Market Report

Record-High Freezer Inventories Can’t be Ignored

By Julie Stepanek Shiflett, Ph.D.

We have to talk about it: The elephant in the room. Lamb and mutton freezer inventory hit a record high in July at 31.2 million pounds, 24 percent higher monthly and up 61 percent year-on-year. This is nearly 30 percent higher than any previous years’ high.

The lamb industry is in uncharted waters, perhaps a little nerve-wracking, but it’s not all bad news. First, we don’t know what is in the freezers. It could be mostly imports, we just don’t know. What we do know is that lamb and mutton markets in the U.S. are highly heterogeneous. This means product in the freezers might not necessarily compete against each other. Australian racks might be sold into retail whereas U.S. racks are shipped to foodservice. The Northeastern market might take different U.S. product than the Los Angeles market.

Second, stocks can be an important attribute to the industry. Given lamb production is highly seasonal, lamb stocks can help reduce the margin volatility faced by packers which can help boost industry investments. It also can help reduce price volatility. If quality is consistent and prices more stable, I believe this could do much to promoting lamb demand. Building stocks also enables the industry to keep quality consistent. This year, weekly slaughter has hovered around 40,000 head, preventing the back up of over-finished lamb and maintaining quality. During the crash of 2012, weekly slaughter averaged closer to 38,000 head.

Many in the industry maintain that the stocks are primarily imported product, but there is still cause for concern. According to the Livestock Marketing Information Center (LMIC), the level of frozen product indicates a limited demand profile for both domestic and imported product even in the face of surging wholesale prices of the other red meats and some increase in imported product (7/27/14).

Price Transmission Muted

It is expected that stronger slaughter lamb prices are passed on as higher consumer prices at retail and foodservice. However, we haven’t seen much of a price transmission in the lamb industry in the last year in spite of higher slaughter lamb prices.

In the six months to October 2013, feeder lamb prices jumped 73 percent, slaughter lamb prices gained 29 percent, wholesale prices were up 30 percent and estimated retail prices were up 0.2 percent. It is fair to say that increases in production costs were not transmitted to retail. In the following six months to June, feeder lamb prices fell 28 percent, slaughter lamb price slumped 8 percent, wholesale prices fell 1 percent and retail prices saw a 5 percent price contraction.

Most commodities see some price transmission forward. In a recent year, the Farm Products producer price index (PPI) rose by 24 percent (average producer prices), while the Processed Foodstuffs and Feedstuffs PPI increased by 8 percent and the CPI for All Food by 3 percent (food at retail), (U.S. Department of Agriculture, Economic Research Service (USDA/ERS), May 2104).

In general, the lack of price transmission at retail can be explained by reluctance to incur the cost to re-price lamb and concerns that input price changes are only temporary. A 2011 ERS study found that retail prices for bread and beef generally respond to changing commodity prices within 1 to 6 months. However, lags for some foods such as eggs and milk are at the upper end – 5 to 6 months (USDA/ERS, May 2014).

Another reason for only particle price transmission is because only an estimated 11 percent of the value of food at retail and in restaurants is accounted by slaughter lamb prices. ERS’s 2011 Food Dollar Series reports just 11 cents of every food dollar goes toward farm commodities and agribusiness expenses. The remainder is allotted to food processing, food service, and other administrative, transportation, and retailing costs, categories which are less volatile due to fixed machinery expenses, multi-year contracts for supplies, and small year-to-year changes in wages (May 2014).

Higher-priced substitute beef and pork and higher incomes can also raise lamb demand which in turn can strengthen retail prices. The lack of any significant price transmission to retail in the lamb industry and the recent back peddling of the lamb prices is unusual in a period when tight supplies are pushing beef and pork prices to record highs and we’ve seen some income gains.

Reasons for lack of recent price transmission might be the publically-reported record high freezer inventory and the recent history of eroding lamb demand, deteriorating quality and a crash in slaughter lamb prices the last time lamb prices at retail prices pushed upward.

It is hypothesized that after Easter lamb packers attempted to pass higher lamb prices onto retail, but with little success. That is why we saw growing freezer inventories and lower slaughter prices in June. By July, however, slaughter lamb prices made an important rebound, gaining up to 4 percent for formula lambs when the carcass market only gained 0.2 percent. Lamb packers might try again at passing higher prices onto retailers and consumers, but we won’t know whether this effort is successful for several months.

