i. feeder and slaughter lamb market trends

Second-Quarter 2012

Sheep Industry ReviewPrepared by the

American Sheep Industry Association

for the American Lamb Board

July 2012

Contents

Executive Summary

I. Feeder and Slaughter Lamb Market Trends

II. Feeder and Slaughter Lamb Price Projections

III. Carcass and Boxed Lamb Market Trends

IV. Retail Feature Activity

V. Price Spreads

VI. Pelts

VII. Replacement Sheep

VIII. Domestic Production and Trade

IX. Total Lamb and Mutton Availability

X. Price Comparison to Imported Product

XI. Exchange Rates

Executive Summary

Weaker prices and lower per capita consumption point to contracted lamb demand in the second quarter. Through May total lamb availability (imports plus domestic production, subtracting exported lamb volume) was 115.4 million lbs., down 2% year-on-year. Retail prices are not available, but featured-lamb prices were higher into the second quarter (due partly to a higher-valued mix) and feature activity was up. By June, wholesale lamb had lost value for seven consecutive months, from a record-high in November of $410/cwt. to $344/cwt.

The industry is challenged to promote lamb demand in a period when two important factors--beef prices and incomes--are stagnant. While ethnic population growth will help boost lamb demand, consumers’ preference for lamb can also supersede other factors in expanding lamb demand.

Expanding lamb demand is crucial as a catalyst for healthy margins throughout the marketing chain and in promoting industry growth. In the 2012 second quarter, the U.S. lamb industry finds itself in a unique predicament. Very slow income growth and sluggish economic recovery put the brakes on passing higher lamb production costs onto consumers. Since last fall, the industry has found that at every price point, consumers have been buying less lamb. Meanwhile, dry pastures and high-priced corn and hay have put pressure on feed costs, filling feedlots and straining feeder and lamb producer margins.

Executive Summary, page 2

Feeder lamb trade is uncertain in the third quarter. Producers have to manage feed and risk in a period when all feed options are less than optimal. To compound the problem, most feeders are reluctant to buy lambs when they are still feeding Old Crop lamb and slaughter lamb prices are down.

Since a record-high last August, feeder lambs lost about $80/cwt., or about 35%, by June. The volume of feeders in direct trade in the first six months of the year was less than one-half of last year’s mid-year volume. The 3-market feeder lamb auction price saw a 14-percent quarterly decline to $182.57/cwt. and down 20% year-on-year. Feeder lambs in direct trade averaged $145.59/cwt., 19% lower quarterly and 20% lower year-on-year.

Live, slaughter lamb prices at auction lost 7% to $140.79/cwt. between quarters and lost 22% year-to-year. Slaughter lamb prices on a carcass-based formula averaged $301.26/cwt. ($151.63/cwt. live-converted) in the second quarter, down 9% quarterly, and down 17% year-on-year.

With feed costs looming higher in the third quarter, the industry is pressured to pass higher costs onto consumers, but recent history showed us limits to this strategy. Options for maintaining feed costs are constrained for pastures are very dry in many sheep producing regions and hay and corn are high. Corn averaged $6.31 per bu. in the second quarter, 1% higher quarterly and down 1% from a year ago. Alfalfa averaged $207.66 per ton in the second quarter, 5% higher quarterly, 30% higher year-on-year.

Executive Summary, page 3

The Livestock Market Information Center reported on July 17 that 71% of the nation’s cattle were found in pastures ranking as Poor and Very Poor condition, up from 39% a year ago.

An additional concern in the second quarter was that there was acute concern that the corn crop would not produce as feeders had hoped. Many forecasted that a record crop could put corn below $5 per bushel, but lack of moisture and hot temperatures by mid-summer had forecasts well above $7 per bushel. As of mid-July, 38% of all corn was reported as being in Poor or Very Poor Condition (CME Group, 7/17/12).

The live to carcass and live to cutout price spreads remained positive in the second quarter as meat market declines lagged behind the weakening slaughter lamb market. The East Coast carcass market averaged $366.10/cwt. in the second quarter, 2-percent lower quarterly and a down 6% than a year ago. The gross carcass value averaged $356.72/cwt. in the second quarter, down 7% quarterly and down 12% year-to-year.

