When asked, "What's going on in the butter market these days," my typical answer is, "Not a lot." But that is not the case during the past three months. Steady-to-increased-consumer-buying patterns in a still tough economy as well as strong butter exports have pushed prices sharply higher in the past three months.

Butter is trading at $2.22 1/2 per pound. This is a rally of nearly 70 cents per pound since the first of June. Butter prices are at the highest level since April 2004, when tight milk supplies pushed prices higher. The skyrocketing butter prices have created significant price movement in the milk market through the summer months. Milk prices are trading at $16.16 in the front-month September contract as traders are focusing on the demand and expected tight supply in the butter market to drive prices higher through the early fall.

This comes as a moderate surprise to even the milk market, as record-high production is still being seen despite the sharp herd reductions that took place over the past year. The rock-bottom milk prices and light demand through 2009 led to significant herd reductions and cullings, which were both voluntary and financially forced. Milk production through July was listed at 16.48 billion pounds. This is a 2.9 percent increase in production over the same month in 2009. Year after year, milk production continues to set new records as management, genetics and feeding practices continue to improve.

Even with record milk production, one look at the current market would have most people asking, "What is going on?" This has even caused some in the dairy industry to scratch their heads. The simple answer seems to come from the most unlikely source: the butter market. Butter is typically a dull market that only trades occasionally on the cash exchange market, and price levels usually are slow to react to market conditions. But in 2010, this overlooked market seems to be leading the industry.

Over the past several months, Cooperatives Working Together (CWT), an industry group developed to coordinate voluntary herd reductions and export assistance, has used export assistance to clear 33.1 million pounds of butter and/or anhydrous milk fat. This is pushing stocks of butter significantly lower. As of the end of July, total butter stocks were just 199 million pounds. Even though this was a 1 percent (or 2 million pound) increase from June levels, it is well off the pace from previous-year levels of 262 million pounds. This is at a time when butter inventories are typically at the highest level of the year.

The butter market is unique in that most demand comes in the last quarter of the year, due mainly to holiday and year-end consumer demand. The late-year demand creates a need for producers to aggressively build stocks throughout the year in order to maintain a working supply of inventory by the end of the year. But with the tight supplies and prices moving sharply higher during the past three months, many traders and merchandisers are concerned that there may be significant butter shortages over the next three months.

This tight supply and strong short-to-intermediate demand in the butter market will likely keep prices significantly higher over the coming weeks. Toward the end of the year, after wholesale purchases are finished, demand is expected to seasonally tumble, which could create a sharp downward move in the market. With milk-production capacity expected to continue to grow due to the increased prices, the market may become much more volatile over the next six months. For now, most traders and marketers are concerned with creating enough product to get through the end of the year, and this could continue to push prices significantly higher through the fourth quarter of the year.

Rick Kment can be reached at rick.kment@telventdtn.com

(SK/GH/AG)

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