In May, the annual Dairy Australia Situation & Outlook report forecast a southern farmgate price range of $5.10 to $5.50 per kg of milksolids for the 2011/12 season.

This forecast assumed that dairy commodities would trade in a range between US$3800 and US$5100 for the year – while the Australian dollar would average between 100 and 105 US cents.

So at half-time in the 2011/12 game, how are we travelling compared to this forecast?

In late November, spot commodity prices were between US$3500 and US$4250 – with butter and milk powder prices under the greatest pressure over the past six months.

Increased economic uncertainty – centred mostly on Europe - has weighed on dairy and other commodity markets.

At the same time, increased milk production in New Zealand, the United States, the European Union and Australia has upped the availability of product on the international dairy market – shifting the balance in favour of buyers.

The Australian dollar has traded at the upper end of the forecast range – averaging 105 US cents since early May. However, the variation in the average weekly exchange rate has seen a high of 110 US cents in July to a low of 96 US cents in October.

Poor economic prospects in other developed economies, and continued demand for our exports, pushed the Aussie dollar higher in the middle of the year. More recently, the US currency has strengthened, as concerns focus on Eurozone issues, and the US

economy shows some faint signs of recovery.

Thus while commodity prices are lower than forecast, the exchange rate is at the more favourable end of the range. So what does this all mean for full year farmgate prices?

The export index in this chart gives some guidance. It encompasses prices of the four major dairy commodities, the weighting of these commodities in the industry's monthly export mix and the exchange rate impacts and comes up with a measure of movement in returns from week to week.

The Australian dollar index has a trend line fitted to show the direction of movement in export returns since May – and highlights the slide in returns to exporters. However, a comparison with the US index and its trend line shows the benefit of the recently slightly, weaker local currency.

Looking ahead, there appears to be limited upside for the dairy commodity prices, as supplies continue to increase. Demand would need to increase significantly to tighten market supply and push prices higher. However, given signs of a slowing Chinese economy, this seems unlikely.

With commodity prices likely to

drift lower, a weaker Australia dollar

will provide some benefit for export returns.

While the forecast for southern prices made back in May remains achievable, the current market outlook suggests the final result for 2011/12 will likely to be closer to the lower end of the range.

Jo Bills is Manager – Strategy and Knowledge with Dairy Australia.