With higher corn, lamb prices are expected to rise. The strength of consumer demand for lamb will determine the extent to which higher feed costs play out at retail. Distinct demands for different lamb cuts, markets and value-added products will likely reveal itself.

I. Feeder and Slaughter Lamb Market Trends

Auction Feeder Lamb (60- to 90-lb.) Prices Weakened Sharply

• The 3-market feeder lamb auction price saw a 14-percent quarterly decline to $182.57/cwt., down 20% year-on-year.

• Markets included San Angelo, Ft. Collins and Sioux Falls.

• Prices averaged $213.97/cwt. in April, $180.98/cwt. in May and $152.75/cwt. in June.

Three Markets Converge in Q2

Feeder Lambs in Direct Trade Averaged $145.59/cwt., 19% Lower Quarterly, 20% Lower Year-on-Year

Feeder & Slaughter Lamb Prices Converge

Volume of Direct Feeder Lambs More than Doubled Quarterly (up 120%) to 45,100 head, Up 111% Year-on-YearBut in the first-half of the year, the volume was less than half of last year’s mid-year volume.

Second-Quarter Feed Costs

Still High

• Corn averaged $6.31 per bu. in Q2, 1% higher quarterly and down

1% from a year ago.

• Corn averaged $6.34 per bu. in April, $6.33 per bu. in May and

$6.25 per bu. in June.

• Alfalfa averaged $207.66 per ton in Q2, 5% higher quarterly, 30%

higher year-on-year.

• Alfalfa averaged $207 per ton in April, $215 per ton in May and

$201 per ton in June.

Auction Slaughter Lamb Prices Down Quarterly, but Up Historically

• Live, slaughter lamb prices at auction lost 7% to $140.79/cwt. between quarters and lost 22% year-to-year.

• Prices averaged $147.89/cwt. in April, $140.41/cwt. in May and $134.09/cwt. in June.

Q2 was Still 17-Percent Higher than its Second-Quarter 5-Year Average

of $120.66/cwt.

Q2 Prices Fall Unseasonably Due Likely to Retail Slowdown

Carcass-Based Formula Slaughter Lamb Prices Lower Quarterly & Year-to-Year

• At 135,800 head, formula trades were down 10% quarterly and up 9% year-on-year.

• Slaughter lamb prices on a carcass-based formula averaged $301.26/cwt. ($151.63/cwt. live-converted) in Q2, down 9% quarterly, and down 17% year-on-year.

• Weighted-average prices were $315.38/cwt. in April, $297.46/cwt. in May and $290.95/cwt. in June.

Auction Prices Hold Below Formula Prices

Premium for Lightest-Weight Carcasses Narrowed by June

II. Feeder and Slaughter Lamb Price Projections

• Lamb demand in the third quarter could get a boost from possible higher beef prices, but not necessarily from income gains.

• The ALB is challenged to boost consumer’s preference for lamb through continued taste samplings and promotions.

Consumer Demand is Key to Stronger Feeder and Slaughter Lamb Prices… and

Ultimately to Industry Growth

If Beef Prices Move Higher, It Could Support Lamb Demand

Fresh retail beef averaged $4.65/lb. in Q2, up 0.02% quarterly and up 4.6% year-to-year.

Positive Income Growth Can Promote Lamb Demand, But Recent

Growth Minimal

• Inflation-adjusted disposable income gained 0.2% monthly in May (Bureau of Economic Analysis, 7/2012).

• Per capita disposable income gained 0.15% between Q4 2011 and the first quarter.

Disposable (Take-Home) Personal Income Has Been Flat

Lamb Prices Forecasted to Gain Quarterly and Post Lower Year-to-Year Values in Q3

• The Livestock Market Information Center (LMIC) estimated in

late July that carcass-based formula slaughter lambs could

strengthen quarterly by an estimated 11% in Q3 to $332/cwt.

and average about 12% lower year-to-year.

