Market Intelligence - 19.05.09
20/05/2009
Macroeconomics
The economic reality at present still looks pretty lousy. However, since the financial markets are not dealing with the present, but with the future, a lot are already in the mood for recovery and better times.
In spite of very low rises, some of the statistical data has been interpreted as the end of the downturn and this means, in the mindset of the investor, that things are changing for the better and money can be invested. However, the better mood and hope for the future is still in extreme conflict with the real situation in the retail markets of the western world. In the US, for example, retail sales fell by more than 10% in the month of April 2009 compared to the same month last year. Seeing unemployment rates rising constantly in most western economies, one can only be very cautious about the situation.
If one wants to be positive, the best that can be said is that productions and budgets have been reduced by much more than the actual declines, which could make a stabilisation of production on levels around 10%-15% below the levels of the first half of 2008 realistic, but it this really good?
Stock markets on average have seen short-term highs and even the possible bankruptcy of GM (at least one of the biggest companies in the world) comes as no shock to anyone anymore.
The European Central Bank has lowered its base rate again by 0.25%, but it remains unclear if this was the last move on the downside or if a further reduction will follow.
Oil prices fell moderately from the $60 level; it seems that the recovery in oil prices is taking a break despite the upcoming driving season.
The dollar also fell on Friday from the peak levels around EUR 1.36 or 1.37 and closed at around EUR 1.35. Experts are presently in serious conflict about the trend of the greenback, and the three-to-six month forecasts of the banks are ranging from EUR 1.25–1.45. This also explains why the dollar finds itself trapped right in the middle.
Market intelligence
Most of what we said last time we could enter again in this week’s report. The purchasing activity in particular from the Chinese tanners has continued and the sales numbers which are officially published continue to be very impressive.
Also in Europe, some specific raw materials continue to be in short supply and tanners with short-term orders to fulfil who are short of the right raw material have had to get into the market and pay what suppliers were asking. This was particularly true for heavyweight, good-quality bull hides and some other specific high-quality raw material.
In the mainstream market, for example for dairy cows, the situation was again almost completely in the hands of the Chinese tanners. They were far from reticent and continued to display impressive purchasing interest, under the condition that the prices asked were not completely wild and sellers were willing to keep increases within an acceptable range.
So we have to admit, that our rather prudent outlook of not believing in continued market activity has to be considered to have been wrong. The tanning industry seems to be rather more optimistic about future business potential than most of the general economics analysts. With most of the activities still lying in China and the European tanning industry now preparing for the summer break rather than anything else, the situation still depends on the views, expectations and consumption in the Far East.
The picture in China
Talking to some of our sources in China, we continue to get a lot of mixed information. Some tanners seem to be very busy, with a decent order book for finished leather, but in many cases it seems that things are also very busy in contract tanning, which leads us to believe the speculation about inventory building on the part of some traders.
We have also heard further information about a lot of enquiries from unknown importers and trading companies from China in the various supply markets. This seems to underline the rumours that there is a mix of individual investment, gambling and some strategic movement directed from the Chinese government going on, which seems to support the idea of increasing raw material inventories in the country.
There were reports in the media that the Chinese government has given the green light to the expansion of available warehousing space for agro-commodities by between 10% and 20%. Reading this in the official economic newspapers, it is actually not linked immediately to hides and skins, but more about foodstuffs and cotton for example. But if you think about it, hides and skins come into consideration too because the vast majority of leathergoods for the global market are still being manufactured in China. And this isn’t only about the export business and the supply of our shoes, sofas, leathergoods and jackets; it is also about the still-rising consumption in domestic China.
Indeed is the situation in the consumer market in mainland China is still much better than anywhere else in the world. The stock market in Shanghai has gone up by more than 40% this year and if one just looks at the rising sales of cars (+7.4 % in April) you can see that the situation everywhere in the world is not as depressing as we in the western world think it is. The Chinese government seems to have been most successful in stimulating the economy while maintaining the trust and faith of the people in their economic future.
Anyway, can this be enough to explain the recent strength in the hide market? The Chinese industry is well supplied with cheap money, the consumer continues to shop, there is a certain strategic ambition to control cheap raw material markets and, last but not least, the general Chinese character loves to gamble and take a risk. As a consequence they just buy the best they can get for the cheapest money they have to pay. So after it became obvious that the raw hide market had bottomed in February, the industry was willing to invest into good quality material even when there was no clear confirmation that leather orders would improve in the short term.
