More Moola for Your Next Gallon of Milk

"Milk -- it does a body good -- if you can afford it."

As taglines go, this probably isn't going to drive quite as many consumers to the supermarket as the dairy industry's original version did. But it's pretty accurate. For the past two months running, American consumers have gotten socked with record-high prices for milk.

'Milk' Isn't as Simple as It Sounds

To understand why, you first need to understand at least four kinds of "milk" are sold in America:

• Class I milk is what you ordinarily think of -- the ice-cold, refreshing, Grade A stuff that comes in gallons, for drinking, baking or pouring over your cereal.

• Class II milk is used to manufacture such soft dairy products, such as yogurt.

• Class III milk gets turned into hard cheeses, such as cheddar. Its producers are paid based on the amount of milk protein, milk fat and other solids contained in the Class III milk. As a rule, the price is set in relation to the wholesale price of cheddar cheese, as reported by the National Agricultural Statistics Survey.

• Class IV is nonfat dry milk -- powdered milk.

As a rule, milk producers consider Class III and Class IV milks the most important. Class I milk's price is based on the prices for either Class III or Class IV -- whichever costs more. Class II milk is set at the price of Class IV, plus a premium.

Now here's why all of the above is important: In February, Class III milk hit an all-time high price of $23.35 per hundredweight (100 pounds). This was a result of that federal cheese price quotes also hitting record highs. In March, Class III milk's price dipped only 2 cents, to $23.33 per hundredweight. At the same time, every other class of milk hit new record highs.

But we repeat: Why?

High Demand for American Cheese

According to dairy industry website DairyReporter.com, it all comes down to cheese -- and who's buying it. Cheese prices determine Class III milk prices, and Class III milk prices determine the cost of the Class I milk you buy at the grocery store. American cheese inventories plunged earlier this year -- despite record levels of production -- because cheese exports also hit a record high.

%VIRTUAL-article-sponsoredlinks%All told, 32,118 metric tons of the stuff left U.S. borders in January 2014 (about 7.4 percent of U.S. production), traveling abroad to satisfy the surging demands of up-and-coming consumer economies in South Korea (which imported 36 percent more American cheese in January 2014 than it did in January 2013), Mexico (48 percent more), and China (up 100 percent) -- and higher levels of export to Canada and Australia besides. (Among developed economies, Australia in particular seems to be going on a cheese bender, importing 142 percent more in January 2014 than it did the previous year.) Adding financial insult to pocketbook injury, American consumers didn't even get to enjoy the benefit of the infinitesimal, two-cent drop in Class III milk prices last month -- because no sooner had Class III "cheese-milk" prices fell than Class IV "powdered milk" prices surged to a new high.

The reason? You guessed it. Exports of powdered milk are also surging. And you're getting stuck with the bill.

How Much Is This Going to Cost You?

Dairy analysts estimate that retail prices of milk gallons at the supermarket could surge 60 cents this year -- perhaps hitting an average of $4.10.

Meanwhile, the U.S. Department of Agriculture is warning that as a consequence of the wholly unrelated drought now afflicting California (America's breadbasket for many agricultural products), consumer food prices overall are set to rise past the 1.4 percent inflation rate set in 2013. Estimates for 2014 are 2.5 percent to as much as 3.5 percent.

Relative to the cost of milk, that's a bargain.

Motley Fool contributor Rich Smith did not wear a milk mustache during the writing of this column. Nor does he have a financial interest in any dairy stocks.