Market Intelligence—14.07.09
14/07/2009
Macroeconomics
The last two weeks have delivered plenty of economical data, much of which has contributed to the impression that the rapid economic slide in some Western countries could be coming to a halt, or is at least slowing down.
The International Monetary Fund had released new estimates for global growth and has increased the forecast for 2010 to 2.5 %, but revised at the same time the figure for 2009 to 1,.4%.
China has also been delivering very positive news and economic growth is expected for the current year at 7.5 %, with some people even saying figures above 8% are likely. Retail sales in China have grown by more than 15% and in particular luxury goods and cars are delivering a very positive performance. Premium brands such as Audi and BMW showed increases of around 30% in China.
Industrial production in Germany went up by 3.7% in May, which was a pretty large increase, but nobody should overlook that the recovery is coming from pretty low level and nobody should forget that orders for industrial goods shrank by more than 40% in the previous months. This did not augur well for the rest of 2009. Also in the UK, the news was not brilliant and industrial production fell to levels more than 10% lower than in 2008.
Since the automotive industry plays a pretty important role for the leather industry, the numbers for premium European suppliers for the first six month were pretty interesting. The sales of Audi were down by only 9.7% in the first half of 2009 while BMW and Mercedes-Benz had declines of between 15% and 20%. We will discuss the influence of these numbers on the leather pipeline in our market section later on.
Although most of the so-called financial experts and politicians have used the latest numbers as a positive indicator for a general recovery, we still believe that one has to be careful about raising hopes too much for Western economies as they still have to expect a sharp increase in unemployment, which will consequently dampen consumer spending. These economies are still far from the levels that we saw in 2007 and 2008. So a return to anything approaching normal is still a pretty long way off and will be reasonably bumpy. This does not even take into account that most national budgets are in complete disorder and one has still to see how the governments will handle the problem without raising taxes.
Although many were quite happy with the statistical data, another pretty reliable indicator is the oil price. Oil prices fell back to levels below $60 per barrel. Oil is one of the commodities that has been pushed up in the last few months in expectation of a solid recovery of the global economy. Now it is sliding back by more than $10 per barrel and this proves that a lot of what went before was speculation and expectation, rather than being based on physical demand from consumers and manufacturers.
US retail sales also declined in May by 5.1%, which does not paint a very positive picture for consumer spending at present.
The fair conclusion of the present situation is definitely the some of the emerging markets, in particular China, have handled the economic crisis reasonably well by pouring huge amounts of money into their economies and holding consumer spending at pretty high levels. In the old markets and in the Eastern Bloc the situation looks much more grim and although consumer spending has not yet reflected the downturn in production, the situation can at best be called stable in Europe and pretty much down in the United States.
Being realistic, there is very little indication that consumer spending over the next months will substantially rise, and any improvement in production will derive from a process of normalisation rather than from a real improvement in economic activity. If the decline of the last quarter of 2008 and the first quarter 2009 is compensated by one-third or by half, we would still be far below the levels of the first half of 2008 and it will never be enough to stabilise the economies in full.
So we have to hope for a strong performance from China, which could shift the focus of economic power from the US to Asia. The consequences would, however, be pretty intense for those in the Western world because China’s strategy of using huge amounts of currency reserves for strategic investments in raw materials and technology will change the economic balance pretty much for the long run. This effect will only take place if China can sustain political stability, and China is not immune to religious and social unrest, as has been seen in the far west of the country in the last few weeks.
Interest rates remain pretty low and the G8 Summit hasn’t given any major results that are of importance in the short term. To help the agricultural production in developing countries and to protect them from subsidies will, however, have positive effects on food production there in the long run and might have negative ones for production in developed countries.
Market intelligence
The trend in the hide market that we have been seeing now for almost three months continues. What started some time at the end of March or beginning of April continues, despite all our concerns until today. Prices are not jumping, but they are rising almost constantly week by week and raw material prices in the countries that are producing medium or higher quality raw materials have gone up by figures between 25% and 50%, depending on the country and currency influence.
The prices for fresh hides at abattoirs are rising much faster than the prices that can be obtained from tanners around the world.
