Market Intelligence—27.07.10
27/07/2010
In the general global economy not too much is happening at the moment. The experts are still fighting about whether we are entering into a double-dip scenario or if the economy is still solid on the path to recovery.
Government deficits are still the biggest concern. The corporate sector is recovering nicely and apart from the banking system most other sectors of the economy are doing quite well and are showing healthy profits again. The banking sector still has question marks over it. Although in Europe most banks have passed the so-called stress test there is still no full confidence. The bonuses paid to management teams and the focus on investment banking to generate profit by speculation are still worrying. How can anyone know whether or not the next disaster is round the corner?
In the meantime the government sector is the biggest concern, at least in the old economies where budget deficits, after all the government stimulus programmes, are hitting record highs. The corporate sector seems to be okay, but the public sector is in deep trouble, which means most likely higher interest rates and less money for transfer payments. It is worrying when nations are overspending and have deep debt problems because this restricts their chances of providing services. It doesn’t help to blame politicians and governments for the mistakes they make. In the end they are never held responsible for them and consequently they never learn from them.
Nations that suffer from debts that are too high are going to destabilise eventually and this is never good news for people’s freedom or way of life. Let us hope that the old economies can still find a way to solve their problems without too many social and political problems.
In the meantime the euro is no longer suffering and all the forecasts about parity with the dollar have been wiped away quickly. The main European currency continued its recovery and is trading close to the $1.30 mark now. Oil and gold continue to trade within their established ranges and are rather sensitive to the currency changes and the changes in supply and demand. Agri-products could become a problem later in the year because the heat and dry weather conditions in many parts of world might reduce the supply of grain and raw materials for bio energy plants. This could be of consequence for animal feed supplies and if product prices rise because of shortages, beef production could become more expensive and farmers might be forced to sell more cattle than they intended.
The period of low interest rates doesn’t seem to be coming to such a quick end and recent statements from those responsible would have us believe that there might be more months of low interest rates to come.
Market Intelligence
The Northern hemisphere is now in total holiday mood and by the end of the coming week almost everyone who can afford to shut down will be taking a summer break. Beamhouses are almost closed everywhere and only contract tanners or a few latecomers will still be soaking hides from this week onwards.
This is reflected also in the general activity in the supply chain. From raw material suppliers to leathergoods manufacturers almost everyone is off in Europe and staff are leaving or have left already for their holidays. This nothing unusual and we don’t think that this is anything more than the normal, temporary break. What is far less normal are the years in which tanners and manufacturers have to be active over the summer because they haven’t planned well or there are unusual market developments influencing activity.
The fact remains that the market is still supply driven. The beginning of the pipeline is still reporting low stocks and we even hear reports from Asia that some suppliers are requesting extensions on their shipping times to fulfil their contracts. This could have hit some traders but regular suppliers are suffering from very low kills, which has made production and shipping plans pretty unreliable.
It is a clear demonstration that, at least in Europe, there are no buffer stocks around and even short positions cannot be covered from others that might have been less active in the market and have some hides ready to sell while the European customer base is on holiday. However, there are no hides piling up to become a threat to prices or the market trend, not at least as far as physical supply and demand are concerned.
Consequently trading over the past two weeks has been pretty light and only a few tanners were willing to continue to secure their raw material supply at present price levels. Reports from various origins were a bit conflicting and weeks of larger activity were followed by weeks that were pretty slow. It is very difficult at the moment to read exactly the situation in the different origins. In theory a certain amount of hides becomes available by the regular slaughter every week and this should be the volume available for sale. However, it is still very difficult to evaluate what volume possible forward positions may have. In some markets people want forward sales to be as big as four to six weeks of production. This could be the case for some specific materials that are traditionally sold on larger continuous programmes, but it seems to us pretty unlikely that this should also apply to non-standard items.
Another remarkable situation is the question on what type of materials the main focus of interest lies. In general we feel that it is fair to say, that top quality items are still in very strong demand as there is hardly any luxury brand manufacturer complaining about sales and outlook. Recent numbers that have been published almost everywhere show pretty healthy double-digit growth numbers and a second half outlook given by the main companies that has no cloud in the sky. Consequently one has to assume that premium quality materials from the top end of the European supply base as well as other top quality raw materials used in the luxury industry will remain in very strong demand for the months to come and have very little chance for the time being of becoming plentiful or available at cheaper prices.
With the continuing strong demand from emerging markets and from the wealthy in this world it seems it would need another severe economical crisis to dampen the interest for these kinds of luxury items.
One has to be pretty optimistic for the future of the shoe industry too. The cold winter of 2009– 2010 has cleaned out inventories and stock positions almost everywhere in the northern hemisphere. Almost all retailers are seeing a good future for the next season of shoe sales. So in this segment too it is unlikely that we are going to see any severe deterioration of the situation in the near future.
