more hesitant to make an investing decision on it.

Just too many variables that depend on mother nature..

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