Market Intelligence—26.01.10
26/01/2010
Macroeconomics
The general positive mood in the financial markets has taken a few knocks and the number of warning voices saying that 2010 could disappoint those hoping for a recovery is growing.
Indices in Germany measuring the business outlook were pretty bleak and also the Organisation for Economic Co-operation and Development (OECD) recently published forecasts for global economical growth for 2010 in which they expect only a very moderate ‘recovery’, but refrain from expecting real expansion of the global economy.
The most worrying factor today is certainly China. Although it has been the strong performer during and after the crisis is could become a problem for a number of reasons. On one hand the government has pumped huge amounts of money in the domestic economy, which has kept production, consumption and speculation high. Meanwhile Beijing has started to realise that it might have gone a bit too far and that the allocation of the money isn’t ideal. Companies and individuals are lending excessive cash to other third parties, mainly for speculation in commodities and real estate. Most are convinced that the bubble is already there.
Beijing is firmly trapped in its ambition to create jobs and to keep the expansion of the economy on track, but it should monitor the financial risks of its policy as well. Since quick and courageous cutting of money supply would endanger the economy, they are only taking half-hearted decisions by asking for more bank deposits against loans.
Last week, there were rumours that the Chinese government had ordered big banks not to grant any further major company credits for the rest of the month of January. Although this was quickly denied, it demonstrated the concerns and the stock markets in China took a quick nosedive.
In any case, with the importance China has today on the global markets further developments should be monitored carefully. China is still not integrating well into the global community and protectionism and the ambition to profit from the recent crisis are still growing.
Meanwhile the US dollar is gaining value; or, at least, the euro is losing value. The problems with the national budgets of a number of euro-zone member states is presently dominating the discussion and some are starting to question the success story by suggesting that the EU currency might only be good for the sunshine days, but not for periods of rain and thunderstorms.
Oil and general commodity prices retreated a bit in sympathy with the rising dollar and concerns that the global economy could not see the rebound many were expecting. Indeed, commodity prices are closely connected to the situation in China. Any concerns, that the situation in China could deteriorate would change the market patterns drastically.
Market intelligence
We are human, and we fail. Our assumption that demand would slow the upward pressure on prices could not have been more wrong. Despite all the complaints and the concerns about the market and raw material price levels, buying activity has remained very strong and prices have continued to rise.
In particular some Chinese buyers seem to be understocked and in Europe the automotive tanners have remained as the driving force behind the market trends. As usual, the market is feeding itself and price increases are gaining pace further down the pipeline. Where packers are selling directly, some of them have refused to contract hides for a longer period. Where fresh hide supplies are involved, shipments have even been planned without a price. That has led to a market without rules, and, in principle, the situation is not very different from what we were seeing when the market collapsed, only on the opposite side.
Orders for tanners
Trying to figure out the reasons has not been too easy, but one thing became pretty clear quickly. Leather orders received by tanners are higher than expected. In particular handbags and upholstery have had an excellent start into 2010.
This demand has affected two types of tanners. One type had been busy already in 2009 and bought continuously. They still hold inventory and contracts at cheaper levels and are, despite the high prices, still in the position to work on an acceptable average. The others did not have the pleasure of sufficient orders last year, and only saw business start to improve from the last quarter of 2009.
Since these tanners did not build inventory in time, they have struggled with their calculations for some time. They have been prudent in the hope prices would ease again. This hope has been disappointed, so they have had no choice now, with their raw material warehouses empty, to re-enter the market and buy what they could get at whatever prices the seller was asking.
Many sellers, especially the more experienced ones, feel rather uncomfortable. In the past weeks things have been too easy and even asking prohibitive prices hasn’t stopped customers from buying. If a customer did say, ‘sorry too expensive’, others showed up quickly to take the material. Many remember that when things become too easy, they also become risky.
We know that we are always conservative and on the cautious side, but there are good reasons for being so at the moment because some parameters in the equation do not fit. One can follow the improved demand for leather. This is also acceptable when we consider that the pipeline still had potential for refill after the 2008 catastrophe, but it is hard to believe that the situation is really as good as the market may suggest today. This is without even taking into account that many leather productions are not profitable on replenishment cost any more.
Domestic demand in China
The big question mark remains over China still. If leather demand is already back to almost pre-crisis levels, then the missing 2007–2008 volumes from the ‘old markets’ and the former ‘Eastern Bloc’ must have been completely compensated for by domestic consumption in China. Well, since there is no reliable statistical information from China one is left to take guesses and make assumptions. Speaking to Chinese people in the big cities, they are all excited about stability and economic development. They report packed shopping malls, a booming housing market followed by strong demand for furniture and so on.