We have already dealt with automotive a number of times. The European premium brand manufacturers are reporting exciting numbers for the sales of the first half of 2010 an almost all of them are holding pretty good order books for the rest of the year. However, we should never forget that almost all their business is based on export with China playing the most important role. The situation in this industry can change very quickly with export sales coming to a quick stop. It doesn’t seem that there is any indication that the Chinese pleasure in consuming is going to stop soon, but one never knows.
The situation in the furniture industry remains difficult. In the western world the demand for leather upholstery remains pretty flat. The financial crisis has left deep drops in private consumption and the risk of a strong decline, with the economic stimulus programmes running out, remains pretty high. The determining factor for this market segment is, again, China or better the emerging markets. In China there is no question but that we see a bubble in the property market and the only question that is open is how big the bubble is. In the meantime nobody is denying that the demand for property and consequently for furniture has already dipped and will most likely decline further.
Upholstery was and is consuming a great proportion of the medium and lower quality end of the raw material product range. There is a fair chance that the decline in the demand for leather upholstery could be absorbed by the shoe and bag industry. However, there is no guarantee and we must not forget that in these markets fashion is also playing quite an important role. We are dealing at the moment with the production cycle for the retail markets in 2010 and there are serious indications that debate about the fashion for ladies handbags could end with an increasing number of leather substitutes in the ‘new arrivals’. It is definitely still too early to take a final decision about what is going to come but there is definitely a certain realistic chance for a situation of declining demand for lower quality raw materials.
Our main concern however is still related to finance. We don’t want to repeat our concerns which we have already displayed a number of times in this report, but one has to be extremely worried about the tanning industry’s ability to handle the necessary finance if raw material prices do not come down in the second half of 2010. We still believe that leather prices are pretty inelastic on the upside and we do not believe that the current problems of profitability and cash flow will be solved by sharp gains in finished leather prices. Consequently the solution has to come from raw material and as we have seen above there is no pressure on the market building from rising stocks yet.
There is another subject we would like to touch on this week. There is a rising number of reports from China talking about an increasing level of pollution control by the government. As usual there’s a big discrepancy between what the government in Beijing is asking for and what the local governments are actually still permitting. So for the time being tanners that are under severe pressure in certain areas are still using the typical way out and they are at the moment busy trying to find new locations where they can continue to produce under conditions that are certainly not acceptable.
Acceptable or not whatever relocation is required is increasingly affecting not only the total cost of processing but also the cost of transportation. In the end this means that the total cost of production mainly for cheaper items is going to increase. As we have already said it is pretty unlikely that this can be converted into higher product prices and so one can already sense that tanners are not willing to pay the present raw material price levels in the medium and lower quality range. This is not only affecting cattle hides but it’s also an important factor for sheep skins for example.
The split market is also in something of a summer break. In Europe a lot of tanners were still pretty busy soaking prior to their shut down, to build up inventories for the time of their reopening. This has created a certain short-term supply increase at the same time as a lot of the gelatine and collagen industry was also already preparing for the summer break. This situation has at least in Europe created a little bit of short-term market pressure but with the shutdown of productions now we think that the situation will be pretty quickly eased again.
The skins market has been pretty steady, although the problems of pollution that we mentioned above are actually showing consequences. In particular in the Hebei province of China many of the small unlicensed tanneries are facing severe problems from the authorities. So big importers and wholesalers for skins have become much more cautious. They had been very active in buying skins until some weeks ago and with the general return of garment leather into fashion most tanners had been reasonably positive for the next season. Also the price and availability of wool was generally supportive of their positive position for the rest of 2010. However, the recent controls and the possible need to relocate production and the consequence of rising production and transportation cost has made many of them much more cautious. Since other markets for skins like Pakistan, for example, have already been falling behind the market prices for some time there is also little support from that area as far as nappa leather is concerned. The only ones who are still very busy trying to source adequate raw material are the Turkish. They are still pretty active trying to secure good quality lambskins suitable for double-face production and although tanners are not willing to increase prices by much, one can sense that for the time being there is more demand than budgets and the market can actually offer.
The next two to four weeks put us right in the peak holiday season. We think that most of the industry has already done its homework and there is not much needs to be done unless there are significant changes in the global economy. Tanners who are pretty certain about their order books are still not carrying any significant inventory, but it seems they can spend the vacation period without taking any additional decisions about raw material purchases. For the big suppliers at least from Europe and the United States and possibly also Australia the situation is pretty much the same. Their warehouses and positions seem to be pretty safe and clear at least into September. So if there are no big undiscovered open positions in the market at the moment anything other than a very quiet August would be a surprise. By the end of the month everybody is going to depart for the All China Leather Exhibition in Shanghai and we think only by then will there be any news that could move and shake the markets. Consequently it would be a surprise to us if the market were to move by more than within the ranges we have been seeing for almost a month already.
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