Market Intelligence—18.05.10
18/05/2010
The European problem is widening and the concerns we were discussing in our last issue have become an issue in the past weeks.
EU politicians were forced a week ago to take massive action to prevent the euro zone from dissolving—at least in their opinion. Everything was about saving Greece and preventing the debt problem there from spreading to other countries. In the end it helped for not more than a day and then they realised that money can’t buy confidence; the markets quickly became sceptical again about the solidity of individual countries and the euro zone as a whole. At least the political leaders have now realised that spending the people’s future today cannot be a concept that can work for ever.
The situation in the European Union is now in the limelight, but Japan and the US are in a situation that is even worse, and in the case of Japan they have been handling the situation for more than 20 years already. Not, that this makes it any better, but it shows what the fundamental problem of Euroland is—confidence. While the US and Japan are single countries run by a single government, the euro zone is a totally heterogeneous conglomerate of nations where it is totally uncertain which directions countries and the people are drifting towards. So, what we see today is a deep crisis, but even more a lack of confidence in a vision and concept.
For the moment, however, the problem is that the regional debt crisis is going to have an impact on the global recovery.
What we see today is a massive discrepancy between the corporate sector and the governmental one. While most companies are enjoying a quick recovery and are publishing an optimistic outlook, the government sector in the western world is down in the gutter. So, after the corporate sector (banks) had dragged governments down in 2008 (rescue packages), the financial community is now scared that the opposite will happen in 2010 and that the public sector will now kill the corporate and private sector into the next real global crisis.
China, which had been—thanks to excessive governmental support—the rock in the sea and helping the global economy to recover by almost endless demand for commodities and machinery, is also showing consequences now. The huge influx of money into the economy has led not only to real estate bubbles, but also to signs of inflation. Inflation last month was almost 2% and prices for food went up considerably (by 5%). The government continues to tighten credits, in particular for property purchases. In some regions of China property trades have fallen already by as much as 80%. This is putting the leaders in Beijing in a pretty delicate situation. Too much tightening could quickly and abruptly end the rise, and letting things flow could inflate the bubbles even more.
In the meantime the present statistics are, for the most part, pretty positive. The EU has shown a small and unexpected growth in the first quarter. Although this might end the sharp downturn seen in 2009, one should not forget that the year-to-year comparison is against one of the worst quarters ever seen.
Stock markets and commodity prices are pretty volatile. Strong gains are followed by sharp declines, but the bottom line is that the trend has been down as investors look for save havens (gold, prime loans) rather than anything risky and speculative. Oil fell back to the early 70s, and the euro, reflecting the concerns in the euro zone, fell by almost 8% in two weeks to levels below 1.24 to the US dollar. Interest rates remain low in most countries.
Market intelligence
Last week the leatherbiz news section delivered a report that explained and confirmed most of the market developments we have seen in the past six months or so.
It said there had been a strong performance by the Chinese leather industry in the first quarter of 2010. The China Leather Industry Association has said that the total value of the output of the leather sector across the country in the first three months of the year was 22.6% higher than in the same period in 2009. The value of this output, which includes footwear, leather, leathergoods, garments, upholstery and so on, was $20 billion. For the tanning sector alone, the value of first-quarter output was around $3.4 billion, which CLIA said represented growth of 16.1% compared to last year.
To complete the trend, there was another piece of news later in the week saying that leather garment exports were also on the rise in China. The reported figures for the first quarter of 2010 showed that a five-year decline in exports of leather garments has been halted. Exports of Chinese leather garments had been in steady decline since 2005. The results for the first quarter of this year showed an increase in volume of 35.1% to 3.27 million pieces. These garments brought in $170 million in export revenues. If we add to this information the strong performance of sales of premium brand cars, then the development of the raw material markets in the past year are explaining themselves.
However this is in the past. In the leather sector China had set the pace and its courage in buying cheap raw materials when nobody wanted them has been rewarded. This has offered the industry in China a fundamental advantage over its competitors in other countries. While there was production on one side there was also consumption on the other.
The boom in real estate expanded the demand for leather upholstery in China, but also shoes, bags and imported luxury cars helped leather production—not only in China—quickly to get out of the deepest slump of raw material prices and production seen for decades. Leather being reasonably cheap last year and still enjoying (in the emerging markets) a positive image, it was one of the first to enjoy a comeback in the consumer markets. The situation began almost exactly a year ago and materialised when the new production season started after the summer break in 2009. Today the situation is different.
Superficially everything is similar to a year ago with the only exception that raw material prices are substantially higher. Another difference is that last year nobody was convinced about the recovery of private consumption, and also the China boom was just about to start. Today most are convinced that the outlook for the next season is also bright and the level of consumption will be at least steady.
