Market Intelligence—28.07.09
28/07/2009
MARKET INTELLIGENCE—28.07.09
Macroeconomics
In the past two weeks the financial markets have displayed rising confidence that the present global crisis could come to an end. Maybe it would be more accurate to say that they believe it has already ended. Stock markets and commodity prices, which were a bit under pressure at the beginning of the recovery, are rising sharply and large banks and other big corporations have published positive results for the second quarter of 2009. With an excess of liquidity cruising around the financial markets, and in view of a lack of proper investment possibilities, investors are pouring their money into commodities and stock markets again, which is pushing these asset prices further north again.
It’s not very popular to offer criticism or warnings; most people prefer to believe the good news and in the rising prices rather than analysing present realities.
Despite all the good news there are quite a number of industries still struggling. While some are claiming that the recession has come already to a halt, very few people seem to see the reality of the present conditions that many western still have to deal with. Although the decline might have stopped there is definitely no major recovery in sight. At least not for the short term.
Many key industries have lost between 20% and 30% of their business and even if they see a kind of stabilisation today, the level remains very low. In many countries unemployment is still going to rise for quite some time and national budgets are in most cases already ruined. No matter which way you look at it, the deep crisis has destroyed a lot of the wealth that nations held and people will feel this in their pockets in the years to come.
In the meantime China remains the driving force behind many market activities. The amount of money and the size of loans the Chinese government has and is still pouring into the economy is actually frightening. From an average of about 400 billion renminbi ($58.5 billion) offered to consumers and industry per month until the first half of 2008, direct loans have already increased almost five-fold to the absolutely enormous amount of 1800 billion renminbi (more than $260 billion) a month. So the Chinese miracle, too, is only built on credits, and credits can quickly turn out to be built on sand, as we have all learned recently.
However, for the time being, this is a powerful demonstration of what the Chinese government is willing to do if the money is also used for further expansion into other global markets. Let’s hope that this is for the good of the general global economy. So far it has propelled property prices in China by 25% in 2009, the stock market has gone up by 70% and car sales by 47%. At the same time, we all know how much consumption and production have been shrinking in the old economies. In our economies we would call this a credit bubble, but we also had to learn the lessons the hard way before we were able to think about in those terms.
In the meantime there was at least some better news, for example from the automotive industry, with the premium manufacturers in Germany announcing that they are going to cut out short-time work and return to almost normal production after the summer break. Some new models and the sale of existing stocks, which have been burdening manufacturers for quite a while, are allowing them to have a more optimistic production budget for the rest of the year.
Commodities, interest and the money markets reflect nicely the present situation. Short-term interest rates remain low, while in expectation of a recovery of the economy and a less restrictive policy from the national banks, interest rates for five to ten years have hardly moved and remain at reasonably high levels. Commodities, such as oil and gold, have started to rise again and reflect a bit of a conflicting picture, with oil demonstrating confidence in the economic recovery and gold the rising concern about inflation; this uncertainty about the stability of the financial system should not be forgotten. In the strange logic of the financial market, the dollar has continued its descent, returning as to a similar situation to the one we saw in 2008.
At the moment the optimists have definitely taken over and for the sake of all of us we can only hope that they are right. For those whose feet are a bit more on the ground, the situation is definitely not yet completely clear, but at the moment any comments to this effect are being ignored. The markets want only good news at the moment.
Market intelligence
The market for hides continues to show a great deal of strength. In particular, good quality hides remain the winner and a number of origins have jumped by another 10% or so in the last two weeks. We still don’t believe that this is the result of any particular improvement in the leather business, but after China had absorbed most of the stocks and production in the second quarter, many other tanneries have been forced to replenish their inventories too and they became, consequently, a very easy victim for the sellers, who were not obliged to offer any mercy and just asked whatever price they found appropriate.
With reduced the availability, and with many sellers already sold forward, those who were in desperate need of material had very little choice other than to accept what they were offered and charged. This is certainly not a very healthy situation, but it is a normal market reaction, and with the developments of recent weeks, it was only to be expected for those who had missed the train and waited for too long.
We have to point out that, as far as the general trend was concerned, we were pretty much correct in our advice in the first quarter of 2009: not to forget to stay in the market and to keep stocks at reasonable levels with the low prices the hides had reached at that time. However we couldn’t have been more wrong on the recent trends in the second quarter of 2009 when hide prices started to rise and we took a much more cautious view of the situation, not having had too much confidence in the enormous purchasing activity and in the rising raw material prices that we saw.
Those who today do not have at their disposal adequate raw material inventories will be, at least for the next couple of months, in deep trouble, and depending on the order situation and the prices for leather, it could become a pretty painful time.
Summer recess
In Europe a number of tanners will be happy that they have closed for the summer holiday season and that they can walk away from their problems for a time. Most likely, those who are being hit most are those who did not have an adequate finished material order book and were consequently also pretty cautious in their raw material purchasing.
Others who were lucky enough to be offering leather types that the market wanted, and were able to maintain a certain level of production, will certainly also have been much more active in the raw material market will now have the benefit of holding reasonable stocks, or contracts for delivery from suppliers.
With Europe in particular delivering at the top end of the quality range, the market is also facing the problem of the sharp seasonal decline in hide production. Many producers, in view of their general economic uncertainties, have taken the decision to commit themselves with sales already over the summer, and they will be pretty unhappy today that they have to deliver a lot of hides at levels that looked very good at the time these deals were concluded, but look pretty low today. Anyway these are the rules of the market and a number will also have taken full benefit of existing contracts when the market came down at the end of last year. So it levels out for everyone.
What is really surprising is that the market, despite the sharp spike, is still finding enough interest at the present levels we have reached. Either tanners have full confidence in their leather business for later this year and into 2010 or there are still enough producers who are caught short on raw materials.