Retailers might have cause for concern. In the last half of 2011, retail prices hovered around $7.70 per lb. – a record high – at which point we know consumers began to balk. In the first half of this year, retail prices averaged an estimated $7.13 per lb., 93 percent of the record high.

Feeder Lamb Prices Gained

Feeder lamb prices gained unseasonably in July as perhaps slaughter rates have been higher than anticipated and anticipation of tight feeder supplies in late summer. Feeder lamb prices in direct trade jumped 25 percent in July to $165.83 per cwt., 62 percent higher year-on-year.

Over 13,000 head of feeder lambs traded out of Idaho in July ranging from 125 to 140 lbs. and all about $165 per cwt. with delivery from July to August.

By comparison, lambs out of Idaho received about $110 per cwt. a year ago. With good pastures, weights were a little heavier this year.

Another 1,300 head traded from California at $160 per cwt. for an average 120 lbs. A year ago, California feeders received just under $1 per lb., but for lighter weights.

Cost of Gain Dropped

By July, the cost of gain in Colorado feedlots moved below $1 per lb. after averaging around $1.15 in the first quarter. The cost of gain has fallen from a recent high in mid-2012 of about $1.50 per lb. The lower cost of gain is directly attributed to lower corn prices.

Although estimated corn acreage is lower than year ago, record yields are forecasted which puts downward pressure on prices.

The combination of increased available corn stocks this summer and a favorable forecasted harvest mean sharply lower corn price forecasts. According to the U.S. Department of Agriculture, the estimated farm price for corn in 2013/14 (seasons ending August) was $4.45 per bushel on “reduced domestic use and late-season price weakness,” (7/1/514). The projected price range for 2014/15 is $4.00 per bushel, reflecting “increases in total feed grain supply,” (7/15/14). According to Dr. Hilker at Michigan State University, there is a 50 percent chance that December corn will range between $3.34 and $4 per bushel (7/24/14).

South Dakota Professor Darrell Mark, an agricultural economist, reported that “mid-summer has yielded feeders and ranchers an opportunity to source cheap feed for the coming winter thanks to the recent decline in distillers dried grains (DDGs) prices. May and June typically see distillers dried grains (DDGs) increase in price but this year values have dropped faster than corn, potentially of great benefit to cattle profitability,” (TheBeefSite.com, 7/30/14).

DDGs might have only limited use in the lamb feeding sector, but the recent drop in price might boost its demand. Lower corn means lower-priced DDGS, but that is only part of the story. DDG stocks are rising domestically due to a recent ban by the Chinese over the presence of a genetically modified trait in U.S. DDGs.

A price drop of $60 per ton was reported after the Chinese ban, added Professor Mark, to about 65 percent of the price of corn by July. Between May and June alone, DDGs dropped 20 percent to $171 per ton, down from $230 per ton a year ago.

Slaughter Lamb Prices Stronger

Slaughter lamb prices at auction averaged $149.74 per cwt. in July, 5 percent lower monthly yet up 37 percent year-on-year. Markets included San Angelo, South Dakota and Kalona, Iowa.

In July, slaughter lamb prices on formula jumped $11 per cwt., more than compensating for the $5 per cwt. loss seen in June. On average prices were $288.75 per cwt., up 4 percent monthly and up 27 percent year-on-year. On a live-equivalent basis, July’s average was $145.13 per cwt.

On a live, negotiated basis, slaughter lamb prices were $148.90 per cwt., 5-percent higher monthly and up 26 percent year-on-year.

Meat Market Stable

The wholesale composite price (gross carcass value) was $360.53 per cwt. in July, up 0.12 percent monthly and 29 percent higher year-on-year. After accounting for an estimated $33.75 per cwt. in processing and packaging costs the net carcass value was $325.37 per cwt.

The loin, trimmed 4×4, was the only primal to make significant gains in July with a 2 percent gain to $505.17 per cwt. The rack, 8-rib medium, gained 0.2 percent to $794.30 per cwt., dipping below $8 per lb. where it sat most of the year. The shoulder, square-cut, averaged $298.98 per cwt. in July, down one-half percent monthly. The leg, trotter-off, lost 1 percent in July to $352.04 per cwt.

In other boxed cuts, the rack, roast-ready, frenched averaged $1,493.80 per cwt. and the leg, trotter-off, partial boneless averaged $433.16 per cwt.

Ground lamb averaged $541.08 per cwt. in July, 3 percent higher monthly and 3 percent higher year-on-year. Ground lamb has bounced between $5.00 and $5.50 per lb. since late 2012.

