Market Intelligence - 05.12.09
06/05/2009
Macroeconomics
The last two weeks brought strange situations; the general mood and expectations improved considerably.
Statistical data reflecting expectations were positive. Consumer confidence in the US rose, the IFO Institute for Economic Research index in Germany went up, stock markets continued and extended their gains, all of which was in conflict with the data one was getting from the present markets.
Gross national product data for the first quarter shrank almost everywhere. The banking system is still far from being safe and solid, and unemployment is rising almost everywhere. In the car industry many companies are fighting for survival, incoming industrial orders are still down if not falling. From the real facts one has still to expect a rough and tough second half of 2009.
We have to admit that we would love to believe in a positive trend and in an improvement of the situation, but we still fail to see the signals and we will continue to monitor the financial market for news which would justify the optimism.
For the time being stock market investors should be happy and watch their profits carefully.
In the meantime all the other important data for the leather industry is reasonably stable. Energy prices are stable and also currencies have continued to trade in a very narrow range.
Market Intelligence
Serious analysts of the leather pipeline look a little foolish at the moment, and that includes us. With the reasonably prudent outlook that we have been taking recently, it is hard to explain the activities of the last two weeks. Most pundits are scratching their heads looking at sales activities, the export sales numbers from the US and the reports coming in at the moment from the European marketplace.
We think that all serious people in the business would agree that the demand for finished leather and finished leather products is significantly lower than in the same seasons in 2007 and 2008. One may argue about the percentages, but almost everybody would agree that the situation is not the same for the different sectors of leather production. All in all, a decrease of approximately 20%–30% does not seem to exaggerated when we talk about production as a whole.
But how does this tie in with the absolute record numbers of sales which we see from the US market and the sharp aggression that is reported to be in evidence at abattoir doors in continental Europe, especially when we add in the fact that the leather market has not yet really picked up? We should also mention that there has not been the same level of activity in South and Central America, in most parts of Africa and in eastern Europe; there are still huge stocks of raw material waiting desperately for buyers to come along.
We agree that the international tanning industry is certainly buying from the top of the quality range down, but this does not explain everything that is happening at the moment.
A time for cool heads
So it was time to pick up the phone and call some of our regular sources, whom we consider to be among the few sober analysts of the present situation in the trade.
The first impression we got was that everyone is as confused as we are, but at least there were some interesting explanations or opinions. So let’s start first with the facts in the still leading global raw material market, the US.
Watching the export statistics being published on a weekly basis by the US Department of Agriculture, one has been for quite a while pretty impressed by consistent volumes almost every week. Comparing this information with trading activity, statistical data and reports from individuals and institutions, it is been difficult for some time to match everything up.
Despite massive sales and export numbers, most people have been less than positive about the market situation. In our view, there has been a pretty clear conflict and it means that people are not converting their daily selling and trading activity into a positive mood. There are two possible reasons why.
Number one would be that sellers are still shocked by the drama which we have seen in the last six months and the reports they are hearing about the economic situation, in the US in particular. Under option number two, a lot of the sales are being reported at the moment refer only to the same hides that had already been sold once some time ago, and are coming onto the database for a second time. A lot points towards option number two being closer to the truth.
Inventory position
We certainly believe that some of the strong hands in the leather pipeline are willing to take a certain inventory position before the market turns around, but for our taste it is a bit too early for this to be the explanation of the volumes we are seeing.
In the case of the US, some people are saying that the Chinese are trying to control more raw material markets and their next target is the bovine hide market. We don’t agree in this case, because it’s not only the Chinese who are reported to be buying big volumes; South Koreans are also buying far above the purchasing levels one would consider to be reasonable under the present market conditions. Apart from that, the Chinese don’t really need to extend their market position in the US, because they dominate the export of bovine hides there already.
Vested interests
At this point we should mention that a lot of people in the leather pipeline have an interest in the market being on a strong footing for a number of reasons. The easiest and most obvious one is the producer or seller of the raw material. Not only will they secure more money for their products, but a moderately rising raw material market is also protecting their outstanding sales positions and the contracts that still need to be shipped and for which they have still to receive letters of credit or payment. Having to ship material that looks cheaper than the present market level is an advantage.
Tanners, as strange as it may sound, can also have an interest here and could have two reasons for supporting a firm market. Firstly, it supports their negotiations for finished leather prices. One of the biggest problems of the leather industry is the dramatic deflation of finished leather prices, which have fallen, in most cases, far below anything that can be called average. This leads to the risk that when raw material prices return to normal, it can take too long for the finished leather prices catch up. This would be too much, after the massive losses tanneries have already had to take in the recent crisis because of the devaluation of their inventories.
