Does the specific gravity of a lead-acid battery  indicate degradation?
Neither choice is perfectly accurate and specific gravity is going to vary based on temperature and the quality/purity of electrolyte in the water over the life of the battery.

The fundamental change to a battery over it's life is that the internal resistance of the battery increases and therefore the same level of chemical charge will end up resulting in less delivered energy to the load. So, from that perspective, #1 is the most correct, assuming the electrolyte has not broken down and is in an ideal state.

However, in many practical circumstances, the electrolyte solution becomes polluted over time and the relative ratio of the water to acid mix changes making it hard to use specific gravity alone to assess the state of charge of the battery.

See this reference for some more specifics on the topic.