Market Intelligence—22.09.09
22/09/2009
Macroeconomics
The financial sector is continuing to bet on the end of the recession and the progress of the recovery. Stock markets continue to rise. Risk aversion is declining and the game of ‘making money with money’ is back in play.
This is at the end the same story that we witnessed until the big crisis last year and banks and investors are again on the money-makes-money trip. Although one cannot really support government regulation of the markets, it is difficult to accept that unproductive work can again be better rewarded than productive work and investment.
On the one hand, the finance industry is needed and powerful, but on the other it is hated and the focus of criticism at the moment, so an adequate handling of the situation is difficult to achieve.
For the time being the gamblers are back and the so-called carry trades have become pretty popular again. Borrowing money in low-interest areas and investing in high-yielding countries seems to offer almost risk-free profits. While this has been popular in the past for the yen or Swiss franc, it is now the US dollar that is offering cheap borrowing conditions while countries with a strong commodity basis and raw material resources such as Australia or South Africa offer higher yields and decent risk-protection.
The large amounts of liquidity that had been parked during the crisis are flowing back into the stock markets and pushing indices back to record levels for the year.
However, there are also a number of heavyweight opinions that continue to warn about the future. A number of analysts of good reputation see the present recovery and the rising figures for production as being mainly related to replenishment of inventories as a result of government stimulus programmes. They do not see a real and sustained improvement of the economy and expect another sharp downturn of the global economy in the first half of 2010. Checking the present situation one can find good reasons to support this point of view.
For the moment however, the market is still under the impression that things are positive and it is this that is sending the stock markets to record levels for the year. The oil price is holding pretty well around the $70 mark, while the dollar is being hammered down and on its way back to the level of $1.50 to the euro. Gold continues to rise and has safely broken the $1,000 level. Apart from those investing in the stock markets there is also a great number of people fearing inflation and find it adequate to protect themselves by the traditional investment in gold. Another sign, that far from everyone sees the future as bright as many are trying to paint it at the moment.
Market intelligence
The leather pipeline is still waiting to see what direction things are going to take next. Buyers and sellers have (of course) different opinions over what the future is going to offer, but we think that the indications are becoming clearer.
The hype we saw during the summer has definitely cooled down. People all along pipeline are now seriously talking to each other and the market is no longer just impressed by low raw material prices, replenishment needs and speculation about better times ahead. This was the main driving force behind the bonanza that we saw in the second quarter and which had lasted into the first half of the summer.
As a matter of fact the market realities had already taken over by mid-August, but emotions were running high and, with the lack of a real market due to the holiday period, there were very few real facts to base any opinion on.
Having now passed the first half of September, more hard facts are coming into the decisions and these hard facts are less positive than the enthusiastic view taken by many in early summer.
Not that we want to be pessimistic or negative, but it seems to be better to deal with the realities to prepare for the rest of the year. It is extremely important to gather more market feedback until the end of October to get the final picture for the high season of production. However, what has been collected in the past week is already giving some indications:
- The sharp gains in raw material prices are finding little support from manufacturers and retailers.
- Retailers are not aggressively ordering, but remain pretty cautious about their decisions
- The retail market in China continues to perform much better than the rest of the world, but domestic demand cannot compensate for the flat conditions on the export markets
- Inventories in the automotive supply chain had been run too low and needed, and possibly still need more, replenishment. Particularly in China.
- On the other side there are many reports about good stocks of wet blue in China deriving from the speculative purchasing of the second quarter. Mainly people are talking about lower grade material.
- In mass consumer products leather now has a fading role as a manufacturing material. Synthetics and artificial leather are gaining market share.
- The leading luxury brands related to leather had been passed the crisis pretty well and top quality leathers are still in good demand.
- The trend of further consolidation in the supply chain continues, as seen from the possible merger in Brazil of JBS and Bertin. This is shifting the balance of power a bit more towards the raw material suppliers.
In detail
We don’t want to deal with all the various topics, but let us just have a look into some of them to get a feel for what might be indicative of what is to happen in the near future.
