Markets for shares, currencies and commodities have all been moving up and down by large amounts in recent weeks, with a bias to the downside.  At a simplistic level there has been growing concern around the slowing growth in China which is reverberating around the world.  Countries like NZ, Australia, Brazil and Canada are especially impacted by this as we all produce a lot of products, either dairy, iron ore or oil that are consumed by China. 


In NZ we have seen the share market weaken, but with moves both upwards and downwards.  The NZ dollar has also seen substantial weakness in recent weeks, which should soften the blow to our economy to some extent.


China grew so quickly that it really bolstered both the NZ and the Australian economies for many years. The Chinese paid exceptionally high prices for the products both countries produce, so its sharp decline in demand has hurt. 


The longer term impact of the slowdown in Chinese growth has really manifested itself in the decline in dairy prices that have been seen throughout 2014 and 2015. This will specifically show up in the form of a much reduced pay-out to farmers for the FY15/16 season, which is underway at present.  


NZ dairy farmers are forecast to get just $3.85[1] per kg of milk solids for the 2015/16 season, following an estimated c$4.40 per kg of milk solids for the 2014/15[2].  These payments will result in many dairy farmers being loss making for both years, following a boom season in 2013/14 where $8.402 per kg milk solids was paid out.  We believe that the real impact of this is starting to be felt around the country at present.  


While share market volatility driven by concerns around Chinese growth has been recent, the decline in dairy prices has been occurring for 18 months.  Following a period of elevated prices, dairy farmers in Europe, the US, NZ and China itself, have been stimulated to produce more.  It takes time to increase the number of cows in the herds and to put in the infrastructure to produce more milk.  But, probably unsurprisingly, production growth really accelerated during 2014. 


Unfortunately, this strong growth in global dairy supply coincided with slowing growth in demand from China and the Russian ban on importing some dairy products.  So the recent volatility in the Chinese stock market is really just exacerbating an already weak market for dairy and other commodity markets.


Fonterra (and therefore NZ) is a big part of the global trade in dairy, making up around a third of product traded (interestingly a similar amount to the OPEC oil cartel).  However, NZ, when compared with Europe, the US and China is a much smaller producer.  Those geographies are set up differently to NZ – with the majority of their product consumed locally.  So while NZ farmers have been exceptionally hard hit by the low international dairy prices – producers in other countries have not been as impacted due to sales into local markets.


Why is that important to NZ?  Because the price signals to produce less are muted in European, US and Chinese markets by local demand and government support programs, meaning we could be in a period of lower diary prices for some time. 


While there was a sharp recovery in the dairy prices on Tuesday night, overall prices were up 10.9%[3], this is only a small part of the market, and getting smaller.  So the market is becoming less transparent and the true value of milk powder is becoming harder to determine. 


For the market to truly stabilise we need to see supply decrease (rather than growth moderating) and demand to increase from a range of global regions.  With increased volatility in global equity markets and slowing growth in China, this return in strong demand growth is becoming less assured, in our view. 


So while the short term news flow for the dairy industry has shown some improvement, there is a long way to go before farmers will be at a level to break even.  The fall in the NZ dollar has provided some cushion, but we still remain cautious about the outlook for the dairy sector at present.


Brooke Bone

Portfolio Manager

Disclaimer: This blog is intended to provide general information only. It does not take into account your investment needs or personal circumstances and so is not intended to be viewed as investment or financial advice. Should you require financial advice you should always speak to an Authorised Financial Adviser.



[3] Event 147