Taking a bit of a longer-term view, one can still say that,even at the prices we are talking about today, we are well below the historical average. Even buying today at the prices we have got might be a mistake in the long term. However we should bear in mind that market recoveries never really run in one direction for ever.
On alert
We know, that we have not been very smart in our evaluation of the raw material trends of the last two months or so, but we are still of the opinion that there are a number of problems around in the leather pipeline and the level of alert should be pretty high these days. Of course, we have to realise that retail in leathergoods and bags, in particular in China, remains pretty strong. We have always been of the opinion, even in the deepest crises, that people still look for the small things to please themselves. Small luxury items are a good example, and bags have become such a fashion item that they have been harmed very little by the recent price-drops.
The shoe business is also rather more stable than many people thought, due to the basic demand. Automotive sees a short-term recovery and with the pipeline being pretty empty they might be the ones who are mostly forced to buy their preferred raw materials to meet the budgets that manufacturers are sending them at the moment.
The upholstery market remains a problem as it is at best at a level of 70% to 80% of normal.
That means that one has to find an adequate price level for raw material under the present market conditions. Since there is never an adequate level, we will definitely not find one today. Since the demand side is, in our view, not the key problem; the big question concerns how much raw material and semi-finished products are stocked along the supply chain. We are dealing today with the situation that players along the supply chain are gaining confidence and are increasing their stocks back to normal, or even increased levels.
Financial questions
When we follow this logic, then today’s prices can be easily justified since they are, as we mentioned above, still below the long-term average. One problem however should not be overlooked, the financials. While possibly in China producers have no problem financing their businesses because the government and banks are offering them very easy access to credits and loans the situation in the rest of the world is a bit different. Many tanneries in Europe, but also on other continents, are having limited access to credit and have only had one advantage, that falling raw material prices and falling productions were reducing their cash needs.
If raw material prices stay at present levels, as seems likely, the cash needs of the tanneries are going to rise quickly. And since leather prices in many cases are mostly inelastic, the profitability of many tanneries could also be harmed pretty much.
So the risk remains that despite the improving situation and outlook, demand could be negatively influenced by tanners going out of business or being no longer in the position to pay their invoices on time and consequently needing to reduce production as well. This is normally the beginning of the end, in particular when your production is not profitable.
Another subject we have to watch carefully are the ongoing reports about value added tax (VAT) fraud in Italy. Last week more people were captured and the damage is easily reaching a number in access of €100 million. Despite the possible consequences for some tanneries, we also have to consider that a lot of the survival strategy of tanneries in northern Italy has been based on the positive influences of reduced raw material cost due to the avoidance of VAT. This will add to the existing problems of many of the tanneries.
We have to consider it pretty likely that we will see production in this area shrink even further and this is also going to have a negative influence on raw material demand. In the end, the total global production and demand for leather will certainly not change, and some of the inflated raw material needs will definitely disappear.
Demand will decline
For the summer period it is pretty unlikely that we will see a major change in the trend. Demand will decline because of the summer holidays. Also, one day, Chinese tanners will most probably think that they might have enough for the moment. Another effect that definitely plays a role in today’s market is that a number of suppliers and customers, in particular in the United States in China, still have to sort out a couple of issues related to contracts from 2008.
With prices having gained roughly 30% so far, it has put a number of suppliers in the position of being able to remember who honoured contracts last year and who didn’t.
A lot of tanneries today are looking for new options, new suppliers, which is certainly inflating demand. How much this is influencing the order book of a number of suppliers remains open to question. But if suppliers decide not to honour existing contracts because they feel that they have better options, it is no surprise that buyers, too, should look for new sources.
Splits in demand
The split market is also gaining a bit of pace now. The levels of enquiry are constantly rising and in this segment, too, production is failing to keep up with demand, albeit to a lesser extent than in the hide market. But after the long drama in the split market, which had more fashion reasons than market reasons, the present situation is giving a bit of relief to those who have to buy expensive hides and can now at least get a bit more of a return for their splits.
The skin market has not seen much of a change. There is definitely more enquiry now for new season lambskins for double-face production, but prices have not reacted much yet; only moderate increases have been reported. A number of players are now becoming very interested to see if the sharp rise in hide prices will also spill into the skin market. Skins have not really had any benefit from the situation and they look still very, very cheap. In particular for garment leathers skins would be the attractive alternative to cow hides. If the market is really strong and if global consumption is really going to increase, this attractive alternative should begin to receive more attention pretty soon. After the summer holidays we should quickly get an indication as to the chances producers and sellers of this kind of material have of a better future.
For the coming weeks we think that the market is now entering holiday mood. In Europe in the second half of July and the first half of August almost all leather producers are on holiday and the kill is at a very low level. Consequently, market activity can be high for the simple reason of the lack of quantities and players. With Asian people not on holiday, they will be the market makers. Will they have the courage and the need to push the market even higher?
With the oversold situation that we see from suppliers, it would need very little to keep this market on fire. However, with the All China Leather Exhibition in Shanghai already on the horizon and Chinese buyers aware of the situation today, we think they will also take a short break and wait for visitors to discuss face-to-face what to do for the rest of the year. This includes not only raw material suppliers, but also finished product buyers who traditionally travel at the present time too. There is a fair chance that we will still see some latecomers needing raw material and having to take whatever is available, but they will definitely find it tough to negotiate on price. Sellers are pretty confident that if one buyer doesn’t take the product, another one will. This might be true for the time being, but the situation will change again when the slaughter in Europe picks up in September and October. We will have to wait and see if the leather business is strong enough to allow all tanneries to keep their productions running until then. For the time being it might be best to look for a nice place on the beach or wherever and let the holiday season pass.
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