• Forecasts based upon underlying tight supply situation.

• If all meat moves higher with higher corn prices then retail lamb

might also gain, helping to support higher slaughter lamb prices.

Feeder Lamb Forecasts• USDA Agricultural Marketing Service (AMS) reported in July: “Demand very

light and trade activity slow. With the overstock of market ready lambs in the

feedlot and a decreasing carcass market, lamb feeders are very reluctant to buy

feeder lambs.”

• USDA/AMS continued: “Corn and hay prices are increasing rapidly pushing cost

of gains to even higher levels. The combination of all these factors coupled with

very light consumer demand is pushing bids for feed lambs lower.”

• However, (higher-valued) New Crop relative to Old Crop sales could continue to

drive feeder market.

• LMIC estimated that 60-lb. to 90-lb. Texas feeders could average $190/cwt. in

Q3, 5% higher quarterly and 8% lower year-to-year.

Seasonal Price Indices Contradict LMIC Forecasts

• In 2010 and 2011, increasingly tight supplies trumped

other seasonal factors, overwhelming seasonal patterns.

• Current lower demand and short-term ample feedlot

supplies can trump the fundamental of continued tight

lamb supplies resulting in softer, not stronger, prices.

• The index shows the average relationship of prices in

each month to the average for the year. An index of 105

means prices are 5% above the annual price average.

The index for feeder lamb prices at auction estimated a 10% price weakening in Q3 from its annual average.

The index for converted formula carcass-based slaughter lamb prices estimated a 0.07% weakening in Q3.

The index for live, auction, slaughter lamb prices forecasted an 8-percent weakening—from its annual average--- in Q3.

Forecasts for Higher Lamb Feed Bill

• In the 18 primary corn-growing states, 30 percent of the crop is now in poor or

very poor condition, up from 22 percent the previous week (U.S. Drought

Monitor, 7/10/12).

• Half of the nation’s pastures and ranges were in poor or very poor condition as

of July 10, up from 28% in mid-June (U.S. Drought Monitor, 7/10/12).

• The hot, dry conditions have also allowed for a dramatic increase in wildfire

activity since mid-June. As of early July, the year-to-date acreage burned by

wildfires increased from 1.1 million to 3.1 million (U.S. Drought Monitor,

7/10/12).

• 80% chance that December corn is forecasted to range between $5.90 and

$10.10 per bu. (Hilker, J., MSU, 7/25/12).

Hay Forecasted to Stay High

• It is forecasted that hay acres could increase 3% this year (USDA, 4/30/12).

• LMIC reported, “Hay prices in most regions of the nation are still expected to be below a year ago, even in alfalfa, but this is largely expected because of the pull-back demand by the livestock industries, especially dairies. Dairies and cattle feeders alike struggled with high prices last year and have not recuperated from costs,” (7/9/12).

III.Carcass and Boxed Lamb Market Trends

Carcass Prices Lower, Yet 37% Higher than its 5-Year Q2 Average

•Carcass prices averaged $366.10/cwt. in Q2,

2-percent lower quarterly and a down 6% than a year ago.

• East Coast carcass price was $377.70/cwt. in April, $368.51/cwt. in May and $352.10/cwt. in June.

Carcass Trade 17% of Total Weekly Slaughter, Down from Average 22% in 2010 & 2011

YG 1 and 2 Down in 2012

• Yield Grade determination is positively correlated with heavier slaughter lambs and increased deposits of back fat.

• Yield Grade 1 & 2 in lbs. was 32% in Jan.-May of total slaughter compared to 39% a year ago.

• Yield Grade 4 & 5 in lbs. was 28% in Jan.-May compared to 18% a year ago.

Affect of Heavier Carcasses

• Larger carcass will have a larger loin eye/rib eye area, which can make them more valuable.

• Plant throughput is inherently higher with larger carcasses.

• However, the shoulder is one item that is difficult to remove fat from when the carcasses are Yield Grade 4 or 5. Trimming it can be labor intensive and will squeeze packer margins.

