The 'Saudi Arabia' of milk shakes off dairy gloom

The New Zealand dollar and stocks are rising as a delay in a US rate hike lures investors to embrace risk.

Summary: In New Zealand, stocks and the currency have been climbing. Although milk prices are down compared to a year ago, they have jumped since August as Chinese demand holds up. Tourist arrivals are at record levels and home prices have jumped.

Key take-out: New Zealand’s overall market doesn’t look cheap but now may be a good time to look for bargains ahead of a possible rate cut.

Key beneficiaries: General investors. Category: International investing.

Got milk?

Bet you wish you did: New Zealand, the Saudi Arabia of milk, is enjoying a revival of popularity among the global investment herd. With the prospect of a US Fed rate hike now slipping over the horizon, investors are stampeding back into risky markets they had abandoned for fear of their exposure to receding Chinese demand. Low US rates don’t really have much to do with how much China imports or how much its citizens eat or drink, but they do make investors a lot more willing to risk cheap dollars chasing higher returns in the farthest corners of the world.

New Zealand’s dollar, the Kiwi, has climbed 7.5 per cent in the past month. That’s triggered a rally in stock prices, which have climbed 3.7 per cent in the past two weeks, with giant milk exporter Fonterra (FSF.NZ ) gaining 2.6 per cent.

The market for milk remains somewhat sour. Like oil, the world is in the midst of a milk glut. According to Rabobank, production is still rising even as big importers work through massive stockpiles of milk powder. Prices are down 7 per cent from a year ago and 50 per cent below their peak in February 2014, according to HSBC. Prices have fallen farthest in New Zealand, where Rabobank says milk prices are still below the cost of producing it.

But after falling in August to their lowest in a decade, prices are rebounding – dairy auction prices have jumped 63 per cent since August, according to Bloomberg. With demand in China holding up despite the slowing economy and turbulent stock prices, Rabobank predicts the milk glut will evaporate by the middle of next year as producers cut excess production. That could help arrest a dramatic slide in New Zealand’s exports that saw them drop 18.3 per cent on year in the second quarter.

Another wild card is El Nino. Back in August, Nomura’s strategists warned that the periodic weather pattern was shaping up to be the most severe since 1950. That could hurt agricultural output and push up food prices, including prices for milk. Rabobank warns El Nino could cause pastures to wither from Argentina to Australia. And because milk prices are still historically low, farmers aren’t likely to compensate for lost grass by buying feed. While that would be bad for most of Asia, it would be great for New Zealand, the world’s largest exporter of dairy commodities.

New Zealand’s dairy farmers also stand to benefit from the recently sealed Trans-Pacific Partnership, the comprehensive trade deal between the US and 11 other countries around the Pacific Rim. If ratified, New Zealand’s dairy cows would gain access to five new markets, according to Moody’s: Canada, Japan, Mexico, Peru and the United States.

Looking beyond milk

But forget milk: the outlook for cow juice may not be the biggest reason to be bullish on the Kiwi. HSBC economist Paul Bloxham notes that even as milk prices fall, tourist arrivals are at record levels, led by a near-tripling in the past five years in visitors from China eager to see something rare in China: the sky. Indeed, tourism is on track to overtake dairy products this year as New Zealand’s biggest export earner. A weaker Kiwi has only helped.

Chinese visitors are buying more than a lung-full of fresh air. While no reliable statistics exist, it’s an open secret in New Zealand that buyers from China are helping fuel a housing boom. Auckland home prices have jumped 24 per cent in the past year, according to Bloxham. That’s supporting a boom in housing construction.

The housing boom is also making it more difficult for the central bank to cut rates. Economists expect the Reserve Bank of New Zealand to lower interest rates this year – to 2.5 per cent from 2.75 per cent – to boost growth and revive inflation, which according to data released last week cooled to 0.4 per cent in the third quarter, well below the RBNZ’s target of between 1 per cent and 3 per cent. Yet markets are still betting the central bank won’t cut, which is fuelling a rally in New Zealand government bonds.

Bloxham believes the RBNZ will cut again this year, which along with rising tourism should cushion the economy while demand for its key commodities remains weak. He expects GDP growth to improve next year to 2.6 per cent from 2.3 per cent this year. New Zealand’s overall market doesn’t look cheap, and the Kiwi remains vulnerable to outflows if new fears of a Fed rate hike re-emerge. But with the cost of hedging the currency relatively low compared with many Asian currencies, now may be a good time to skim for bargains in New Zealand’s stock market before a rate cut delivers a fresh burst of stimulus to equities.


This piece has been reproduced with permission from Barron's.