“Don’t cry over spilled milk” is one cautionary cliché about dairy. New Zealand hasn’t spilled any, but the country’s economy is on the brink of tears because of it.
Diversification is one key to being a successful investor. It’s also important for entire economies. When a country becomes too dependent on one industry or one customer it’s like an investor that only owns one or two stocks – its fortunes are tied too much to one thing. New Zealand – and, of all things, milk – are a good example of what can happen when a country’s economy isn’t diversified enough.
Unlike oil or gold, milk isn’t a commodity that investors spend much time thinking about. It’s a multi-billion-dollar global industry and an important source of nutrition. But you won’t hear updates on CNBC about milk production disruptions. And it isn’t the cause of serious geopolitical tensions or conspiracy theories.
That is, unless you live in New Zealand, now home to not only more sheep than people but more dairy cows too. There are 6.4 million cows and only 4.5 million people.
Thanks to a good climate, and lots of grazing space, New Zealand is the Saudi Arabia of milk. New Zealand is the world’s largest dairy exporter, and accounts for 40 percent of the international dairy trade. Dairy products make up 7 percent of the country’s total economic output.
The world’s largest dairy exporting company, Fonterra, is also New Zealand’s largest company. Fonterra has a market capitalization of around US$6.3 billion, and controls over 20 percent of the world’s cross-border dairy trade. For the year ending June 2015, New Zealand’s dairy cows supplied 21.3 billion litres of milk. That’s nearly 11 cups of milk for every person in the world.
So, just like Saudi Arabia’s economy is a hostage to the price of oil, New Zealand’s fortunes are closely tied to the liquid white gold. The graph below shows the relationship between the value of the New Zealand dollar and global dairy prices. Dairy prices are measured using the Global Dairy Trade (GDT) price index. (Global Dairy Trade is headquartered in New Zealand and is owned by Fonterra.)
When milk prices are high, importing countries need to buy more New Zealand dollars to buy milk from them. When milk prices fall, there is less demand for the New Zealand dollar, and so it falls in value.
New Zealand has long been a giant in the dairy world, but the industry exploded when the country signed a free trade agreement with China in 2008 that cut dairy tariffs. Increased Chinese demand resulted in New Zealand’s dairy production growing by 5.4 percent per year in the following seven years. Before the deal, dairy production was rising just 1 percent per year. Meanwhile, milk prices increased sharply, rising 172 percent in the five years after February 2009.
China became New Zealand’s cows’ most important customer, accounting for 25 percent of New Zealand’s dairy exports. One of the fastest growing exports was whole milk powder, which is what’s left after water is removed from milk. Milk powder is easier to ship than whole milk, has a much longer shelf life, and it can be used as an ingredient in everything from ice cream to nutritional supplements to candies.
China’s imports of whole milk powder rose about 13 times from 2008-2014, with New Zealand accounting for more than three-quarters of those imports. Prices rose from US$1,851/metric tonne in February 2009, to over US$5,000/metric tonne in 2013 and 2014.
We’ve written before that the “solution” to low commodity prices is nothing more than low commodities prices themselves. The opposite is true, too. High dairy prices attracted more competition around the world, as farmers were drawn by the profit margins of milk production. As a result, global milk production rose from 697 million tonnes in 2007 to 789 million tonnes in 2014, growing at 1.8 percent a year.
Meanwhile, import demand from China (as well as Russia, a big milk importer) fell. China increased its own production of milk, and also stockpiled milk powder. In 2015 China cut the amount of whole milk powder it imported by 53 percent.
After the average price of milk peaked in early 2014, it fell 40 percent by the following year – to US$3,042/metric tonne in February 2015. At the most recent price auction on May 3, it hit US$2,203/metric tonne, down 56 percent from it peak in February 2014. These are the lowest prices since 2009.
(There is even a milk conspiracy theory… During the boom times, China was actually stockpiling huge amounts of milk powder. They did this when prices were rising with the idea that when they stopped buying, there would be excess milk, prices would crash – and then they could swoop in and start stockpiling again at much lower prices.)
Partly as a result of a slowdown in the agricultural industry, and the dairy industry in particular, New Zealand’s economic growth slowed to 2.3 percent in 2015, from 4.1 percent in 2014.
The New Zealand dollar has fallen 16 percent since milk prices peaked. That means that everything New Zealand imports has become more expensive. (A lower kiwi dollar also means that these same milk exports become more attractive because they’re now cheaper in foreign currency terms.)
The country’s dairy farmers are hurting the most, as their collective revenue has fallen by nearly US$5 billion – equivalent to about 2.5 percent of GDP. The country’s dairy farmers also have a lot of debt, with total dairy farm debt more than tripling since 2003 as the sector expanded. Now, New Zealand’s farms have an average debt of nearly US$3,500 per cow.
The country’s central bank warned that low milk prices, along with a drop in property prices, could together push non-performing loans in the dairy sector to 44 percent. If milk prices stay low, land prices could fall another 40 percent over the next two years, the central bank warned.
For Russia, Saudi Arabia, and a number of other countries, it’s oil. New Zealand faces a weaker economy, falling land prices, increasing debt, worries over bad loans and the stability of its banks – all because of milk.