• Legs and loins primarily carry fat on the outside of the cut.

YG1 YG2 YG3 YG4 YG5

2007 4% 32% 47% 12% 3%

2008 5% 31% 47% 14% 3%

2009 4% 34% 45% 14% 4%

2010 5% 38% 43% 13% 2%2011 4% 27% 49% 17% 3%1-5/2012 4% 24% 36% 21% 15%

Yield Grades for Federally Inspected Lamb and MuttonPercentages, Fiscal YearSource: USDA, AMS, Livestock and Seed Division.

YG 1 & 2 Trended Down Since Mid-2011

• The gross carcass value averaged $356.72/cwt. in Q2, down 7% quarterly and down 12% year-to-year.

• Gross carcass price was $367.25/cwt. in April, $359.03/cwt. in May and $343.89/cwt. in June.

Q2 Gross Carcass Value (Wholesale Average) Softer Quarterly

and Year-to-Year

Second-Quarter Gross Carcass Value was 22% Higher than its 5-Year Average

Gross Carcass Value Down $66/cwt. Since Record-High Last November

Wholesale Rack Dropped Below $7/lb. for First Time Since Mid-2010

• The rack averaged $681.97/cwt. in Q2, down 12% quarterly and down 24% year-on-year.

• The rack was $715.18/cwt. in April, $685.62/cwt. in May and $645.11/cwt. in June.

June Rack Falls Back to 2010 Levels

Q2 Loins Gained Year-to-Year in June

• Loins, trimmed 4x4, averaged $522.49/cwt., down 1% quarterly and up 0.4% year-to-year.

• Loins were $513.34/cwt. in April, $515.73/cwt. in May and $538.40/cwt. in June.

Loins Holds Value Compared to Summer Values in the Past Two Years

Leg, Trotter-Off, Down Quarterly and Down Year-to-Year

• The leg averaged $415.26/cwt. in Q2, down 5%

quarterly and down 7% year-to-year.

• The leg was $426.03/cwt. in April, $418.55/cwt. in May

and $401.19/cwt. in June.

Leg Still High Historically

Shoulder Gained Sharply in 2011

• The shoulder averaged $251.38/cwt. in Q2, down

11% quarterly and down 22% year-on-year.

• The shoulder was $265.03/cwt. in April,

$256.50/cwt. in May and $232.61/cwt. in June.

Shoulder is an expensive cut to remove fat from when the carcasses are heavier, Yield Grade 4 or 5.

Ground Lamb is One Item That Gained Quarterly

• Ground lamb averaged $590.98/cwt. in Q2, up 0.4% quarterly and up 4% year-on-year.

• Ground lamb and loins only products to gain year-to-year.

IV. Retail Feature Activity

Retail Prices Move Up Quicker Than They Come Down

• When wholesale prices drop, retailers are reluctant to drop prices, but will increase featuring.

• USDA/AMS reported lower wholesale prices make it “more favorable” for retailers to feature lamb into June.

• In Q2 feature activity jumped 20% quarterly and was up 40% year-to-year.

• Feature-average prices in Q2 were $7.00/lb., up 6% from a year ago and up 3% quarterly.

• In Q2 some higher-valued items such as rack and rib chops were featured more, moving the average price higher.

Feature Activity Aimed to Move Product

• Feature activity of the shoulder blade chop—one of the more featured items-- was up 30% in Q2 year-to-year with prices down 3% to $5.12/lb.

• Offseason leg features unusual, yet…leg feature activity was up 61% in Q2 compared to a year ago with feature prices averaging $7.48/lb., down 1% year-to-year.

• Loins chops are often featured during the summer grilling season. This year, feature activity was up 34% in Q2 with prices 7% lower from a year ago at $9.32/lb.

Shoulder blade chop prices—one of the more featured products—dropped sharply into July.

V.Price Spreads

The Rack-Loin Price Spread very Volatile, Marginally Higher

• The rack-loin price spread fell 36% in Q2 to $1.59 per lb., down 57% year-on-year.