The loin often strengthens through August so hopefully it can continue to support the gross carcass value, but it might not carry sufficient value to trump other primals if they move lower.

In July the carcass market averaged $312.70 per cwt., up 0.2 percent and up 22 percent year-on-year. Since Easter, the carcass market has made only small gains, from about $311 to $312 per cwt.

Pelt Prices Continued to Slide

By July average pelt prices fell another 16 percent to average just $2.56 per piece, down from close to $9 per pelt a year ago. Fall Clips averaged $3.75 per pelt, down 12 percent, No. 1 pelts averaged $3.25 per piece, down 9 percent and No. 2s averaged 25 cents, down 56 percent. For the shortest No. 3 and 4 pelts, packers charged producers a 50-cent disposal fee.

The U.S. is wholly dependent upon international pelt market trends which has been able to find support in recent months. Perhaps improved quality, new season Australian pelts will allow the market to find its footing.

Prices Tied to Carcass Market

It is believed that formula slaughter lamb prices uses carcass prices as a basis for the formula, coupled with premiums and discounts for weight and or yield grades. It would then follow that if the carcass market rose, so too would formula slaughter lamb prices. For the most part the two price series move closely together.

The correlation between slaughter lamb prices on formula and carcass prices was 0.96 since 2010. This means that in 96 percent of the weeks since 2010, the two prices moved together.

This spring and early summer formula slaughter lamb prices diverged from the carcass trend, falling below steady carcass-market prices. However, by July the two prices were trending together again. The departure could have been a function of heavier carcasses in the mix.

Indeed, between late March and early June, carcass weights averaged above 80 lbs., but by July fell back down to 74 lbs.

The fact that formula prices are tied to the carcass market is of concern because the carcass market is becoming a shrinking portion of total lamb slaughter. In the last couple months only 13 percent of total lambs slaughtered were sold as carcasses. Last year the portion was 16 percent and 5 years ago it was 26 percent.
Dr. Paul Peterson, University of Illinois agricultural economist, cites two concerns with using reference prices such as the carcass average: inaccuracy and manipulation (6/25/14).

Inaccuracy because the carcass price might not necessarily reflect the true value of the commodity. Perhaps all carcass are particularly heavy or lower quality. And, manipulation because it is possible that the carcass prices is intentionally lowered in order to weaken formula slaughter lamb prices. When a small number of trades (carcasses) sets the price for a larger number of trades (slaughter lambs) there exists an economic incentive to manipulate prices.

Forecasts

On July 31 the Livestock Market Information Center (LMIC) forecasted that national slaughter lamb prices in direct trade are forecasted to reach $377 per cwt. in the third quarter, 47 percent higher year-on-year. This is equivalent to about $189 per cwt. live. The three-market average for feeder lamb prices 60-lb. to 90-lb. are expected to average $217 per cwt., up 55 percent year-on-year.

According to LMIC in late July, price forecasts are based upon a lower level of stocks. If that does not occur the year-over-year slaughter lamb price increases forecast for the third quarter of this year will be dampened significantly and year-over-year gains in subsequent quarters may be even more modest than current forecasts.
Pelt prices are one factor determining slaughter lamb price offers by packers. It is possible then that lower pelt values might be another reason slaughter lamb prices come in lower than forecasted.

In late July LMIC forecasted that in the third quarter supplies could become significantly leaner with the number of head slaughtered and slaughter weights dropping off to yield sharply lower production. Perhaps this contraction is just what the industry needs to clear out some inventory.

Lamb Imports Increased

According to the Australian Ministry of agriculture, lamb exports to the U.S. were up 16 percent in the six months through June, year-on-year. If we include New Zealand, all lamb imports to the U.S. were up 4 percent year-on-year through May to 66.1 million lbs. (last available official data).

The Australian data show that the breakdown of chilled versus frozen product this year is about the same as a year ago with 59 percent chilled and 41 percent frozen product this year.

Retail Market Stable

The retail price of lamb in grocery ads (features) was relatively constant, with some ups and downs over the last 12 months, but lost 1 percent in June year-on-year.

Lamb and veal feature rate held relatively constant through the July 4 holiday week, with only a slight decrease noted. USDA reported that lamb features consisted mostly of loin and racks, at weak to lower prices as retailers tried to spark interest for the grilling weekend (7/2014). By mid-July the lamb and veal activity index rose modestly compared to last week with both species contributing to the uptick.

Feature activity remained well below year ago levels however.

By late July ad space was distributed more evenly among the various individual items than last week, while price levels were generally steady for the majority of items
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