Drake's Market News
By J. Richard Drake,
Drake Livestock Company
Submitted March, 2011
In earlier letters, I have mentioned volatility. I was generally talking about the overall volatility in all proteins and grains throughout the world. A leader in volatility now is our lamb business. Is it out of control? Has supply blinded decisions about demand and true needs? What are true needs? Do packer/processors need to weigh going "Dark" versus red bottom lines and market share? I do not have the answers to these questions, but I will offer some ideas, right or wrong.
Basic economics generally says start any model with supply and demand. Over the past few years, basic economics has been thrown out by the business community. Stocks of meat and poultry in U.S. commercial freezers have increased by 6.1% during January, reaching 2,054 billion pounds according to USDA's monthly Cold Storage report. This is 9.6% higher than one year ago. That increase was shared by the four major species but the largest year-on-year increase belonged once again to chicken whose stocks were 23.5% larger than last year at 778.3 million pounds. A driving factor in higher inventory is the fear of shortage in the future brought on by higher feed costs and the low costs of money in comparison to the increase in inventory value. On the other side, the volume of money it takes to do business has many businesses wondering where the limit is.
During January, Australia exported 9,409 MT of lamb. Although this was 33.2% lower than the previous month, it was 15.4% higher than January 2010. Lamb exports to the U.S. during January equaled 1,795 MT. This was down 38.4% from the previous month and was down 12.4% from January 2010. To put this in perspective, the domestic market produced about 3497 comparable MT while we imported 1795 MT from Australia, which was 51.3% of domestic production. Lambs on feed are relatively the same as last year. On feed numbers for March will move down dramatically during March and April, as a late Easter will drain the inventory. Replacement feeder lambs have achieved new price levels. Lamb feeders are very concerned about projected breakeven costs with both feeders and commodities prices setting new highs this week and moving back down at the end of the week. Many of these lambs will deliver in May with a few in April. The estimated breakeven price of these lambs (115 lb.) for slaughter in July will be about $165.00/168.00/cwt. on a lamb weighing 150 lb. This live price gives an estimated plant cost of about $340.00/cwt. As an independent lamb feeder, do you want to take this kind of risk to play with the "Big Boys"? If there are contracts that help you manage your risk, use them. If you have corn to sell, sell the corn. Slaughter for the first quarter will come in at about 450,000 head or 24% decline from 2010. Projected slaughter for the 2nd quarter 2011 should be about 560,000 head or an increase of 2%. Overall the slaughter for the first half of the year will be down about 11.2%.
The latest USDA numbers provided further confirmation that both US and global feed supplies remain particularly tight, with the stocks to use ratio now matching the lowest point of the last 15 years. This year, corn acres are expected to increase. I think this is going to be very difficult due to weather. Now I am not nor have I ever been related to "Mother Nature". History tells me though, with the snow pack and probable flooding, planting will be late for much of the corn area and highly productive land could be under water. It became quickly apparent this year that corn prices in the $5-$6/bbu range would start rationing out livestock feed demand but they had little impact on ethanol. The main reason for the decline in projected ending stocks is because USDA further increased projected ethanol use by 50 million bushels. High sugar cane and crude oil prices have limited the availability of Brazil ethanol and US ethanol exports to Canada and the EU have surged higher. Also, current blending margins remain positive despite high corn prices.
The bottom line is how costs keep climbing. So how will high meat and poultry prices impact demand? The answer from Econ 101 class is that they will have no impact since prices are part of the demand function and changing them merely moves a consumer along a demand curve, it does not shift that curve. That assumes, of course, that as prices change, their relative levels remain the same and there lies the rub. Higher input costs will favor the more efficient converter of feed to gain, which is the chicken. Cattle and lamb fit the last description best but it is also the species that is by far the least efficient in converting feed to gain. Critical for the lamb business is the restaurant business. Since the summer of 2007, NRA index has been below 100, which mean a shrinking industry. Today, the total value of the index stood at 101, 1.1 points higher than in November. Promotion is moving ahead full steam and demand is very stable even at these high costs. One change in the demand for lamb is the price of lamb for the "Non-traditional" market. The price is such that demand increases in this market have stopped. The regular market prices have caught up with the "Non-traditional" markets. Incased in our market is that consumers want food that tastes good, but they also want food that is good for them. Today's chefs have a tremendous opportunity to help consumers eat better by providing healthy, great-tasting menu options, as well as increasing transparency about meal content so that consumers can make informed decisions.
As volatile as our industry is at these supplies, prices are on the high side, but still have a relation to other proteins. The critical point comes from the supply factor, which may not play a factor until the 4th quarter, but definitely by the 1st quarter of 2012. NASS continues to tell the industry that it is losing inventory. I do believe that the industry inventory will increase this year. People that eat lamb want lamb and today demand trumps supply. The trick is to not get supply costs out of proportion to demand costs. After Easter, supplies may get tight enough that some packer/processors may take dark days or dark weeks as supply will be tight. Maintaining market share will be a real trick of management.