Feeders in the Red due to Heavy Lambs, Prolonged Days on Feed & Higher Feed Costs

• Industry still killing Old Crop (OC) lambs when OC lambs often finished slaughtering by May.

• Producers losing an estimated $38 per cwt. or $76 per head.

• June estimated break-even was $172 to $185 per cwt. compared to $134 to $147 per cwt. slaughter lambs (auction & live-converted formula slaughter lamb price).

• By comparison, LMIC reported that July steers sold on cash market lost more money than ever before, over $250 per head (7/9/12).

Cost of gain up sharply in Q2 to $1.30 to $1.50 per lb. – about 20% higher than a year ago and 128% higher than its 5-year low in Q1 2010.

Sensitivity Break-Even Analysis A: June kill of Old Crop California feeders that entered Colorado feedlots in January at $1.30 cost of gain.

Item Cost

1. Total cost of feeder (75-lb. CA feeder @ $232 per cwt.)

$174/head

2. Freight from California $8.00/head

3. Cost of Gain in Colorado feedlot (125 lbs. gained @ $1.30/lb. to 200 lbs.)

$162.50/head

4. Break-even price of slaughter lamb @ 200 lbs. $344.50/head

  Break-Even $172.25/cwt.

Sensitivity Break-Even Analysis B: June kill of Old Crop California feeders that entered Colorado feedlots in January at $1.50 cost of gain.

Item Cost

1. Total cost of feeder (75-lb. CA feeder @ $232 per cwt.)

$174/head

2. Freight from California $8.00/head

3. Cost of Gain in Colorado feedlot (125 lbs. gained @ $1.50/lb. to 200 lbs.)

$187.50/head

4. Break-even price of slaughter lamb @ 200 lbs. $369.50/head

  Break-Even $184.75/cwt.

Live to Carcass Price Spread Up

• The value of live slaughter lambs fell more sharply than carcass values.

• The live to carcass price spread averaged $82 per cwt., up 7% quarterly and up 118% year-to-year.

Carcass to Cutout (Ave. Wholesale Values) Price Spread Fell into Negative

• The carcass held its value relative to the weaker cutout

value.

• The carcass was worth $7/cwt. more than the cutout in Q2.

• The carcass to cutout spread was -$7/cwt. in Q2, down

222% quarterly from $6/cwt. and down 173% year-on-year

from $10/cwt.

Cutout to Live Spread was $59/cwt., down 8% in Q2 and up 78% Year-to-Year

In Q2, the cutout weakened by more than the live lamb.

VI. Pelts

Late Q2 U.S. Pelt Prices Suspended Under Limited Trade and Weaker Demand

• Stronger U.S. dollar made U.S. pelts less competitive in international markets.

• Heavy offerings from Australia, Ireland and England flooded the market leading to lower prices (USDA/AMS, 6/2012).

• Early Q2 prices: Fall Clips were $15.50 per piece, down 13% quarterly and down 2% year-to-year.

• Early Q2 prices: No. 1 pelts were $14.06 per piece, down 6% quarterly and up 4% year-to-year.

• Recall pelt prices are prices received by packers.

Absence of Pelt Report Interrupted LRP-Lamb

• Several weeks of pelt prices were not reported in June and July due to the lack of pelt trades.

• Coverage price for LRP-Lamb not issued during this time.

• LRP-Lamb is based upon a slaughter lamb price prediction model in which pelt prices are an integral component because slaughter lamb offers can be partly a function of pelt prices.

VII. Replacement Sheep

Ewes Not Traded; Rams Weaker• Only ram prices reported in the second quarter

(only in April), ewe trades not established.

• In April, black-faced rams averaged $573.31 per

head, white-faced rams were $597.28 per head

and cross-bred rams were $549.19 per head.

• Prices about 27% lower than a year ago.

VIII. Domestic Production and Trade

Federally-Inspected (FI) Lamb & Mutton Production Up in Q2

• At 687,437 head, FI slaughter was up 41% quarterly and up 32% year-on-year.