Following these reports one tends to believe that it could be possible that demand has just shifted, and Chinese tanners serving the domestic markets are the winners. This might be partially true, but is it really realistic that in 12 months all the losses of consumption have been made up? Well, we don’t believe that.
Maybe we are wrong again, but there is a gut feeling that the Chinese policy of easy lending and cheap money has just extended the overcapacity in the industry. With all the hides that have been shipped to China since the second quarter of 2009, a lot of tanning drums that would already have been demolished or be standing idle have kept rolling, and what started as speculation on cheap raw materials proved so successful that the system is now feeding itself.
China is big and the domestic pipeline can absorb quickly and easily these extra quantities. However, knowing about all the numerous steps product can take in China before it is really bought and paid for by the end consumer, we can say that, in China, a lot of things can be different from what they seem. What we mean is that there is at least a pretty reasonable potential that the easy money and the good mood in China are covering possible risks regarding payment and stock in the pipeline. A lot of business in domestic China is still on an open-credit basis and, with the easy money policy and the good outlook, suppliers are willingly selling and delivering on a credit basis. If this system starts to show cracks by fading confidence or a tightening money policy, it could quickly become a danger for the market.
Lessons from the past
This is what concerns those who have seen similar rallies and bonanzas before. Some are mentioning that most tanners were not profitable during 2008 and, at the Hong Kong leather show suppliers were hanging up ‘sold out’ signs. The sky was the limit. Then the financial crisis hit the market, but what if a little financial crisis hit China this time.
Anyway, the fundamentals are telling us, that despite there not being a cloud in the sky—with hide producers being sold out and sold forward, and leather orders being abundant—we are now at a stage of the cycle in which a high level of precaution should be taken. This doesn’t mean that the stampede has come to hold yet. There is always exaggeration before the correction.
Splits in sympathy
The split market is firming in sympathy with the hide market. Since raw material is becoming more scarce every day and even low grades and low-priced hides are starting to rise, split buyers are also starting to rush and to secure raw material. It’s not that there is any real justification for this in terms of demand from fashion or general demand, but at present the general dynamic is feeding itself and this is also spilling into the split market.
The skin market has been extremely firm on prices, and European skins in particular have been rising week by week. Lambskins have moved by more than a dollar per skin in just about two weeks. That accounts for a 20% increase.
The China Fur & Leather Products Fair in Beijing brought another buying frenzy and raw material suppliers visiting the show were chased for offers in raw materials. It is still high season for Chinese buyers as they like European skins to be shipped before the end of the winter as they believe this way they will get the biggest skins with the most wool on them. But it is still quite impressive how active business had become after a pretty slow and difficult 2009. Also other markets such as New Zealand and the Middle East are reporting pretty similar situations.
For the coming weeks it is pretty difficult to make a forecast. The easy thing would be to believe that the firm market trend is going to be extended. Most likely, this is going to be the case on paper. Sellers will now desperately check where the limits of this market are. Since they have pretty little to sell it is not a big risk to lose; and the less they push prices up, the safer their existing contracts may look. However, as usual we think everyone has to be pretty cautious these days. Indeed the raw material pipeline is pretty empty and anyone who hasn’t got enough raw material today needs to find a seller willing to sell to them and accept the price asked. Is that really a basis for solid sound business? Not really, and everybody knows that today’s raw material prices do not correspond to the present prices for finished leather.
It would be much less of a concern if the main driver behind the market trend weren’t China. There is no question that a lot of the market activity is related to the easy money policy and a great deal of optimism in this economic powerhouse. It is encouraging business people to take too much risk, and private consumption is just boosted by the general excitement. If those who are warning already about a bubble are proved right eventually we have to get ready for another difficult time.
However, we have been talking about this and issuing warnings for quite a long time already. And so have many of the experts. We have been wrong so far and for the past six weeks the speed of the price rises has just accelerated. For the time being the supply chain is so empty that only an external influence can create a major correction. Let’s assume that credits in China become much tighter, that payments in the domestic supply chain are interrupted, stock markets crash, letter of credits are not opened any more, it could possibly become a trigger for a complete change in the market. Nobody forecast the financial collapse in 2008 and nobody was expecting the massive rebound we have seen in the second half of 2009. So let us see what the future has to offer us now. One thing is pretty sure: whatever happens, it is going to have a massive consequence in the market because of the high level of sensibility we have reached in the meantime.
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