Third-Quarter 2014 Sheep Industry Review Prepared by the American Sheep Industry Association for the American Lamb Board November 2014

Executive Summary On the surface, this has been a very good year for the lamb industry. Through the third quarter, feeder and slaughter lamb prices were sharply higher than a year ago and above their 5-year averages. The wholesale and retail markets also saw some 2014 strengthening, posting year-on-year gains. In addition, slaughter was current and quality was excellent. However, market fundamentals are responding to an artificially-created supply situation: there is over 40 million lbs. of lamb and mutton sitting in the freezers, four times our monthly production. In doing the math, we know there was an increase in total supplies this year. Domestic production was down marginally, but imports were up sharply. However, much of that product was not released to the markets, but held as stocks. The million-dollar question is what happens now? As the Livestock Market Information Center (LMIC) reported in early October: “The question becomes how will these stocks filter into the market and at what price levels?” Reportedly, if prices move higher then packers would be willing to release more product (in hopes of covering storage costs) (LMIC, 10/2014). If prices remain stagnant or fall, will packers be forced to sell at a loss? What will happen to feeder and slaughter lamb prices in this case? There is no easy fix to the high freezer inventory, but it is possible to reduce stocks without creating a bulge in supply. It is hypothesized that freezer stocks will be a new, structural component of the sheep industry for some time.

It is forecasted that 2015 will look a lot like 2014, but with some drawdown in stocks. It is uncertain, but perhaps unlikely that imports will slow. Australian production will be marginally lower next year, but the relative profitability of the U.S. market will support its strong exports. Perhaps by 2016, Australian rebuilding efforts will have a significant impact on its production, curbing its exports. Further, U.S. domestic production could slow in 2015 which will help the supply situation. Perhaps by 2016 the U.S. will see significant income growth which would support higher-priced lamb at retail. Only then will the higher prices allow for more product to be released from freezers. Markets Stronger The 3-market feeder lamb auction price saw a 2-percent quarterly gain to $199.36/cwt., up 75% year-on-year. Feeder lambs averaged $177.29/cwt. in direct trade in the third quarter, up 14% quarterly, and up 62% year-to-year. In the third quarter, live, slaughter lamb prices at auction gained 4% quarterly to $155.44/cwt., 39- percent higher year-on-year. Slaughter lamb prices on a carcass-based formula averaged $298.87/cwt. ($151.40/cwt. live-converted), up 5% quarterly and up 29% year-on-year. Slaughter lambs in live, negotiated sales averaged $153.02/cwt. in the third quarter, up 3% quarterly and up 29% year-on-year. Weighted average carcass prices averaged $332.04/cwt. in the third quarter, 2-percent higher quarterly and up 30% from a year ago. By contrast, the wholesale market weakened in the third quarter.

The net carcass value (wholesale composite less processing and packaging) averaged $330/cwt., down 1% percent quarterly and 32-percent higher year-on-year from $249/cwt. The rack made a significant recovery in 2014, from $5 per lb. to over $8 per lb. Other primals were mostly stagnant. Production and Trade At 40.1 million lbs., September cold storage was 18% higher monthly and 83% higher year-on-year. Given relatively high wholesale and retail prices, not all that was produced or imported was available at retail or foodservice. During the first nine months of the year, domestic slaughter was an estimated million head, 0.5% lower year-on-year. At million lbs., estimated lamb production was down 1.1% year-on-year from January to September Lamb and mutton imports were up year-on-year. At million lbs., lamb and mutton imports in 2014 through August were up 5.3% year-on-year, or 6.3 million lbs. Lamb imports totaled million lbs. in 2014 through August, up 6% year-to-year, or up 5.7 million lbs. Mature Ewe Disappearance This year has seen an increased mature sheep disappearance from both increased live exports as well as increased slaughter of culled ewes. The drought in California and surrounding areas might explain part of this increase. Mature sheep slaughter was an estimated 12% higher in January through September year-on-year at 101,323 head. U.S. live sheep exports to Mexico totaled 22,982 head in 2014 through August, up 18% year-on-year. According to LMIC, total ewe disappearance this year is the largest year-over-year increase since 2010 when drought hit Texas and surrounding areas (10/3/2014).

I. Feeder and Slaughter Lamb Market Trends

Q3 Auction Feeder Lamb Prices (60- to 90-lb.) Up Quarterly, and Sharply Higher Year-on-Year The 3-market feeder lamb auction price saw a 2- percent quarterly gain to $199.36/cwt., up 75% year- on-year. Markets included San Angelo, Ft. Collins and Sioux Falls. Prices averaged $187/cwt. in July, $201/cwt. in Aug. and $209/cwt. in Sept.

