The Price of Milk

Sep.18.09 | About: Dean Foods (DF)

As the G-20 looms ever nearer the sword rattling, chest pumping and feather fluffing is building towards the crescendo that inevitably leads to smiles and hand shakes, hugs and kisses (both cheeks of course) that will be captured by thousands of impromptu photo-ops during the course of the gathering.

The U.S. and China have been at it pretty hot and heavy as of late with tire tariffs, the crimping of cross border chicken commerce and filing law suits with the WTO. This all in addition to calls earlier this year for removal of the USD as the world’s reserve currency and increased emphasis on the IMF’s SDRs.

Behind the scenes, however, China continues to be the largest holder of U.S. Treasury securities; minding a mere $800.5BN for Uncle Sam as of the end of July, up from $776.BN at the end of June.

While the world watches this Sino~American waltz, something else appears to be going on behind the scenes. In thinking of how to describe this to you, the movie “Fantastic Four Rise of the Silver Surfer” comes to mind or at least the part of the movie where any contact between the 4 would cause the exchange of the “Fantastic” characteristic between the two heroes. The Thing catches on fire and the Human Torch turns to stone etc. etc. etc.

Half of what gave rise to this comparison was recent news that dairy farmers are petitioning federal antitrust regulators to investigate competition in the industry. It all began when milk prices began to rise dramatically in 2007 and being capitalists, at least temporarily, the dairy farmers began to increase herd size as quickly as possible adding 190,000 milk cows, a 2% increase, between early 2007 and December of 2008.

The global recession made sure to stop by Old MacDonald’s farm and the result has been a 36% drop in milk prices in the last year. Now those same dairy farmers are accusing Dean Foods (NYSE:DF) and the Dairy Farmers of America, a milk buying co-op in Kansas City, MO of duopolistically controlling the price of milk. DF says it buys “less than 15% of the nation’s raw fluid milk supply” and “does not control dairy prices or the dairy market.”

That said a group of dairy farmers is set to meet with the chief of the Justice Dept.’s antitrust division at a Vermont hearing of the Senate Judiciary Committee which evidently has Democrats from the big dairy states of Wisconsin, Minnesota and New York among its members. Talk about a bail out of a different color!

On the other side of the world, farmers in the Middle Kingdom have figured out that they can make more money by renting out their farm land than by working it themselves. The land itself is owned by “village collectives” which translates into local representatives of the Communist Party but the farmers have been allowed to “lease” their right to farm the land since 1984 and furthered by legislation passed in 2002 in an effort by the government to battle persistent rural poverty.

Rental rates doubled between 2005 and 2008 and now an acre of arable land fetches $267 which might sound low but is comparable to the price paid for irrigated cropland on this country’s West Coast. This all works because the renters raise high value crops like tomatoes and peppers for export while the locals use the land for rice and other subsistence foods that rarely make it off the farm.

So there you have it: our dairy farmers want to eliminate one of the essential elements of capitalism, competition, while the Chinese farmers are finding ways to become capitalists.

By the end of the “Silver Surfer”, everyone has their proper powers back and we can only hope the dairy farmers' delusions are temporary as well.

The CDS/equity relationship for Dean Foods appears as screwy as the situation in the dairy market as there are fairly long periods where the correlation between the two price streams is positive which is a contradiction to empirical evidence. Both prices streams have been range bound this year with the CDS peaking at 428bps in March and reaching its nadir of 317bps on August 6th with a few round trips close to the edges in between.

The stock posted a close of $17.61 on May 7th and $17.60 on August 27th. On the upside, $20.70 was reached on April 30th and $21.92 on July 23rd. The interesting bit is that between these dates and prices the CDS and equity spend a lot more time going in the same direction than they do moving oppositely. A relationship to watch to see if and when things go back to the way they should be.

Enjoy the weekend, Comrade.