What touches us most from the list is firstly the situation of stocks. Following high export sales in US, one can see that, with the rising market, the decline of sales numbers had already set in by mid-August. Well, if the number of sales is low and prices high, it can only be either that there have been sales to latecomers who have been understocked or that low prices for outstanding contracts have been mixed with high levels, suiting both parties in a market like this.
We have already been dealing with this issue for a while, since seeing the sharp rise of prices over the summer. Chinese tanners in particular had built inventory when prices were low and could now easily defend themselves against the higher market by just buying minimum quantities to protect their stock valuation, but at the same time let the sales positions of their suppliers erode to encourage prices to fall again. The idea is always the same. Well, so far the strategy has been successful and the key question now is over who can hold out longer.
When we believe that stocks are still sufficient and that leather demand is, with a few exceptions, failing to keep pace.
Looking at the sales and shipment in the first eight months of 2009 and comparing them with the estimated level of leather production and consumption, we should assume that there is still plenty of inventory in China before tanners need to replenish. Raw material exports were extremely high when leather demand was well below the levels of 2008, which will lead to adequate levels of inventory in the manufacturing pipeline still waiting for sales and consumption.
On the other hand this simple calculation is leaving quality unconsidered. From the markets, we hear that demand has been preliminary for better selections. With low prices for the top end of the quality range, a lot of the business had shifted to the medium-high end of the product range. Most sources close to the market in China are reporting large stocks of wet blue in the lower end around the country. Some are still in trader hands from the time before the crisis of 2008 and some have been built in 2009 as left-over from the production of the better raw material.
Quality questions
From what we understand, however, leather demand remains pretty much concentrated on better leather and this brings another topic onto the agenda. Some of our sources are discussing the trend towards more artificial materials. A number of people we talk to are displaying concerns that there is a trend in a number of consumer products related to leather to use artificial leather, PU or synthetics. This applies in their opinion not only for the ‘no name’, low-quality section, but is starting also to penetrate the medium and higher end, including brand names and labels. Examples include handbags, sport shoes and also upholstery, which are advertised without mentioning the term leather.
This is not really new, but if the trend is accelerating, and if a larger number of manufacturers and retailers do not consider leather as a positive component any more, something to improve product image, the leather industry could face a serious problem. The consumption of leather would then only be price-driven and no premium would be granted any more. In reality it would be even worse, because leather would be traded at a discount as manufacturers could consider the high price volatility and more complicated manufacturing processes as a reason to value leather lower than the artificial alternatives.
If this theory has a basis in reality, it would cap the value of hides for some time because finishing costs for lower selections would be relatively high while most of the alternatives of leather are based on oil. With a price of $70 per barrel, prices for synthetics are not prohibitive and will keep the revenues for heavily finished leathers under tight control.
Another option would be for leather, especially leather with more natural defects, to regain preference in the world of fashion. This seems unlikely in the short term, but remains a possibility for more long-term trends.
Suede persuades
The split market continues to be driven be a strong performance of suede leathers. Splits that are suitable for that purpose or for heavyweight specialty products are still in good demand.
The skin market has shown no change. Goats for suede for shoe production are still in strong demand and suitable supplies are almost completely absorbed. Sheep and lambs are still struggling. Although some origins are trying to increase prices, the market response is still far from enthusiastic. There is still a lack of interest in lamb nappa leather and without a strong recovery of Russian demand or a sudden fashion trend there is little hope for a short-term recovery. The situation in the lambskin market is so depressed that a number of markets are not even separating double-face and nappa skins anymore.
For the coming weeks one has to remain cautious. At the moment it seems that buyers are not willing to support the high levels of raw material prices and want just to sit back and wait for their cheaper contracts to be shipped without being bothered about new purchases at the present levels. There is no indication that there is any immediate need to buy raw hides in large quantities due to a sudden wave of leather demand. The present price levels are not inviting and are finding no support from the finished product market. There might be a few exceptions such as top quality leathers or automotive until the inventory levels are satisfied again. For the remaining articles and for the standard items one has to be more pessimistic and the market seems to need more adjustment to re-encourage the industry for new purchases. The top end of the quality range will have a much easier position than the more commodity types of articles.
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