Retailers are planning accordingly and so the producers of hides and skins are pretty optimistic, believing that any decline in demand and prices will only be temporary and not a real threat to the value of their main by-product. The second quarter is traditionally low season and this is also adding to the relaxation about the rest of 2010.
Out of control
The situation as it developed over the past week is, however leading to growing concern. The EU debt crisis is something that again cannot be clearly analysed as far as the potential risks and consequences for the general economies are concerned. In Europe most people realise that it will not be good in the short term for their personal finances. Although Greece is only a small country it is pretty clear to most that it is only a symbol for other countries and not only in Europe. Nations are spending constantly more than they possibly can earn in tax returns now or in the future. With an outlook for only limited growth in the western world and the massive debts created before and during the crisis the situation has run out of control in the EU, Japan and the US at least.
The Chinese believe that for them the problem doesn’t apply. Double-digit growth rates and rapidly rising asset prices have created a massive self-confidence. The huge and still increasing foreign currency reserves and the development of the country that people have seen in China over the past year has created a massive feel-good factor and to faith in the nation’s future. There can be no question that China has invested smartly, and the combination of low labour costs, an undervalued currency and a huge domestic market has given China a very strong economic position in the global community these days. Other countries can in most cases be happy that China has been a global economic locomotive since the 2008 crisis.
However, the crisis should not be overlooked. China is facing inflation, asset bubbles are evident and the period of making easy money is over, even in China. The government has injected more than $750 billion into the economy to keep the success story on track.
Why are we talking about all this? Well, it made us think when we talked to one of our sources in China recently and we were asking about his forecasts for the coming months. He was not as excited as unusual for a Chinese commentator these days. The concern he had was the real estate market. Credit terms have already been tightened three times in China and in some areas it is said that real estate sales are down by up to 80%. So his logic was simple. No new flats, no new furniture.
While this applies mainly to the upholstery sector it at least explains why upholstery-related hides are showing most uncertainty and one wonders what would have happened if the outbreak of foot and mouth disease in Japan and Korea had not stopped the export and use of cowhides from these countries.
Positive demand too
Talking then about the positive situation of demand for shoes, leathergoods and cars, the feedback was that tanners in China will not produce at a loss. He was convinced that if raw material price do not ease quickly or leather prices rise sharply, tanners will cut production by June at the latest and take final decisions in September about the next season.
On top of these concerns the subject that is most discussed at the moment is the question of whether the debt crisis in Europe will have an impact on the global economy. For the moment it seems that if it does, the effect is going to be very slight. Immediate effects on people will only be seen in Greece and Portugal, while in the other member states the situation of the individual is only going to be affected with a time delay. With the recovery of the economies and the labour market, exports flourishing and the weaker euro bringing increasing competitiveness, a short-term deterioration of consumption cannot be expected.
However, the psychological factor should not be underestimated. Although the last crisis was pretty limited in its effect on consumer spending, one never knows if the renewed risks could not change the mood. Also any decline in Europe and the US was compensated by the booming demand in China. So, this brings us back to the main factor. Can China maintain its growth and consumer spending to support the global economy and at what price? What would this mean in regard to raw material consumption and prices? Will inflation be the global price to be paid? These are all questions that have to be part of the decision process, not for today, but for the next six-to-12 months.
Split and skin market
We were not able to trace too much new information from the split market. Business was reasonably quiet and followed the pattern of the hide market. Despite the same situation with low stocks and steady demand, players, after the strong performance of the last months, have also taken a more wait-and-see position, although it hasn’t much of an effect yet.
The skins market is now a bit between the seasons. In Europe the spring lamb season is starting very late this year due to the very cold and long winter. Hardly any trades are reported. Prices and quote are bouncing all over and the price spreads heard are totally unrealistic. On a delivered-China basis, quotes are ranging from $9–$15 per piece. It seems that opinions between sellers who want to really sell and other who do not have anything to offer yet are drifting apart. Even at the low end of the price range we haven’t heard about any tanner willing to spend this money yet. Nappa type skins offering good wool returns are still in good demand, but the season in the northern hemisphere is now quickly coming to an end.
For the coming weeks we are expecting more of a wait-and-see situation and we still believe that raw material prices are entering a phase of moderate correction. Europe now has the currency market on its side and despite the general worries about the currency and its future, it has saved the market from a major and rough correction. Almost 8% in about two weeks has been a great help. EU hide prices had been totally out of range and only the currency market has lowered the pressure. The only exception might still be the market for automotive and premium calf. We remain pretty sceptical for cows and we expect the general price trend to be moderately softer with the risk for a sharper correction in upholstery-related hides.
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