Like Saudi Arabia and oil, New Zealand is a world leader in the dairy industry. But what was once New Zealand's "cash cow" has now soured their economy.
Diversification is essential to success for any investor or country. If a country's economy is not well-diversified -- if it becomes too dependent on one source of revenue and growth -- the results can be disastrous. This is the case with New Zealand, which became too reliant on the dairy industry.
When investors think of multi-billion-dollar commodities, milk isn't usually the first to come to mind (it's usually gold or oil). Unlike oil, dairy is not making headlines, nor is it causing any political tension.
However, in a country where cows outnumber people by nearly two million, a decline in dairy is serious business (New Zealand has 4.5 million people and 6.4 million cattle).
The geography and climate of New Zealand provide the perfect landscape for dairy cattle. The island nation exports more dairy than any other country, controlling about 40% of the world's international dairy trade. Dairy products make up about 7% of the country's total economic output.
Fonterra, the largest company in New Zealand, is also the world's largest dairy exporter. Fonterra controls over 20% of the world's cross-border dairy trade.
New Zealand dairy cows supplied 21.3 billion liters of milk in the fiscal year ending June 2015. That's about 11 cups of milk for every person on the planet.
The New Zealand dollar is strongly impacted by dairy prices. When milk prices are high, other countries need to buy more New Zealand dollars to import milk from them. But when milk prices fall, there is lower demand for the New Zealand dollar -- and therefore a decrease in the value of the currency.
The New Zealand dollar and international dairy prices follow each other closely, as shown below. (Dairy prices are measured using the Global Dairy Trade price index.)
New Zealand has been a major player in the dairy world for a long time. So when the country signed a free trade agreement with China in 2008 that reduced dairy tariffs, the industry skyrocketed. New Zealand's dairy production grew by 5.4% per year in the seven years that followed as a result of the increased demand from China. (By comparison, dairy production was rising by just 1% per year before the deal.) Milk prices shot up quickly, increasing 172% in the five years following February 2009.
China became New Zealand's dairy farmers' new best friend. About 25% of New Zealand's dairy exports were going to China. Whole milk powder -- the white powder that's left over after the water is removed from milk -- became one of the fastest growing exports. Milk powder is easier to ship and store than fresh milk, and it has a much longer shelf life. It can be used in ice cream and nutritional supplements, as well as in candies and baby formula.
After a big scandal over tainted milk in China in 2008, China's whole milk powder imports rose by about 13 times over the next six years. New Zealand provided more than three-quarters of those imports. Prices jumped to over US$5,000 per metric ton in 2013 and 2014 from US$1,851 per metric ton in February 2009.
The solution to low commodity prices is low commodity prices. Logically, the solution to high commodity prices is also the high commodity prices themselves. High dairy prices attracted more competition as dairy farmers all over the world were captivated by the high profit margins of milk production. As a result, global milk production rose from 697 million tons to 789 million tons from 2007-to-2014.
Meanwhile, though, demand for dairy from China (and Russia, another big milk importer) dropped. China increased its own milk production and stockpiled milk powder. In 2015, China cut its milk powder imports by 53%.
(Dairy conspiracy theorists speculate that China was stockpiling huge amounts of milk powder during the boom. This was so that when they stopped buying, there would be an excess of milk and prices would crash. Then, China could stockpile once more at much lower prices.)
After milk prices peaked in February 2014, they fell by 40% the following year to US$3,042 per metric ton in February 2015. Milk prices hit their lowest value since 2009 through early May, fetching $2,203 per metric ton. This is down 56% from February 2014.
New Zealand's economic growth slowed from 4.1% in 2014 to 2.3% in 2015. This was partly because of the slowdown in the agricultural industry -- in particular the dairy industry.
Since milk prices peaked in 2014, the New Zealand dollar has dropped 16%. That means that New Zealand's imports are now more expensive. If there is any silver lining to this, the lower dollar also means that milk exports from New Zealand are cheaper to foreign buyers, making them more attractive.
The people hurt most by this quick reversal of fortunes are New Zealand's dairy farmers, who are now stuck with a lot of debt and falling revenues. Their revenue has dropped by almost US$5 billion (that's about 2.5% of GDP). Dairy farmers now owe more than three times what they owed in 2003. The total average debt works out to almost US$3,500 per cow.
New Zealand's central bank warned that low milk prices, along with lower property prices, could result in the number of non-performing dairy sector loans rising to 44%. The central bank feels that if milk prices continue to stay low, it could mean land prices fall even further -- as much as 40% over the next two years.
New Zealand's weakening economy, increasing debt, falling land prices, fears about bank loans and instability of its banks all come from a one culprit: milk. But this is the price any country has to pay for relying too heavily on one industry.
Kim Iskyan is the founder of Truewealth Publishing, an independent investment research company based in Singapore. Click here to sign up to receive the Truewealth Asian Investment Daily in your inbox every day, for free.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.