The second reason why some tanneries could be interested in rising raw material prices does not apply to the industry as a whole. However, if we believe that many of the hides that have been purchased since January are actually cheap inventory today, tanners who bought then would be well protected because of the cheap stocks they own. Their potential competitors who haven’t bought enough materials at these cheaper prices will face a strong competitive disadvantage. Knowing the trade as we do, this theory sounds a bit too sophisticated.
The main problem is that we have seen similar situation many times in spring when a large sales number has proved in the end to be a protective action of buyers against rising prices.
Turbulence in Europe
In continental Europe we hear from our regular sources that the market there is also experiencing tremendous turbulence. A number of people from various countries are reporting stories that could be easily become the foundation of a bestseller. And if we put little bit more fiction and fantasy into it, it could become a fascinating conspiracy story. The basis of this are reports about a rising number of obscure buyers contacting central European slaughterhouses “on behalf of interested buyers in China”. The buyers are said to dispose of almost unlimited funds and are willing to offer tremendous cash deposits to secure the supply.
In some cases, small Chinese trading companies that are registered in Europe are the driving force for this. It’s also true that, in other cases, fake companies have been used for this purpose.
All kinds of fantasies have come to light about what the real background of these activities is. Some are suspicious that this scenario has been created by abattoirs to push raw material prices up and to re-value their existing stocks. Others strongly believe that it is ‘dirty money’ from China that is coming into the market. Still others think that it is ‘clean money’ from China in an attempt to buy and control the superior quality raw material markets. As if this were not enough, some international investors are said to be attracted by the physical limitation of bovine hides and their persistent low price levels. One thing is definitely true, it is hard to believe that there is any real market justification at the moment to push raw material prices up by 10% or more.
We do not really believe any of the conspiracy stories, but we still have to deal with the fact that there is fierce competition and that abattoirs and the established companies are finding it more than difficult to understand why, all of a sudden, the market has been set on fire without any real justification from the business.
Nobody is disputing, that sales have been reasonably active over the past three months, but in this part of the world everyone who has a bit of knowledge of the market is fully aware that recent purchases have not been a reflection of improved leather business. It seems simply to have been a case of some Chinese tanners being willing to invest their money in raw materials of superior quality.
Favourable loans
This brings us to another interesting subject in today’s economic world. It is no secret that the Chinese government is presently offering very favourable loans and financing possibilities for many companies. Some people are even talking about 0% finance options.
Under these circumstances one can easily understand if producers are willing to invest in raw materials of superior quality at historically low price levels. If there is no need to repay these loans within a period of up to one year, then one can understand that tanners or traders in mainland China are finding it easy to invest into raw materials and take such an aggressive stance in the market.
If we believe there is some truth in the stories it is certainly going to be a big headache for most of the leather industry in the short term. Rising raw material prices would not reflect the present situation or be justified by the leather business. It is true that the raw material market is not really taking any notice of the situation of the leather business; there is still enough inventory in the pipeline and not enough demand for the finished product. What the real intentions are of those who are pushing it at the moment nobody really knows, but it would not be a surprise if they were to be disappointed in the end.
Our regular readers know very well, that we were always of the opinion, that it would be wise to run a certain level of stock just to be protected against possible market turbulences but we do not see any serious reason for substantial raw material price increases at the moment.
In any case we will continue to monitor the market situation very closely from now on because it is pretty obvious that there are things happening far outside the normal supply-and-demand ratio within the leather pipeline.
Cheap material available
The split market is still pretty uncertain. We see some interest for suede material, and splits of superior quality suitable for this kind of production can probably obtain today better prices than some time ago. However, the general market for splits for leather production is definitely not doing any better. This is not a surprise because there are still plenty of cheap raw hides available. So there’s no particular reason to use splits other than possibly fashion motives. It is a bit different for lime splits, which still have the privilege of being used for non-leather consumptions.
For the coming weeks we think that the market is entering a period of high uncertainty. Those who have sold product will be watching to see if they are going to receive letters of credit. When the letter of credit comes in, the next problem is if they can get hold of enough containers and freight space to ship the material in time. As long as the market is pushed forward, the way we see it at the moment, there shouldn’t be too much problem. If we think that part of the present situation could be a market bubble, things could certainly be more tricky when we get further into the summer.
There seems to be not much risk as far as prices are concerned, but the physical movement of hides is also pretty important. With the high kill in the US that is expected for the weeks to come, insufficient movement of physical product could change the situation pretty quickly again. If retailers around the globe are still taking a prudent view in the second half of the year—considering the increasing rate of unemployment one has to expect for the rest of 2009—we could see things become pretty difficult again. We don’t like to say this because, generally, we tend to be positive. However, when we look at the risk potential of the present situation and the fundamentals we have on the table today, we tend to think it could be wise to be a bit prudent. This applies more for sellers today than for buyers.
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