Market Intelligence - 05.05.10
05/05/2010
Some problems can be solved just by waiting, but in the financial market this is rarely the case. Consequently, the peace and tranquillity of the past weeks were just a break and not the solution. Greece, Greece, Greece … and … maybe Portugal, Ireland, Spain or others too ? The public has taken the budget deficits of many countries in Europe much too easily.
In Germany in particular there has been hesitation in the decision-making process, although nobody knows if quicker decisions would be better decisions. It remains unclear if Greece will be able to repay the financial aid eventually. The big fear now is that Greece is just the beginning and that other countries in the euro zone are going to follow. The big rating agencies have already downgraded Portugal and Spain and who knows what is going to happen in the future for the big economies like France and Germany.
The present problem is that nobody could imagine that a country would or could leave the euro zone as this would certainly destabilise further confidence in the European currency. Some say that the departure of Greece would be a change for the better, but this could also become a pretty dangerous strategy if the financial markets then start to bet that it means the start of the dissolution of the euro.
One way or another the present situation is no good and this is what people are starting to realise. Bailing Greece out would burden taxpayers in Europe and the International Monetary Fund in the short term. Budget deficits all over Europe are very high and there is no money left now for further aid programmes. However, it seems that funds are going to be pumped into the deep hole of the Greek economy.
With all the general news about a recovery of the economy nobody seems to be taking into consideration that the financial problems of governments could be as serious as the financial problems we have seen with banks since 2008. So, the risk for the global economy should not be underestimated and let’s just hope that the excessive budget deficits and problems of individual countries are not going to turn into some kind of avalanche in the financial markets as has happened before.
The critical issue today is that speculators are taking full advantage of the situation. The banks call it investment banking; the normal person in the street calls it gambling and speculation. One can have any opinion about the free market and regulation, but as long as the consequences are that big and again social losses turn into private profits we must be careful about the potential political and social consequences, at least in Europe.
Volatility in the commodities and stock markets has increased. The euro took a nosedive and fell against the US dollar to levels below $1.32.
The economic news has been fundamentally positive. Exports from Europe rose, Germany supplied better than expected unemployment figures, and business sentiments within the European community are entirely positive. In China, EXPO 2010 has opened its doors in Shanghai and the Chinese government will use the event to demonstrate all the strength and self-confidence they have developed in recent years. Generally it seems, that the economical crisis is behind us and the global economy is back on track. However, as we have discussed above, the situation is a bit similar to the one we had in the summer of 2008 and we can only hope that we are not running into the same accident again, just at a different junction.
Market intelligence
The market complications that we discussed in our last issue have intensified over the past two weeks. The problematic situation of product shortage of heavy male hides in central Europe has continued and dominated the market situation. It is another demonstration of the difficult situation when there is hardly any buffer between supply from the abattoirs and demand from the tanneries. Many tanneries cannot, and do not want to, use salted material so there is no buffer between the hides being produced during the week and the tanneries’ need to cover their order books and to fill their drums.
Everybody can read the sales statistics from the automotive industry these days and follow the quarterly reports. For a while now we have seen that almost every month the sales and forecasts are beating the budgets, and so the short-term plans of the automotive industry and orders for the supply chain needed to be revised almost monthly. Some insiders said that this was in the region of 30% or more for the premium brands since beginning of the year. This is mostly based on the sales in Asia but is also due to a rebound of sales of the premium brands in the standard markets.
There is a similar situation in the leathergoods and luxury products market. Although not having suffered that badly during and after the financial crisis, it also needed some time to regain full confidence in the market rebound. The strong performance of the emerging markets—China again—bolstered sales and strengthened confidence for the budgets for the rest of 2010 and also into 2011. Growth of the established brands plus more brands trying to benefit from the trend and also trying to expand into leather products generated a demand from premium-quality cattle hides and calfskins, outpacing the supply of the same.
The shortage of adequate material overshadows at least in Europe the general market situation. The market for extra heavy bullhides and calfskins was dragging the rest of the raw material market along. We think this is a misleading situation. The premium end can still convert premium materials into premium prices. The rapid price rise is hurting manufacturers, but not so much the brands and retailers.
Contribution margins on the finished product can still absorb the rise in raw material prices and the exclusivity of real, flawless, genuine, naked leather can, in combination with a premium brand name, still be converted into retail prices that are not really a threat to the leather and raw material prices, provided brands are willing to let their manufacturers get a fair share of the retail value. For the top quality end, the resources of adequate raw material are limited and their prestige lies in a great part also in the scarcity of the product. And so, if I want to own a consumer product of outstanding and unique quality material quality I need to pay the price. Nobody actually needs diamonds or has to have truffles on their pasta either. So, as long genuine leather in top quality remains in fashion the rules apply and volume limits are set.
High-value material?
