U.S. Dairy Industry Curdles Under Pressure: Part 2

Matthew Carr By Matthew Carr
Emerging Trends Strategist

Commodities

To describe the topsy-turvy political and social climate of 2017, Oxford Dictionaries chose “youthquake” as its “Word of the Year”… a word I’d never heard of.

The American Dialect Society picked the far more relevant “fake news.”

For 2018, I’d be surprised if they aren’t considering “tariff” for their annual honor. Or maybe “retaliatory.”

You can’t turn on the TV, listen to the radio or wade into the tumultuous waters of the web without being bombarded by those two words.

“Tariff” is moving the markets. And it’s diverting investors from what they should be focused on – robust corporate earnings.

This month there’s no getting around the fact that “tariffs” and “retaliatory” are the dominant words on investors’ minds.

The U.S. has lobbed tariffs at multiple countries. The goal is to eliminate trade inequities. The problem is those countries are lobbing them right back in retaliation.

Love Thy Neighbor?

To kick off July, Canada slapped tariffs on $12.6 billion of U.S. goods. These include 25% tariffs on U.S. steel and iron. And then there are 10% tariffs on everything from beef, dishwater detergent, ketchup and maple syrup to orange juice, pizza, whiskey and yogurt.

Canada is the U.S.’ second-largest trading partner.

China, America’s largest trading partner, began imposing a 25% tariff on dairy, pork, soybeans and more than 500 other U.S. products just yesterday.

Mexico, the U.S.’ third-largest trading partner, instituted a 20% tariff on U.S. pork on July 5. And it’s also launching 20% to 25% tariffs on U.S. cheese and dairy products.

That was just the first week of July. And it doesn’t include all the tariffs levied in June.

So this tit-for-tat appears poised to escalate.

Here’s the biggest problem: Canada and Mexico account for one-third of all U.S. agricultural exports. And the U.S. dairy industry has already asked the White House to suspend tariffs on Mexico.

That’s because the retaliatory tariffs Mexico is launching will inflict long-lasting damage on an already weakened industry

A Tarnished Silver Lining

Since 2000, half of all American dairy farms have disappeared.

That’s the result of the fact that farmers are getting paid less for milk than what it costs to produce.

But one of the few bright spots for the U.S. dairy industry has been exports.

Since 1996, the percentage of U.S. dairy production shipped overseas has soared from 3.6% to 14.7%.

And the biggest exporting opportunities have been to those countries now levying tariffs…

Dairy exports to China and Japan increased more than 40% last year. Part of that is because Japan’s own dairy industry is dying.

Meanwhile, Mexico is by far the largest market for U.S. dairy products. In fact, our southern neighbor’s imports of U.S. cheese topped $400 million in 2017.

That’s why American dairies are concerned about retaliatory tariffs. They open the door for European competitors to slip in and grab market share.

Tariffs may target countries or industries, but they hurt individuals and companies the most.

For example, the U.S. dairy industry’s third-largest export market, Canada, has made headlines with its trade policies.

The country’s tariffs on U.S. dairy imports can range between 200% and 300%. And this became a pulpit-pounding soundbite when talking about unfair trade practices.

But those tariffs are applied only to surplus.

For instance, Canada applies a 7.5% tariff on U.S. milk imports that are within the quota. But the tariff surges to 241% once imports go over the quota.

The country has long employed this strict supply management system. Canada’s dairy industry is very different from the U.S.’ It’s built to avoid any sort of surplus.

And there aren’t 10,000-cow dairy farms in Canada like there are in the States. It’s a lot of small family-run farms that are profiting as the rest of the world is drowning in a milk glut (as I covered previously).

Canadian dairy farmers are paid only for milk that’s produced within their allotted quota. And quotas are sold among Canadian dairies for millions of dollars.

Because of this strict system, prices for milk in Canada have been on the rise. And in 2016, Canadian dairy farmers received 61% more per liter than their U.S. counterparts.

On the surface, it appears grand. Canadian dairy farmers are thriving during the global dairy deluge.

But the reality is that the individual is sacrificed. For the consumer, it’s a worst-case scenario.

For example, in Canada, a gallon of milk costs roughly $6.40. That’s double what it costs in the U.S.

Wait and See…

July marks the beginning of a difficult new era for U.S. dairies. A month full of my Word of the Year candidates.

New export markets – particularly in China, Japan and Southeast Asia – have provided some relief. But a bevy of new tariffs from Canada, China and Mexico threaten to unravel all of that.

For investors, the U.S. dairy industry is in dire straits. This isn’t quite a “buy when there’s blood in the streets” moment because the first shots have just been fired.

But the industry is one I’d avoid… for now.

Good investing,

Matthew