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'Perfect storm' churns milk into gold for farmers

Justin Solomon | CNBC

Like many dairy farmers around the U.S., Mitch Breunig has had a good year. The four hundred dairy cows at his Mystic Valley Farm in Sauk City, Wis. produce 35,000 pounds of milk each day. The average cow, milked three times daily, yields 95 pounds.

In layman's terms, that's 12 gallons of milk per animal. It also represents a whole lot of fat for a previously lean industry.

This year, the U.S.'s prodigious dairy output has benefitted from what Breunig refers to as a "perfect storm"-high dairy commodity prices and low feed costs-that is lifting profit margins and providing a much-needed windfall after a few turbulent years.

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"Prices have been really good," Breunig told CNBC. "Crop yields were really good so feed prices have moderated. The fourth-generation Saux City dairy farmer added that "milk prices have stayed high and beef prices have stayed high, so it's be a nice period to recover."

This year, raw milk, cheese and butter prices all hit new highs, after dairy production slowed in nearly every major milk-producing region in world-except the U.S. That tight supply drove up global demand for U.S. milk products, and with it their value.

In the first half of 2014, the volume of dairy exports increased 14 percent versus the same period in 2013, according to the U.S. Dairy Export Council (USDEC). The value of those exports set a record, averaging $653.6 million a month.

"Exports have a large influence on the price, and it's been a very good period for the United States in terms of exports," said Patrick Geoghegan, senior vice president of the Wisconsin Milk Marketing Board. "Wisconsin exports have grown significantly over the past few years."

For many farmers, that strong performance has enabled them to reinvest in their operations, a process many dairies had to delay during a string of rough years. In the wake of the 2009 recession, milk prices plummeted precipitously. Those conditions converged with a 2012 drought that sent feed costs skyrocketing.

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Nowadays, however, the backdrop is different. For farmers, the milk business is booming.

"It's allowed us to do some maintenance and updating on some equipment that may be didn't get done when prices weren't as good," says Breunig.

The dairy windfall "allowed us to put some money away so that as prices go down again, we're going to have some money stored so we can work off that and not go back in debt," he added.

Still, nobody expects the land of milk and honey days to last forever. Prices have begun to moderate, as production levels in other countries have risen. The shaky global economy is also cutting into demand. China, which had been aggressively importing milk, has pulled back on its milk consumption as well.

Then there's the U.S. dollar, which has been rallying on expectations that the Federal Reserve will start tightening interest rates. A stronger greenback makes U.S. milk more expensive overseas, and the dollar's current levels - it hit an eight year high against a basket of major currencies on Friday -may start to price domestic farmers out of foreign markets.

In fact, the effect is already being seen in exports, which have begun to fall. According to USDEC data, milk exports slipped in the third quarter, and the organization projects a larger impact in the final three months of the year. Export volumes are expected to drop 15 to 20 percent versus a year ago.

With roughly 15 percent of U.S. milk products shipped abroad, the constant supply-cows always need to be milked -weighs on prices domestically. Since liquid milk consumption has been falling in the U.S. for decades, opportunities for growth have come mainly from international markets.

"We're anticipating for 2015 that [price] to average out to about $16.50 per hundred pound," says Brian Gould, professor of agriculture and applied economics at the University of Wisconsin Madison. "That's a pretty significant drop, but $16.50 per hundred pounds is historically a reasonable...price, given what current grade markets are."

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Still, that's a steep drop from the recent $24 per hundredweight (or hundred pounds) peak, which represents a 30-percent-plus drop in price. It's setting off alarm bells for many farmers and futures traders as 2015 closes in. January milk futures trading on the Chicago Mercantile Exchange (CME) are already probing that $16 per hundredweight level.

The slide, and that fact that milk is a highly volatile market in general, is motivating farmers to develop additional revenue streams. The better-than-average profit of 2014 are helping to fund those ventures as well.

The cows at Mystic Valley Farm are becoming the source of another kind of export. Breunig is developing cow embryos from his best Holstein stock to be sold and shipped to China.

"It's allowing us to have another form of income and not have to milk more cows," the farmer said. "Diversification is a really good thing and it helps us weather when milk prices go lower."