The decline of milk prices this year has been a welcome development for consumers pressured by $4 a gallon gas, but could be a bad sign for the economy.
Falling milk prices—particularly over the past decade—have been a warning signal for a slowdown, while rising prices have accompanied upturns in the economy, according to research from Nicholas Colas, chief market strategist at ConvergEx in New York.
"That's good news for this high-profile consumer good and its effect on inflationary expectations," Colas said. "At the same time, milk prices have been cyclical since the Great Depression. The pullback in 2012 could therefore be a useful early warning sign about a slowing U.S., and global, recovery."
Prices pulled back during the recessions of 2002-03 and 2009, while they surged in 2001, 2004, 2007 and 2011.
More recently, milk has been on a slow but steady decline since reaching a historical peak in September, falling nearly 4 percent at the supermarket and nearly 25 percent in recent days at the distributor level.
The current price of $3.86 a gallon is still high by historical levels, but drifting lower as demand fades.
The milk futures contract has risen 6 percent over the past month a half, but the American Restaurant Association expects that to fade due to a larger than expected milk cow herd.
"A more sluggish domestic economy is always bad for milk prices, so we have to treat the recent pullback as a warning sign about the national economy," Colas said. "Moreover, exports of milk products were an estimated 13 percent of production, which means weaker prices may also be a sign of diminished demand in global markets."
Other indicators are confirming what milk is showing, though consumer pricesbroadly are up 2.7 percent over the past year.
The Chicago Federal Reserve's National Activity Index, though not one of the market's more widely followed barometers, nevertheless posted a minus-0.29 Thursday, indicating economic contraction.
"An index reading of less than zero depicts an economy growing at below trend and easing pressures on future inflation," said Andrew Wilkinson, chief economic strategist at Miller Tabak in New York. "That is a positive development set against the higher inflation projections at yesterday’s (Federal Reserve) meeting although no one wants to see growth tapering off."
One area of which investors should take note: Colas found that demand for organic milk actually has increased 22 percent, translating to higher prices and perhaps indicative of a two-speed recovery where higher-end goods are trending stronger than their lower-cost alternatives.
"Not only are milk prices a useful economic indicator...and a proxy for inflationary expectations... but also a great barometer between a commodity and a differentiated good," Colas said. "Different, in this case, is very good."
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