The fact is also that inventories of better-quality raw materials have been completely absorbed and some categories have even entered into a situation of short-term shortage of material. In particular in Europe where we have seen since May the sharp decline of the kill, certain types and weights are not being produced in sufficient numbers to even meet the present low level of production of many tanneries.
Many European tanners who had been buying very little and not taking advantage of the cheap and abundant supply of hides that we saw in the first quarter of the year were surprised to realise that the information given to them by many suppliers, that many of the privileged hides had been absorbed by new buyers particularly in the Far East, turned out to be true.
Slow reactions
This has hit automotive tanners and some of the Italian premium product producers in particular. Automotive tanners who, today, are less tanners of the old-style and more industrial companies led by managers who haven’t had training in the leather pipeline have suffered most. These companies, run more by controllers and supply chain managers who react to day-to-day budgets and order income from the automotive industry, have had a pretty rough time because the short-term notice to replenish inventories could only be met by paying sharply higher prices, and in some cases even this was not enough to get the volumes they would have liked.
We have mentioned already that car sales of the premium brands are significantly lower than a year ago but still well above the production cuts we have seen in the past six months. The classical reaction of the supply chain braking too hard and too long applies also for the present situation. Order volumes within the supply chain neither reflect the real variation of production nor are they reacting in any kind of timely manner. No matter how intelligent some of the managers tried to be and how sophisticated the programmes they are using, they are still not good enough to handle such a difficult business as the leather pipeline. They simply do not bring anticipation and anti-cyclical action into play and, consequently, they are mostly acting far too late.
So when we had in the last quarter of 2008 huge stocks of unsold cars, the normal reaction of the manufacturers was to cut or stop production and to do anything to move stock before increasing production again. Much of the stock that had been sitting had been cleared by the end of the first quarter of 2009. Production was however cut to much lower levels than the remaining demand. Until this was realised and management began trusting the pipeline, inventories were reduced by so much that with the sales and production forecasts of many brands for the second half of the year, quick replenishment was needed, although neither production or sales are anywhere near the levels that we were used to seeing until a year ago.
Sales in China have, once again, done a lot to compensate, and car sales of premium brands like Audi, Mercedes and BMW are strongly up, in some cases by as much as 30%. Even for local assembly, parts from overseas had to be quickly moved into China to meet production requirements. Emptying inventories and the demands of short-term replenishment seemed to take some purchasing managers by surprise.
Chinese optimism
The key question today is not what has happened, but if this situation can be sustained. In China, optimism is great. The Chinese government and Chinese business leaders and consumers believe that their way of handling the global economic crisis has been much more successful. They feel they have been less influenced by the financial crisis (which, by the way, is true). They will sustain economic growth, they have answers to the problems of global markets, they will conquer more control of raw materials and technology with the money they spend and consequently come out of this present cycle much stronger than any other economy.
Their self-confidence is massive and this can also be seen by tackling the US dollar as the world reserve currency. In the meantime they feel strong and optimistic enough about their economic future for consumers to continue to spend money on the luxury products that are enjoying such an excellent performance in retail there at the moment.
The mixture of better retail, easy access to finance, government support and self-confidence has given the Chinese tanning industry the courage and ability to buy the large quantities of hides in the US and Europe that we have seen over the past few months. This is definitely the main reason for the strong recovery of raw materials markets in the second quarter of 2009.
European tanners have done exactly the opposite. With orders declining, financial resources eroding, and an increasing fear about the future they felt neither tempted nor able to take part in market activity; their raw-material purchasing was hand-to-mouth at best, but until a few weeks ago mainly still driven by the reduction of inventories. This gives us to a status quo that presents two main questions and problems for the outlook for the second half of 2009.
Status quo
China has bought cheaper, better and more raw material. Since one has to believe, that all the volumes bought are not used up in finished leather sales, the Chinese tanning industry now holds cheaper and better quality stocks for next season.
Cheaper hides have also gained some value, but rather because of sympathy and speculation than on a real physical demand for the material.
A lot of enquiries from around the globe recently have been for medium- or higher-quality hides. Their prices were low enough to disqualify any purchase of more economic hides. They have absorbed the majority of demand in the last six months, but account for only about 30% of global production.
