Dairy prices looks set to remain firm, into the medium term, underpinned by a twin step of higher feed prices and rocketing Chinese demand, Commonwealth Bank of Australia said.

The rise of some two-thirds in grain costs since June has turned an index of dairy prices, versus feed prices, "sharply lower" – and into negative territory for the first time in a year, CBA analyst Luke Mathews said.

The ratio of whole milk powder prices to those of corn had fallen to six, below a trend figure of eight, and a level which has represented the bottom of recent cycles.

The rise in feed costs, which account for one-third of cash costs even in Australia, has one of the less intensive dairy industries among major producing nations, may "temper" plans by dairy farmers to rebuild herds.

"The resultant possible slowdown in global dairy production may help maintain dairy prices at strong levels," Mr Mathews said.

'Minnows to mammoths' 

And he added that he was "positive about the medium term prospects for dairy prices" too, given where growing demand from China might lead.

"As rates of dairy consumption improve, China will evolve from their current status a dairy minnows to dairy mammoths," Mr Mathews said.

Even raising China's milk consumption levels to those in Taiwan – well below world average levels – would add an extra 18% to world demand for fluid milk, and nearly one-third to consumption of skimmed milk powder.

"Comparing China's dairy consumption with advanced nations with similar traditions… indicates that significant expansion in Chinese dairy consumption is probable."

Global trade, which has historically accounted for less than 5% of world cows milk production, "is already starting to lift with Chinese demand".

'Ride the dragon's back' 

New Zealand, whose promotion to top rank among world exporters in 2006 had been helped by Chinese import demand which has risen by 15% a year since 2005, looked set to continue to benefit.

"New Zealand looks set to ride on the dragon's back for some time yet."

 However, Mr Mathews said that Australia's dairy farmers should be able to take "greater advantage" of Chinese demand, provided they can recover from the latest drought, part of a trend which has driven the industry increasingly into the wetter areas of Victoria and Tasmania.