Shift in stock
This explains at least why the markets in Europe and the United States have risen from their low points and seem to have a pretty strong performance ahead. However, without being pessimistic and overly concerning everybody, we have to take into consideration that recent purchasing activity has been, in part, just a shift of stock from the raw material producer to the tanner, and just one step forward in the pipeline. We haven’t heard of any leathergoods manufacturers joining the party and actually stocking leather themselves.
Of course, the shift of stock up or down the leather pipeline is always an indication of the general direction of the market trend, but for our taste the move is neither strong nor sustained enough at the moment to be called a real trend. Only when buyers are willing to pay another substantial increase to secure raw material orders will we believe that we are at the beginning of another bull market like many international commodity traders want to believe already in expectation of a general global recovery later in 2009 or 2010.
We should however also consider another scenario. Some experts consider that the recent sharp rise in many agro-commodity products focused too much on Chinese demand only. They believe that, with the end of stocking activity on the mainland, many commodity markets could drop again in late summer before really taking off with a new cycle of rising prices, but this will not happen before the end of the year or perhaps even into 2010.
Indeed one has to question how much money from its foreign currency resources China is going to allocate to these strategic investments and how much stock the government in Beijing will consider adequate before pulling out again. That the country has enough resources and these need to be invested is without any question. And that investing in commodities could be a better deal than investing in US bonds might also be true in the long run.
Dairy cow kill
While we have been pretty much focusing on the demand side for some time, we came across a pretty interesting report about the dairy cow market in Europe recently. A number of milk producing countries in Europe are reporting an unusually high kill of dairy cows at the moment. Like other commodities, milk prices are suffering in Europe at the moment, having fallen by 50% or more. Milk is one of the battlefields of discount retailers and many prices have not only fallen massively, but have even dropped below levels that are profitable for farmers today.
Many smaller farmers in particular have decided to pull out of milk production and to sell their cows to the slaughterhouses. As a result we are not seeing a sharp decline in the kill of dairy cows this spring, but quite the reverse—in many countries we see a sharp rise. This has increased supply and this might even continue for a while, but it will also result in a shortage of the same material in the future. It might even have an impact on general supply, because the logic applies not only to cows, but to the supply of calves. We are only at the beginning of such a cycle and who knows if the prices of food and milk might also recover quickly, as food is still a basic commodity and the global population is still rising. We will continue to monitor the situation because it could have a strong impact on the market in the future.
Consumer spending
There has been little news from the leather market. Sales are down and orders are not reported to be impressive. Reports from the European upholstery manufacturers were steady, but well below 2008 levels. Despite a few signs of improvement of consumer sentiment it does not seem that we can really expect a strong season of consumer spending later this year. Unemployment is still going to rise before it is going to fall again.
The split market is starting to get a bit better now. We don’t know where all the splits that are, of necessity, being produced in China at moment are being absorbed, but in other markets, reduced tanning has and is reducing the supply of splits a lot. Supplies of some specialty splits are now in the balance or may already be in short supply. The fall in prices has certainly stopped already and in some cases prices have also risen from the bottom.
The skins market is a bit twofold. While fine wool skins are still in demand for lining purposes and also some garment productions, nappa skins are still pretty depressed and prices are still close to their historical lows. Traditional markets like Turkey, Poland and also China are not actually showing any increased activity and the upcoming summer season is not looking promising. The good supply of cheap cows in the first quarter has also not helped to improve the attraction of lamb nappa. Only a rise in demand from the fashion industry could actually do any good to this market in the months to come.
For the coming weeks sellers seem still to have the upper hand and asking prices are supposed to stay firm or at least steady. It is going to be an interesting period now to see if some latecomers are going to help sellers to move their average sales revenues higher again. For some premium hides this might be possible, but for mainstream articles we doubt that tanners are going to rush to pay higher levels in the short term. With many suppliers having reduced their stocks, they will remain reasonably stubborn with their asking prices also in the attempt to protect their existing contract books as long as possible. If buyers too want to see prices stay steady to protect their position with finished leather buyers, they would be well advised to keep on buying smaller volumes at market levels and to make sure that sellers don’t get nervous too soon. In the end all will depend on existing sales being converted into shipments to prevent accumulation of hides throughout the summer which could change the mind of sellers again.
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