Raw material purchasing of top quality selections has given European tanners new competition. Not only for raw materials, but also for finished leather sales. Since the strategy has worked so well for the Chinese with the markets rising and their increased inventory, they are confident that while most European tanners are now facing higher raw material prices, more complicated access, further deteriorating financial conditions and falling margins or rising losses, the same will happen to their leather prices.
Pole position
The Chinese leather and tanning industry is for the moment in pole position. Better local market conditions, easy finance and low-cost stocks give them almost a perfect start if the global economy is really improving. They couldn’t be better prepared and that is what they feel today.
It’s not a very popular thought today, but what if things do not get better soon, or at least not to the extent people are expecting? So far everything is based on a recovery in late 2009 and 2010. The Chinese bet is also that domestic demand there will be strong enough to compensate for reductions in exports. This could become a tricky game. While local consumption in China might be well cushioned for the reasons stated above, retail demand abroad has at least the potential to be disappointing.
Everything depends on the orders placed by the big retailers over the months to come. If they feel also that they might have run their inventories too low and they should replenish to have enough product on their shelves, the bet could be won. If retailers take a more cautious view of the situation and decide that unemployment and reduced private income will not allow consumers to spend, then the situation could become pretty critical after September.
No market collapse
The market will definitely not collapse as it did last year because levels of production, inventories and prices are not as high as they were a year ago, so the reaction cannot be as rough again. Some weeks of insufficient orders could change the mood quickly, in particular if people really have to realise that their expectations can’t be met.
It will be October before we can be sure of this. Many in the trade will be able to obtain primary information from trips at the beginning of September to Asia for the All China Leather Exhibition in Shanghai and meetings with customers there.
A reasonable insurance policy is still the financial support given by the Chinese government and Chinese banks to producers purchasing raw material and financing stocks. If this shield is pulled away and tanners have to look desperately for short-term cash, it could turn into some kind of short-term problem again.
Over the past weeks, the hide business was still reasonably active and there was enough purchasing still going on to clear productions in the United States and Europe. Some categories are completely cleaned up and even oversold. Chinese interest persists although many exporters confirm, that the interest for first-class tanners is diminishing and more and more small importing and exporting companies are entering into trading activity.
Holiday mood
We are now entering the summer season. In Europe we still see a few automotive tanners and some tanners who are at the top end chasing hides. The former, because they are acting late on the increased short-term needs from the supply chain and the latter, because they realise that top-quality hides are not exclusively reserved for them any more. The rest seem to have covered their needs and they just want to discuss if they should cover their September and October productions already, or if they are better off waiting in the hope that the buying bonanza will run out of steam over the summer and they will be able to get more and better hides after the holiday season. In China it all depends on the confidence and financial resources tanners have for the production season after September.
In all the discussions we have had with our sources in China we get the impression that the real producers have covered what they need. Demand is for better-quality leathers and lower selection remain stuck. Smaller tanners are still searching for better-quality hides as they understand that this is the only business they can make money from. In the autumn also the domestic kill starts again and then the need for imports will also decline moderately.
In Europe the slaughter will also rise after August and this will probably help a bit on the supply side.
Steady split market
The split market is at least steady and suedes are still doing quite well; heavy splits as well. Collagen and gelatine take also their summer breaks in the Northern hemisphere as do their suppliers. The higher production of splits in China should actually guarantee enough split supply in the months to come.
The skins market is not showing much change. Top-quality skins for exclusive productions are still doing well, fine wool skins also. For the rest, and in particular the commodity nappa skins, there is still not enough demand. Neither are course wools in good demand, and lamb nappa garments are not in fashion these days either. The rise in dairy cow prices should at least give some support, but the prices and the interest for UK domestic or similar skins remains pretty low and prices are just above cost levels. The summer will show if the skins market can also grab a bit of the market activity seen in cattle hides recently.
For the weeks to come, we have to watch China. In Europe business will be limited to the last action to cover short-term needs and some tanners and sellers are already acting for September and October. Suppliers and also tanners with stocks are possibly interested to hold the market on the same steady and firm tone. In the triangle between US, Europe and China, there doesn’t seem to be much risk of prices falling much at the moment. In Europe, we are still scared about possible failures in the tanning industry; many fear this may happen in September when the limited cash-flows from the summer could create severe cash strains.
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