Market Intelligence 23.03.10
23/03/2010
The financial world isn’t very exciting at the moment. Neither stock nor commodity markets are showing much movement and the situation in Greece is still making headlines, but there is little progress to be seen.
The Chinese government is giving no impression that it is not listening to the global voices asking for a revaluation of the renminbi. Meantime the growth of the Chinese economy continued and even through the holiday period in February: imports and export grew by more than 40% compared to a year ago.
The recovery of the global economy is still on track. While in Europe development is still pretty flat, things in Asia and South America are much better. Better private consumption and falling unemployment are keeping many of these economies on track while the ‘old economies’ continue to fight with unemployment and high budget-deficits. The fear of inflation and possible tax increases to get the deficits back under control are the main concern for the years to come.
Commodity values and currency rates have not changed much in the past weeks. Speculators are still betting on an improving global economy and are trying to push metal and oil prices higher. Diesel and petrol prices have gone up, but generally the trend is not yet fully convincing. Interest rates remain low and neither the Federal Reserve in the US nor the European Central Bank are willing to raise rates yet and instead pretend that inflation is still not an issue.
The markets are of a different opinion and many players are expecting inflation rates to rise substantially sooner or later in view of firm raw material prices, rising freight rates and the excessive liquidity in the markets. The futures markets are anticipating this already and the medium-to-long-term curve of interest rates is pretty steep.
The US dollar has remained in a very narrow trading range and most currencies have gained substantially against the greenback over the past year. In particular commodity-rich and emerging market currencies rose by substantial figures.
Oil remained closely around the $80 per barrel level over the period.
Market intelligence
There are a couple of things that have moved and shaken the leather pipeline in the past two weeks. We had two major leather fairs to look forward to and the industry is trying to find answers on how things are going to proceed in the second quarter. Everyone has been impressed by the strong performance and demand the leather pipeline has enjoyed over the past six months when the real recovery after the collapse of 2008 started.
Raw material prices continue to rise and have already exceeded the pre-crisis levels. The logic is that leather demand should be at least as good as it was before the world fell into deep trouble.
Our regular readers know that we have not been subscribing to the position that things are as good as the markets reflect them today. However we have to accept the simple facts and they are that beef consumption is down and so is the supply of cattle hides. At the same time demand for leather products has recovered quicker and more extensively than anybody expected. The decline of supply and the level of demand has led to a serious—at least temporarily—shortage of raw material.
Shrinking supply
We said already (in World Leather Business Week on March 9) that leather demand has not just recovered, but the cheap raw material prices have also invited non-regular producers to re-enter or expand their productions in view of the attractive profit margins that have been obtainable in leather production, in particular in China. This inflated demand and consumption of raw materials has added to the problem of shrinking supply. When we now look back to exactly a year ago and compare the situation with today, things could not look more contrary.
In March 2009 warehouses were too small to hold and receive all the raw hides that were coming onto the market. Emergency plans were developed to get rid of the hides that were not expected to find enough interest from the leather industry to clear the production. Exactly a year later we see empty warehouses and some say already a severe shortage of raw materials. Prices, if there were any, were close to all time lows then and today we are seeing margins even in the regions where hides were thought to be expensive.
Consequently the trade as a whole is getting increasingly nervous because people know that extremes always have severe consequences. While some say that raw material price levels are not yet close to the historical highs (and so one should not be too worried) others are pointing to the fact that quick and constant price rises can never be sufficiently passed through the pipeline so that step-by-step margins are eroding and in most cases have turned already into losses on the basis of replenishment cost.
In particular, speed is the problem here. When we consider that the consumer markets at present, in their vast majority, are allowing no price increases and the competition in front of the consumer is still keeping inflation under strict control, it can be easily understood that the courage and hope for manufacturers to pass price increases on to their clients is reasonably limited. And here is again the old and fundamental problem. No inflation means no justification for higher raw material price levels.
Scientists will argue that first raw material prices rise and then inflation is the consequence. This might be true for essentials but not for a product like leather, which can be easily replaced or decreased in its consumption in the various products it is used for. This should never be forgotten, even in market situations and cycles that are so convincing that a new page in a book of history is turned.
We may have all indications that raw material and leather prices have only one way to go and that is further up. Declining supply and increasing demand is what people see today and this is what their optimism is based on.
However please do not forget three major topics.
The first is that leather is a seasonal product and when prices rise too fast and too high, manufacturing is going to use less and reduce demand.
Secondly, leather has to be produced profitably. Tanners making losses will either have to close or to reduce production. And lastly, we may need to wait until next season, possibly well into the second half of 2010, before we see any of the normal consequences of the present market environment.