Feeder Lamb Prices at Auction Gained in Q3

Feeder Lambs in Direct Trade Gained 57% Year-on-Year o Feeder lambs averaged $177.29/cwt. in direct trade in Q3, up 14% quarterly, and up 62% year-to-year. o Feeders averaged $166/cwt. in July, $174/cwt. in Aug. and $193/cwt. in Sept.

Feeder Prices Posted Sharp Q3 Gains

At 182,050 head, the volume of feeders in direct trade was down 5% year-on-year in 2014 through September.

At $3.38 per bu., corn was down 37% in Sept. year-on-year.

At $197 per ton, alfalfa was 2% higher year-on-year in Sept.

Q3 Auction Slaughter Lamb Prices 45% Higher Year-on-Year Live, slaughter lamb prices at auction gained 4% quarterly to $155.44/cwt., 39-percent higher year-on-year. Prices averaged $148/cwt. in July, $142/cwt. in Aug. and $157/cwt. in Sept.

Auction Slaughter Lamb Prices Generally Trending Higher Since Late 2012

Third-quarter slaughter lamb prices rebounded after summer lull.

Carcass-Based Formula Slaughter Lamb Prices Gained 29% Year-on-Year Slaughter lamb prices on a carcass-based formula averaged $298.87/cwt. ($151.40/cwt. live- converted), up 5% quarterly and up 29% year-on- year. Weighted-average prices were $289/cwt. in July, $298/cwt. in Aug. and $310/cwt. in Sept.

By Q3 Prices by Weight Converged

Live, Negotiated Prices Top Formula Prices Slaughter lambs in live, negotiated sales averaged $153.02/cwt. in Q3, up 3% quarterly and up 29% year- on-year. Lambs averaged $158/cwt. in July, $146/cwt. in Aug. and $142/cwt. in Sept. Q3 weights were 136 lbs., up 3% quarterly and up 11% year-on-year.

Slaughter Weights Drop: Quality Current Slaughter weights in carcass-based formula trades down 7% quarterly to lbs., down 6% year-on- year. Weights in live, negotiated trades also down, down 15% to lbs., 1-percent higher year-on-year. Federally-inspected weights averaged 68 lbs., down 5% from 72 lbs. in Q2.

Formula Trades Down Year-on-Year In Q3 the volume of lambs purchased on formula was down 23% quarterly to 84,800 head and down 43% year-on-year. Live, negotiated trades 4-percent higher to 82,500 head in Q3, up 30% year-on-year.

Percent of Formula Trades in Total FI Slaughter Down to 20% from 29% in 2013

II. Carcass and Boxed Lamb Market Trends

Carcasses Up in Q3 Weighted average carcass price averaged $332.04/cwt. in Q3, 2-percent higher quarterly and up 30% from a year ago. Carcass price was $313/cwt. in July, $324/cwt. in Aug. and $332/cwt. in Sept.

Q3 Carcasses Continued to Gain

Q3 Carcass Sharply Higher than Third Quarters of 2012 or 2013

YG 3s Up with Current Market

% YG3s in 2014 High Yield Grade determination is positively correlated with heavier slaughter lambs. Yield Grade 3s in lbs. was 35% of total slaughter in 2013 and jumped to 49% in January through August.

Yield Grades for Federally Inspected Lamb and Mutton Percentages, Fiscal Year Source: USDA, AMS, Livestock and Seed Division YG1YG2YG3YG4YG %28%37%18%12% 20137%36%35%14%7% Jan-Aug %32%40%16%7%

 Percent Graded Trending Lower On average, 60% of lambs in commercial slaughter were graded in January through August 2014.

64% of Lambs Graded in Federally- Inspected Slaughter in 2014 through August

The net carcass value (wholesale composite less processing and packaging) averaged $330/cwt. in Q3, down 1% percent quarterly and 32-percent higher year-on-year from $249/cwt. The rack made a significant recovery in 2014, from $5 per lb. to over $8 per lb. Other primals mostly stagnant. Net carcass value was $325/cwt. in July, $329/cwt. in Aug. and $336/cwt. in Sept. Q3 Net Carcass Value Down 1% Quarterly – Compared to Feeder and Slaughter Lamb Price Gains

September’s Net Carcass Value at 5- Month High

Rack sharply higher in 2014, other primals’ gains relatively less impressive.

