Macroeconomics

The descent of the euro has continued. The markets continue to be worried about the euro and the debt crisis in many countries. New rumours about possible problems in Hungary and a misinterpreted statement from France that the country would welcome a euro/dollar parity hammered the currency again and it reached levels of below 1.19 to the US$ before rebounding a bit.

European countries are fighting for programmes to reduce debt. There is the traditional conflict between the social groups about government decisions and strikes and aggressive opposition has been the result in several countries. This was not good news for the financial markets as tax rises or cuts in social benefits would reduce consumer spending and could be a danger in terms of economic recovery. The US is more focused on the oil spill in the gulf of Mexico and this has, to a certain extent, driven economic problems into the background.

Meanwhile, some are also drawing positives from the currency decline. The euro has just reached approximately the same value as when it was introduced and a number of pundits believe the devaluation is a great opportunity for export-related countries such as Germany, France and Italy to boost industrial production and exports. In Germany the labour market is extremely robust and unemployment rates fell again in May.

Excitement in China is also starting to fade a bit. The rate of expansion within the Chinese manufacturing sector was lower than expected and the purchasing managers’ index fell from 55.7 to 53.9 points. Although levels over 50 still signal expansion, the rate is not in continual acceleration any longer. Stocks in Asia measured by the MSCI Pacific World index fell by 9.8% in May, which was the biggest monthly drop since the Lehman Brothers crisis in 2008. Chinese inflation rose while manufacturing output shrank, so in this respect no clear directions were given and this leaves options open for pessimists and optimists alike.

However, towards the end of last week confidence returned with the news that Chinese exports had risen unexpectedly. This was snapped up quickly by the markets and, as we have seen a number of times over the last few weeks, commodity prices and stock markets rose sharply and erased the losses seen before. So the yo-yo continued; however, the optimists were taking this as proof that the global economy is still on track for a healthy recovery.

Commodities such as metals and oil were also in yo-yo mode. Prices jumped up and down with oil prices bouncing within a range of about $70-75 and the world is still waiting to find out whether another serious financial crisis triggered by the debt crisis in Europe can be avoided. However, it seems it will only be a matter of time before the limelight shifts to include budget problems in the US.

In the coming weeks the globe will mainly be lost in football fever and a lot of people will forget their problems for a month while they watch one of the most popular sporting events (and businesses) in the world.

Market intelligence

The new information and trends we were expecting from the Guangzhou leather show didn’t actually arrive in the quality and quantity we were hoping for. Most visitors were pretty disappointed with the number of booths and the general interest that was shown by the public in the aisles. So it seems the real business and activity happened outside the fair in the factories and offices.

The final reports we did get simply confirmed what we already knew before the event. The shoe business is still pretty stable and there is definitely no complaint about general demand for shoes or for leathergoods. And there has been no clear indication that manufacturers are willingly and readily substituting leather in their production. Here and there people mentioned that some factories are seriously thinking about shifting to other materials, but it hasn't become a real trend as yet.

However, those hoping or believing that manufacturers are actually accepting the situation in the raw material markets and willingly increasing leather prices to the levels tanneries need today were disappointed too. Wherever price increases were discussed they were pretty incremental and couldn't cover the rising raw material costs we have seen over the past nine to 12 months. Another interesting point was that one of the main raw materials for bag leather production couldn't benefit at all. Good quality dairy cows, which for such a long time have been a solid basis for the production of quality bag leathers for ladies’ handbags did not meet with any demand from the market and, with the lack of upholstery business, these hides, which have been facing quite a bit of price pressure for a while, are expecting further difficulties ahead.

The question is, how far can prices drift apart? In the past we have seen that the Chinese are not too bothered when it comes to money, so even cows have found their way into the production of side leathers. Why is this not happening again when everyone is saying that price is the main problem?

In the meantime, buyers are trying to take as much advantage from the market as they can and, as we discussed in our last issue, there is great hope for a further slide in prices in order to bring leather production back into profit. While this may work for cows the situation for males is a bit different. Demand for male hides from the shoe and automotive industry is still intact. Tanners are trying to wait as long as they can, but one way or another they still have to return to the market to make sure that their supply pipeline is not interrupted.

So far this has been enough to prevent any major pressure on market prices and the declines and rises in various origins are more currency than demand related. However, buyers feel that the sharp decline in demand and the reluctant position of Chinese tanners to continue to support the market with larger contracts is increasing the likelihood of an orderly market decline in the near future and over the summer period.