• FI lamb & mutton production was 52 million lbs. in Q2, up 39% quarterly and up 46% year-on-year.

• Heavier weights boosted production.

Estimated Slaughter Weights Climbed Through Q2, Boosting Production

153-lb. Average in Q2, up 2% Quarterly and Up 5% Year-to-Year.

Estimated Q2 Lamb Slaughter was Up 34% Year-on-Year and Production was Up 40%

Q2 Estimated Lamb Production a Higher Portion of Easter Production Than in Past Years

June Cold Storage was 19.7 Mill. Lbs., Down 0.13% Monthly and Up 31% Year-on-Year

Lamb Imports Through May Totaled 54 Mill. Lbs. -- Down for 3rd Consecutive Year in this Period

Lamb Imports Through May Down 8% Year-to-Year

• Australian lamb imports through May were 36.4 Mill. Lbs., down 6% Year-to-Year

• Through May, NZ’s lamb imports were 17.6 Mill. Lbs., Down 13% Year-to-Year

• At 9.2 million lbs., mutton imports were 63% lower in the five months through May year-to-year.

• Mutton imports from Australia were 6.5 million lbs., down 45% in this period.

• New Zealand mutton imports were down 79% to 2.8 million lbs.

Mutton Imports Sharply Lower Year-to-Year

Lamb & Mutton Exports were 4.4 Million Lbs. through May, down 46% Year-on-Year

• At 146,000 lbs., lamb exports were down 72% through May year-to-year.

• Mutton exports totaled 4.3 million lbs. through May, down 44% year-on-year.

Live Sheep Exports Down 53% Through May

• U.S. live sheep exports to Mexico were zero through May. Last live exports to Mexico were in early November

• Live exports to Canada were down 34% through May to 19 million lbs.

Cull Ewe Prices Fall in Q2, but High Historically

San Angelo ewe prices averaged $54/cwt. in Q2, down 28% quarterly and up 4% year-on-year and 29% higher than its 5-year Q2 average.

IV. Total Lamb and Mutton Supplies

• Through May total lamb availability (imports plus domestic production, subtracting exported lamb volume) was 115.4 million lbs., down 2% year-on-year.

• Through May, U.S. domestic lamb production was up 3% year-to-year and lamb imports were down 8%.

Total Lamb Availability Contracted in Five Months Through May Compared to a Year Ago

Total Lamb Availability Contracted an Annual Average of 3% from 2006 to 2011

U.S. Lamb Market Share Up

• In the five months through May, domestic lamb market share was 53%, up 4% year-to-year.

• Through May, domestic lamb & mutton market share was 51%, up 18% year-to-year.

• Through May, domestic mutton market share was 29%, up 60% year-on-year.

X. Imported Product Price Comparisons

U.S. Leg Loses Competitiveness Compared to 2011In the first five months of 2012, the U.S. leg, trotter-off, was $4.31 per lb. and the imported leg was $4.11 per lb.

Through May, the U.S. Leg Had a $0.20 per lb. Premium, Compared to -$0.15 per lb. a Year Ago.

U.S. Loins Less Competitive In the first five months of the year, the U.S. loins, trimmed 4x4 was $5.23 per lb. and the imported loins was $5.19 per lb.

U.S. Loins Gained Competitiveness U.S. loins held a $1.21/lb. premium in Jan.-May 2011 and narrowed to $0.06/lb. this year.

U.S. Rack Less Competitive U.S. rack still less competitive in Q2, but both values down quarterly.

The U.S. rack averaged $1,473/cwt. in Jan.-May and the imported equivalent was $1,104/cwt.

U.S. Gained 15% in Price Competitiveness between Jan.-May 2011 and the same period 2012.

XI. Exchange Rates

Stronger U.S. Dollar in Q2

• Rate change makes imports relatively more competitive and exports less competitive.

• In Q2 the U.S./Australian dollar was $1.01 down 4% quarterly and down 5% year-to-year.

• In Q2 the U.S./New Zealand dollar hit $0.79, down 3% quarterly and down 1% year-to-year.