Rack Fell Below $8 per lb. in June- Aug., but Rebound in September The rack averaged $799.63/cwt. in Q3, down 1% quarterly and up 58% year-on- year. The rack was $794/cwt. in July, $795/cwt. in Aug. and $809/cwt. in Sept.

Loins Gained Seasonably in June Through the Summer Loins, trimmed 4x4, averaged $510.96/cwt., up 5% quarterly and up 13% year-to- year. Loins was $505/cwt. in July, $509/cwt. in Aug. and $519/cwt. in Sept.

Leg, Trotter-Off, Saw an Easter Uptick, then Weakened The leg averaged $350.36/cwt. in Q3, down 5% quarterly and up 17% year-to-year. The leg was $352/cwt. in July, $350/cwt. in Aug. and $349/cwt. in Sept.

Q3 Shoulder, Square-Cut, at 3-Year High The shoulder averaged $298.17/cwt. in Q3, up 1% quarterly and up 32% year-on-year. The shoulder was $290/cwt. in July, $296/cwt. in Aug. and $308/cwt. in Sept.

Ground Lamb Up Year-on-Year Ground lamb averaged $538.06/cwt. in Q3, up 2% quarterly and up 3% year-on-year. Ground lamb was $541/cwt. in July, $537/cwt. in Aug. and $536/cwt. in Sept.

III. At Retail & Food Service

Only Marginal Retail Gain: In Q3, retail prices averaged $6.98/lb., up 9% from $6.43/lb. in Q Note that cuts featured not constant across time.

Retail Featured Lamb Prices Mixed Depending Upon Cut Q3% Change Quarterly % Change Year-on- Year Leg bone-in$5.72-2%1% Shoulder blade chop $5.4611%15% Loin chop$9.361%8% Rib chop$15.651%24%

IV. Price Spreads Ralmonline, 2008

The Rack-Loin Price Spread Softened in Q3 The rack-loin price spread averaged $2.89 per lb. in Q3, down 10% quarterly and up 426% from $0.55 per lb. year-to- year. The loin has remained relatively flat compared to gains in the rack.

Understanding Packer Spreads Packer price spreads do not include any costs of processing. Packers sell wholesale primals (cuts) which are combined together and called the cutout. Packers also sell carcasses, to the processing industry and to one another. The price spreads assume that all that is processed sells and no allowance is made for cold storage tonnage.

Packer spreads dropped in late 2013 as slaughter lamb prices gained and the meat market lagged, but rebounded in the first half of 2014 only to weaken again by Q3.

The live to carcass price spread averaged $16 per head in Q3, down 28% quarterly and down 60% year-to-year.

Live to cutout spread was $44 per head in Q3, down 27% quarterly and down 19% year-to- year. – In Q3, the value of slaughter lambs fell, but by less than the drop in the wholesale composite.

Carcass to cutout spread was $28 per head in Q3, down 26% quarterly and up 98% year- on-year. --The carcass held relatively strong compared to the lower cutout.

Break-Even Analysis Mid-year producer break-evens not as robust as earlier in 2014, but by Q3 margins much healthier. Recall the breakeven analysis is only one snapshot of feedlot marketing. On average, cost of gain dropped from about $1.10 in Q1 to about 95 cents per lb. by Q3. The September estimated break-even was $165 to $166 per cwt. compared to $158 per cwt., the live-converted formula carcass-based price in September.

Cost of Gain in CO Feedlots Continued to Fall, Reportedly about $0.85-$1.05 per lb. in Q3 --Reportedly cost of gain could fall to 70 cents with 2014 corn harvest.

Sensitivity Break-Even Analysis A: September kill of July-traded Idaho feeder lambs with a $0.85 per lb. cost of gain. ItemCost 1. Total cost of feeder (in mid-July 4,200 head traded out of ID at $165 per cwt.) $206.25/head 2. Average freight from ID$5.00/head 3. Cost of gain in Colorado feedlot (6 lbs. $0.85/lb. to 131 lbs.) $5.10/head 4. Break-even price of slaughter 131 lbs.$216.35/head Break-Even$165.15/cwt.

Sensitivity Break-Even Analysis B: September kill of July-traded Idaho feeder lambs with a $1.05 per lb. cost of gain. ItemCost 1. Total cost of feeder (in mid-July 4,200 head traded out of ID at $165 per cwt.) $206.25/head 2. Average freight from ID$5.00/head 3. Cost of gain in Colorado feedlot (6 lbs. $1.05/lb. to 131 lbs.) $6.30/head 4. Break-even price of slaughter 131 lbs.$217.55/head Break-Even$166.07/cwt.