The situation is a bit different in Europe, where the kill is seasonally low. Supply of the preferred items, the heavy bulls, isn’t meeting demand. Almost daily the manufacturers of prestigious cars are reporting rising export orders. The majority of these cars feature leather and as many are from the luxury section the demand is mainly for top-grade types. On top of this there are a lot of newly launched models, which is adding to the market demand.

The luxury sections require top-quality leathers, which keeps demand for the main articles such as top-quality and heavy hides at steady and high levels, which other products have failed to do so far in this production cycle. Consequently, they are meeting steady demand at the moment so there is a reduced supply, which is keeping the market high and overvalued. A decent break during the summer holidays or a decline in demand could produce enough pressure to bring prices back in line with the market realities and their valuation back in line with the general trend.

The upholstery business remains in the doldrums. Declining real estate demand, mainly in China, is weighing on the demand for new upholstery. Some well-informed sources who have been warning us about this for some time are repeating their concerns about wet blue stocks in China. The fact is—and this has been confirmed by a number of sources—that the demand from traders and speculators in China has sharply declined. Speculators and traders are no longer willing to take up positions at the present raw material price levels because they don't see a profit margin and they don't expect raw material prices to go any higher during the second half of 2010.

All eyes on China

As we explained in some of our previous issues, we believe that a lot of the market movement since mid 2009 was driven by speculative money out of China. The speculators, who had been around in all kinds of commodity markets, were also willing to spend money on raw hides and skins and to convert them to semi-finished materials in anticipation of higher prices. This boosted demand for raw materials, and for a while it might have been covered by finish product demand too.

However, overall, it seems that more product moved into China than was actually consumed and some reasonable stocks piled up. The owners were not too concerned and they probably still aren’t today because the value of the stock is far cheaper than raw material prices are now. Consequently, people might still feel pretty comfortable and with many predicting a rebound in terms of business and demand after the summer holidays it could well be that owners will continue to hold on to them and they will not bother the market in the short term. However, with every dollar the market declines pressure increases.

The volume of trade has declined in the past couple of weeks. The raw material market for male hides and quality hides may still be pretty solid and in balance, but we are still dealing with the unanswered question of how profitability within the tanning industry can be restored; higher leather prices, or lower raw material prices. At the moment it seems the tanning industry is holding out more hope for declining raw material prices, and this is affecting the way they behave. Most tanneries are in the low season, for which they are pretty well covered, and they have no immediate need to replenish inventories.

Sellers see the world a bit differently and those who are predominantly dealing with hides for the upholstery leather segment seem to have rising concerns about their production and the prices they will obtain. Most pundits accept the fact that a good round of sales would be needed to bring sellers’ positions back to comfortable levels. At the present price levels it doesn't seem that the industry is willing to take up their positions for the production period after the summer break yet. So we are just moving forward without really clearing the air. Concerns are certainly outweighing hopes at present.

Skins the highlight again

The split market is getting more and more into holiday mood. We are now entering the low season for production and this is reflected in the activity within the split market. Quite frankly, there hasn't been any relevant market information in the past fortnight for us to cover.

The skin market is still probably the best performer at this moment. Fashion is driving the skins market. Demand is still outstripping supply for most grades and prices have been rising moderately this last week. There has been conflict about wool values. While some of the Chinese fellmongers are complaining about falling values, others are reporting rising wool market values. In general, most players are talking about a shortage of raw skins at the moment.

In the coming weeks we would not be surprised if the market continues to float in the ranges we have been seeing for a while. Fundamentally, the price correction for raw materials is overdue and in the areas where it hasn’t take place yet price pressure will persist. However, the correction potential is not evenly spread around the globe and for all items. Mainstream hides have already seen some adjustments, while the high-quality specialties have so far defended well against the trend.

Side leather luxuries and automotive specialties performed best, despite the fact we think they are overvalued. They still seem to have the best shelter in terms of demand and orders. Upholstery hides still seem to be facing the biggest problems as the prices are wrong and demand is not what it should be. The summer holidays are now around the corner in Europe, so the market can only be safeguarded by the refilling of the pipeline in Asia. However, we are not expecting buyers to be busy except for some isolated purchases of selected better qualities. So we are aligning ourselves with the general sentiment that prices are under moderate pressure but are still protected from sharp declines.

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