We believe that some of this concept has been shifted by some players into the general leather market and the recovery of demand for leather products has created an idea that leather as such has the potential for a higher valuation as a material. We have our doubts.
The low material prices of 2009 made leather very competitive and if there is the choice of having the real thing at the same or even lower price than its alternatives, people will choose the real thing. This has led to an inflated use of leather in consumer products and in combination with fashion (handbags) and the general strong performance of consumer products in China, demand and prices for raw materials recovered quickly until they reached the levels of today.
Now it seems that the fundamentals for the mass production market are starting to change. Leather isn’t such an attractive material any more and in contrary to the situation for top-quality material the average quality can be easily replaced in many products. Finishing technologies have improved a lot over the years and defective hides today can be converted into nice looking, good selection with a more than acceptable look, touch and feel. At the same time artificial materials have made enormous progress and the physical presentation of synthetic leathers is pretty close if not the same as finished and corrected leather types. They are not cheap either, but considering the cutting yield and the price stability over a long period they have now become a very serious competitor to the real stuff.
This does not mean that leather demand will disappear or that markets will collapse, but it should explain why we are certainly at a junction for the market direction over the next few months, with the changing of the seasons and the production cycle starting after the summer break. In particular demand from manufacturers in China will demonstrate where we are heading. Lead times in the pipeline are long and decisions will have to be taken soon. The order books from last season are a now fading and with them the effects of lower price raw material stocks, which smart buyers had built up in 2009.
The next season has to be based and calculated on replenishment costs and they are much higher. Those manufacturers sticking to leather will have to accept much higher prices on the leather delivered. We understand from our research with some manufacturers that the final decision on how to deal with the present situation is not yet taken, but many are mentioning their concerns not only about the prices, but also with their impression about raw material shortages threatening their suppliers.
This is another problem which should not be overlooked. The rapid rise of raw material prices and the complaints of tanners not getting enough material at adequate prices is normally pretty much ignored by manufacturers and just taken as the usual poker tactic for better leather prices. This time it is different. While normally you just went next door to find a new and willing supplier the situation has changed, with buyers in the past months finding stiff resistance and very few alternatives. For the first time over a long period buyers are not the kings any more and are no longer being spoiled by suppliers desperate to get a new client and are, instead, frequently hearing a ‘sorry can’t do it’ message instead. This is not what anyone responsible for purchasing and procurement wants to hear and, to get their own responsibilities covered, they will not be likely to keep voting for leather when it comes to design and material decisions. The coming months will bring a number of intense discussions on manufacturing levels.
Pipeline confidence
On raw material supply levels, confidence is still high. Butchers, processors and traders still see low stock levels. Over the past 12 months the market has shown only one pattern. Demand was exceeding supply and not only of current production of hides, but also of the huge stocks that had piled up as the result of the financial crisis of 2008. Whatever concern whatever prudence, the market was hot and demand high.
With the general recovery of the global economy and the success of retailing consumer and luxury goods the sentiments are positive. Some are considering a period of stable prices, but it is hard to find anyone who would opt for a lower market in the foreseeable future. We carried out an informal poll with raw material suppliers and asked them to give us their prediction for the market at the end of September 2010. More than 50% predicted that levels would stay the same, while 20% imagined that it could be higher and less than 25% expected lower levels.
This just shows that raw material supplier confidence is pretty high at the moment, which is not a surprise in a raw material or financial market that has seen such a strong performance. You normally get results like these in other markets after a long bull market.
Splits and skins doing well
The split market continues to be firm. Split is back for the reasons we stated already in previous issues and this is also reflected in the demand and price trends we have seen lately. Splits traditionally perform with a time lag and that is what has happened this time.
Skins are also still doing pretty well, but with the end of the winter season in Europe, Chinese buyers are slowing down. New season lambs are trying to find their levels and we fail to understand where the levels are. Quotes have a spread of more than 30% between high an low and this normally means there is a lot of talk, but not a lot of business. After the long a harsh winter the production coming in is late and volumes are not what they should be.
Serious sources call the market steady with a decline in trading volume.
The next weeks are going to be quite interesting. Asia is taking a break and with a general acceptance that hide prices have grown too far and too fast, buyers will take the chance to take a break and to see how much sellers will notice their absence. Sellers are not too impressed. The business has become much more short term since the crisis. No big programmes, no big plans, sell, ship, pay and this within the shortest possible time frame. Reduce risk, reduce exposure was and is the concept now. The past months have been good for those who produce and own the product at the start of the supply chain. The faster the market moved, the shorter the time window for sales and shipments became. While so many long-term contracts turned sour during the crisis and prices became very low it was an adequate policy for sellers. As long as demand is stable and growing, sales and shipments are expanding it is adequate, but shorter cycles are also increasing market volatility.
Consequently we believe that the risk levels for the market will continue to rise into the summer, although there is hardly any sign of a declining consumer product market for the second half of 2010.
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