V. Pelts

Pelts Fall Further in Q3 Fall Clips were $4.17 per piece in Q3, down 41% quarterly and down 66% year-to-year. No. 1 pelts were $3.38 per piece in Q3, down 41% quarterly and down 63% year-to-year.

International Pelt Market Weakened: Back-log of old pelts & fewer premium quality pelts (LMIC, 10/2014).

VI. Replacement Sheep

September Replacement Ewes Averaged 88-Percent Higher Year-on-Year Ewe Lambs $ per head Yearling Ewes, mos. $ per head Running Age Ewes, 2-4 years $ per head Middle Age Ewes, 5-6 years $ per head Aged Ewes, over 6 years$ per head

Do Higher Replacement Ewe Prices Infer Flock Rebuilding? --Not sure, mature sheep slaughter and live sheep exports higher year-on-year.

VII. Domestic Production and Trade

During the first nine months of the year, lamb slaughter was an estimated million head, 0.5% lower year-on-year.

At million lbs., estimated lamb production was down 1.1% year-on-year from Jan.-Sept. 2013

Slaughter Weights Lower Year-on-Year --At an average 135 lbs. in Q3, slaughter weights were down 6% quarterly from 143 lbs.

At 40.1 Mill. Lbs., September Cold Storage was 18% Higher Monthly and 83% Higher Year-on-Year

Mature Sheep Slaughter was an Estimated 12% Higher in Jan.-Sept. Year-on-Year at 101,323 Head

Lamb and Mutton Imports Up Year-on-Year -- At million lbs., lamb and mutton imports in 2014 thru Aug. were up 5.3% year-on-year, or 6.3 million lbs.

Lamb Imports Totaled Mill. Lbs. in 2014 Thru Aug., Up 6% Year-to-Year, or 5.7 Million Lbs.

Australian lamb imports thru Aug. were 75.7 mill. lbs., up 13% year-to-year. NZ’s lamb imports were 29 mill. lbs., down 10% year-to-year. Australian Lamb Up; New Zealand Down

In the first eight months of 2014, lamb import value was up 16% to $407.4 million.

At 20 million lbs., mutton imports were 1-percent lower in 2014 thru Aug. compared to a year earlier, same period. Mutton imports from Australia were 16.9 million lbs. in 2014 thru Aug., up 23% year-to-year. New Zealand mutton imports were down 52% to 2.5 million lbs. in this period. Mutton Imports Lower Year-on-Year

Mutton Imports Lower Through August

Lamb & Mutton Exports Totaled 4.83 Million Lbs. in 2014 thru Aug., Down 5% Lamb Exports Up 135% to 830,000 lbs. & Mutton Exports Down 15% to 4 mill. lbs.

Mutton exports slow relative to higher lamb export growth.

Total Live Sheep Exports to Mexico Up Total live sheep exports through August were 34,867 head, up 16% year-on-year. U.S. live sheep exports to Mexico totaled 22,982 head in the year thru Aug., up 18% year-on-year. Persistent drought in western U.S. and surrounding areas likely contributing factor to increased sheep exports.

Q3 Cull Ewe Prices Moved Higher --San Angelo ewe prices averaged $59.95/cwt. in Q3, up 8% quarterly and up 80% year-on-year. --Culls averaged $50/cwt. in July, $60/cwt. in Aug. and $71/cwt. in Sept.

XIII. Nontraditional Market Andrew, 2006.

Nontraditional Market Significant Segment of U.S. Sheep Industry The nontraditional market is often characterized by a lighter-weight lamb, around 100 lbs., but very variable depending upon customer. The nontraditional market is mainly comprised of lambs sold direct to consumers. Some nontraditional lambs are processed by state inspected plants and even some FI plants. The largest nontraditional markets are the livestock auctions at New Holland, PA and San Angelo, TX, but nontraditional markets exists across most auctions.

The Muslim Festival of Sacrifice -- Eid ul-Adha – held between October 4- 7, 2014 Boosted New Holland Prices -- Prices jumped 40% in one week in Sept. to $192.50/cwt. for lbs. -- Volume also swelled: up 137% weekly to 3,605 head.

