WBC Westpac Banking Corp

Global dairy prices have risen nearly 17% in four weeks, an encouraging sign for a sector beleaguered globally by low prices and growing stockpiles of cheese and milk powder.

After hovering at historically low levels for much of 2016, prices have finally started to rally as farmers have culled herds to save money, reducing the available milk.

The GlobalDairyTrade Price Index, which covers a variety of products and contract periods in the auction, rose 12.7% from the previous auction on Aug. 2. The index is now at its highest level since Oct. 20, 2015.

The GlobalDairyTrade auction is an international trading platform established by New Zealand's Fonterra Co-Operative Group. The average selling price was $2,731 a metric ton. It is closely watched, as the GDT Price Index is widely considered a market reference price for dairy products.

"The lift over the two August auctions is the first verification of our view that rapidly tightening global supply will lift prices over 2016. We expect further price lifts over the rest of 2016, contingent supply weakness continuing," ASB Bank economist Nathan Penny said in a note.

Having risen nearly threefold from 2009 to 2014, milk prices halved earlier this year as farmers increased dairy supplies to try to cash in on an expected surge in demand from China and the Middle East. The situation got worse when Russia banned imports of food from the U.S., Australia, Canada and Europe in August 2014, cutting off a market for dairy and increasing the surplus.

But that surplus is waning.

New Zealand, the world's largest dairy exporter, saw production fall 1.6% in the year to May 31, while production in Australian fell 2.0% in the year to June 30. In Europe, production is slightly higher year over year, but isn't at levels seen earlier this year, according to data from the European Commission.

"We suspect the market is now factoring in a sizable decline in New Zealand milk production. This no doubt added to the massive 18.9% lift in whole-milk powder prices," said Doug Steel, an economist at Bank of New Zealand. New Zealand's major export is whole-milk powder.

Production has fallen as farmers, many of whom have been operating below the cost of production, have been forced to send cows to the slaughterhouse to raise revenue and reduce spending rather than continuing to milk them. Furthermore, supplementary feeding, which increases milk yield but isn't necessary, has been reduced to cut costs.

"The only one bucking the trend of late has been the U.S. But even in the U.S., there are signs softer prices are likely to weigh on future production," said Anne Boniface, an economist at Westpac Banking Corp. in New Zealand.

The U.S. Department of Agriculture last month lowered the U.S. forecast for milk production in 2016 by 0.2 billion pounds to 212.4 billion pounds due to a fall of the county's herd.

Improved demand from China is also playing a role in pushing prices higher, analysts say, noting that concerns prices could rise rapidly are stoking interest.

"We sense this auction result has a bit of panic buying in it," Mr. Steel said.

Write to Lucy Craymer at Lucy.Craymer@wsj.com

(END) Dow Jones Newswires

August 17, 2016 04:35 ET (08:35 GMT)

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