Spring trade fairs
In the meantime we have had the first of the spring trade shows in the last few weeks, including the Lineapelle fair in Bologna and the GDS exhibition for finished products in Düsseldorf. These offered initial indications about the situation in the leather industry and the outlook for fashion and demand for the autumn-winter 2010–2011.
From the GDS exhibition in Germany we got reports that shoe retail took full advantage from the cold winter in the northern hemisphere and retailers were largely optimistic about the business. The problem was, as already mentioned above, that their ideas about the further development of prices are completely different from what the leather industry thinks and needs.
In any case we have to assume that the number of ordered and produced shoes will certainly not be less than in the previous season. Whether or not they contain the same amount of leather will most likely now be reconsidered by the decision-makers in the companies. When women in Italy are the trendsetters, boots will become higher rather than lower in the next season.
Designers and shoe manufacturers had very little time between the shoe show and the leather show in Bologna. There were hardly two days for them to digest and consider from one event to the other.
The leather show in Bologna was earlier than ever. An event that for years took place at the beginning of May has now shifted to mid-March. The calendar for people in the leather industry is becoming much more intense at the end of the winter but it seems that the timing is not too bad, especially considering that many people used to complain that May was far too late to take serious decisions.
The attendance was moderate, but most people agreed that the numbers of visitors were not too bad, although most of the activity in the fair was concentrated on the middle day only. Tuesday and Thursday saw fewer people but nobody complained about the quality of the visitors.
The main point of discussion during the show was, however, the situation of the raw material markets. The majority of tanners started to show some fatalism. They know it is a seller’s market, and they do not have a large offer to chose from. Quite the reverse—they have to take what they can get at the moment, and price is becoming more and more a secondary issue. Any resistance to prices has resulted simply in the hides going to somebody else.
This also confirms how small and insufficient the inventory position of many tanners has been and possibly still is today. What is most worrying is the fact that the leather industry is likely to lose quite a bit of money in the weeks and month to come even with a good order book.
Mostly this relates to the side leather industry. The situation in upholstery is most likely much worse. While side leather tanners are enjoying at least good orders, most of the classical upholstery tanners are still complaining about a lack of activity from their clients. In Europe most of the industry is talking about production at levels of 70%-80%. Some of the tanners have tried to shift production like their colleagues in China to bag leathers to reach better levels of production. As we all know, newcomers to any market have in most cases to operate with price concessions, which is neither good for them nor for the established players in a market segment.
Attention to splits
With the sharp rise in hide prices, splits are again drawing more and more attention from the market. The price-gap between split and grain prices has become wide enough now that the use of splits is becoming more and more a potential alternative for manufacturers again. This is also reflected in the split market now and could even become a driving factor for this market for the next season. The rising demand from the leather industry for splits is now also staring to become a threat for the producers of collagen and gelatine materials. They had access at very competitive prices for a long time and the competition from leather has been no worry. This could possibly change as well later this year.
The skin market continues to benefit from the general raw material shortage. More and more manufacturers are discussing the possible use of goat and sheep leather in their products wherever possible. Pigskins and exotics are also becoming a possible alternative again where price is the major driving factor. To cut a long story short, it is a very normal process that with rising raw material price levels, more and more cheaper alternatives are returning to the supply chain.
For the coming weeks we have very little option but to extend our view that, in the short term, the logic of simple economics will not apply. Tanners need to cover their existing orders even at raw material prices that are not producing a positive margin. With the excellent sales position of hide producers, the almost-zero stock position and the general optimism about the business future, sellers of raw materials will have no mercy and will raise prices to the limit.
Another possible breaking point for the trend could be the APLF exhibition in Hong Kong next week. Despite all the strong performance and demand, China and Asia are still the decisive factor for the market. The leather business in Asia is now running into the seasonal decline of the second quarter. At the same time the kill in the US is going to rise seasonably. In Europe the extreme winter weather conditions are now fading and might also have some positive effect on slaughter numbers that have been sharply reduced since the beginning of the year. So from the supply side we could see some easing.
However, all the positive trends that may arise from the supply side can be wiped away if Chinese domestic consumption remains high and producers in China take a positive position for their business in the second half of 2010. That will keep them active in the raw material markets and most likely they will continue to invest the profits they made in 2009 into their market positions and continue to use them in the general Chinese fight for the leadership of manufacturing in the world.
If Chinese tanners get a little bit more worried about the future we could see the opposite. Chinese tanners are very well known not to be ready to work at loss. They are also very well known to walk away quickly from markets that do not look promising for them. All this we have already seen a number of times after the APLF show.
Our brain votes for option one; our gut definitely for option number two.
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