IX. Total Lamb and Mutton Availability

Total lamb availability (imports plus domestic production, subtracting exported lamb) in 2014 through Aug. was million lbs., up 2% year-on-year. In this period, U.S. domestic commercial lamb supply (less exports) was down 2% to 97.7 million lbs. Imports were up 6% year-to-year to million lbs. Note: These figures do not include the nontraditional market estimated volume. Total Lamb Availability Up Through August

Total lamb availability up, but due to unknown domestic and import freezer inventories, it’s difficult to know what volume is actually sold.

U.S. Gained Mutton Market Share, but Lost Lamb Market Share In 2014 thru August: Domestic lamb market share was 48%, down 4% from the same period in Domestic lamb & mutton market share was 46%, up 0.3% year-on-year. Domestic mutton market share was 28%, up 22% from a year ago.

U.S. Lamb Market Share Fell About 4% in 2014 through August

X. Imported Product Price Comparisons

U.S. Competitiveness Against the AUS Shortloin Grew in Q3

U.S. Rack Sells at a Premium to AUS Rack -- Perhaps a reflection of different markets--U.S. to foodservice, AUS to retail--and different sized racks. -- $798/cwt. price spread in Q3. *Note weight differences: U.S. rack lbs. and imported rack 28 oz. +, not a perfect comparison, but useful as a snapshot.

U.S. Fabricated Rack Prices Down Quarterly -- Imported Rack Up U.S. rack, roast-ready, frenched (204C) averaged $1, per cwt. in Q3, down 20% quarterly. U.S. rack, roast-ready, special (204D) averaged $1, per cwt. in Q3, down 1% quarterly. By comparison, the AUS rack cap-off, 28 oz. + was $1, per cwt. in Q3, up 10% quarterly.

U.S. Shoulder Lost Competitiveness in Q3 Imported shoulder weakened while the domestic shoulder gained.

XI. Exchange Rates

-- In Q3 the Australian/U.S. dollar was down 1% quarterly to $0.93, 0.9% higher year- on-year from $ In Q3, the New Zealand/U.S. dollar hit $0.84, down 2% quarterly and up 6% year-on-year. Australian & NZ Dollar Weaker Against US$

The Stronger U.S. Dollar Boosts Import Competiveness

XII. Price Projections and Outlook

Feeder and Slaughter Lamb Prices Forecasted to Soften into Q4 In early Oct., LMIC forecasted that slaughter lambs on a carcass-weight basis could range from $292- $298 per cwt. (about $148 per cwt. live), 7-percent higher year-on-year, but possibly lower quarterly. LMIC forecasted lb. feeder lambs to range from $199-$205 per cwt., up 8% over a year ago, but down about $9 per cwt. lower quarterly. Forecasts particularly challenging due to record-high freezer stocks.

Feeder cost of gain could fall to 70 cents per lb. by Q4. Lower cost of gain – less than $1 per lb. -- can support feeder lamb prices in Q4 and early USDA forecasting a record corn crop. USDA/ERS forecasted that 2014/15 corn prices could average $3.50 per bu. (USDA/ERS, 9/15/14). LMIC forecasted corn in the low-$3 per bu. range (10/2014). Hay & forage conditions have improved this year, apart from CA and surrounding areas (LMIC, 10/2014).

Index Lends Predictive Insight: Historical Trends Suggest Higher Q4 Feeder and Slaughter Lamb Prices, but Record-High Cold Storage Stocks and Continued High Imports Dominate the Market, Prices Likely Lower in Q4 Feeder lamb prices typically fall through the third quarter when supply is high and feeders are moving into feedlots then strengthen into Q4. Slaughter lamb prices typically fall in the third quarter as market-ready spring feeders come to market. 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.

History Tells us Feeder Lamb Prices Forecasted to Gain through the Year’s End

Slaughter Lamb Prices at Auction Forecasted to Rise through Q4 According to Past Trends

2015 Outlook a Function of What Happens to Freezer Inventory Market ConditionEffect on StocksEffect on Prices Lamb Demand Expands (I.e., Good quality, high beef prices and higher incomes) Freezer stocks are slowly released into market. Higher prices. Packers Price to Move Product Domestic market is flooded with freezer stocks. Prices fall.

Traditional Demand Factors Still Important Motivators Relatively high beef prices can help support lamb demand; Growing U.S. incomes can help support lamb demand; and Consistently high quality lamb can support prices and demand. Takeaway Message: It is feasible that the industry can manage continued high freezer inventory. This structural change coupled with higher lamb prices could be the new normal.

In Jan.-Aug. all fresh retail beef jumped 11% year-on-year to $5.43 per lb.

This year, per capita income grew an average 0.26% per month.