Market Intelligence—19.10.10
19/10/2010
After a pretty quiet summer for the financial markets the situation has become much more entertaining and exciting since mid-September. We indicated a number of times over the summer that come the autumn the financial markets would have to decide where they want to make their money for the rest of the year. In the past weeks the trends have been clarified.
The main investment business is to bet on further easing of the Federal Reserve in the US and the clear indication, that they will pump more money into the market has made speculation against the US dollar pretty easy. The chairman of the Federal Reserve, Ben Bernanke, used the magic words of quantitative easing again and it seems that the FED hasn’t got much else to offer than to print more US dollars. The opinion that more money will create more jobs continues to be the driving force of the authorities in the United States. Their argument that deflation is a bigger risk than inflation?which is why they think more cheap money will be good for the economy?might become a paradox eventually. The banks actually do not know where to lend money because their clients are not looking for it and so the excessive liquidity is being used again for investments in the markets and commodities.
Consequently many raw materials prices are rising again and this not only because of demand from manufacturers. Rising raw materials will eventually also push consumer product prices higher.
In China we see that the government is focusing more and more on domestic demand so as to become less dependent on export. A new programme containing about $430 billion has been released mainly for investments in the west and less developed parts of China and to support many key industries. The new five-year plan sees the Chinese economy growing this year by almost 10%, but the government is trying to keep growth for the next term within the range of about 7%. Even this number is big. Chinese sources have been pretty optimistic in saying that these numbers can be achieved and the government is able to shift a lot of export-dependency into domestic consumption. This is desperately needed because today the Chinese do not actually know where to invest the massive currency reserves they are holding and which are still growing month by month. The Chinese continue to try to invest into raw material companies around the globe to control more resources. While for some countries, in particular in Africa, this works pretty well, the success in others is pretty limited. However, one way or another the trade imbalances have to be sorted out.
Global investors are mostly betting on a weaker US dollar and rising asset prices at the moment. Consequently the dollar has been falling by almost three cents per week while stock markets and commodities continue to rise. As usual the forecasters are riding the waves and many expect the dollar to decline further and gold and silver, for example, to rise to new record highs. Oil prices have increased moderately and continue to trade around the $80 per barrel mark.
After a pretty stable second quarter on the financial markets it seems that we are heading for much more volatility for the rest of the year and that means everybody whose business depends to some extent on currencies and raw materials prices has to be on high alert to protect against potential risks.
Market intelligence
The last two weeks have been mainly dominated by two major developments and events. On one side the currency market continued to be in focus and for all origins that are not US dollar-based it meant either active hedging or losing on the falling value of the US dollar. This applies to Europe, Brazil and also New Zealand and Australia. Exporters from these countries are not too happy about the falling value of the greenback and with the speed this is happening at the moment. Declines of 2%–3% per week are very difficult to handle.
We have been talking for a while about price imbalances between various raw material origins and the currency market triggered the trend to level the disparities out. In particular in Europe the male hides had been far too expensive due to the strong demand from the automotive industry and the low kill in the summer quarter. Until September suppliers were not really willing to take notice of the needed adjustments and it required some instances of bankruptcy, as well as the decline of roughly 9% in the value of the US dollar, to finally make sellers aware that inflated values cannot last for ever. As a consequence the continental European market for male hides saw a decline of about 10% in the past two weeks. Tanners still do not believe that this is enough and are pressing hard for further reductions. This is leading to some mixed emotions. EU slaughterhouses and packers are finding it difficult to understand why their valuable by-product should come down when they read every day in the newspapers how fantastically the automotive industry is doing with exports, that the recovery is on track and that emerging markets are booming.
We have dealt with this problem a number of times. We have two major influences on prices for European hides. The first one applies to everyone: the price for finished leather. If the price of finished leather doesn’t fit into the price of the raw material sooner or later the manufacturer has to act by reducing or adjusting production, or he will go broke. As it is in all businesses, too many losses and you have to close down. Secondly, we must look at the difference in quality and the return on raw material in the leather production. This leads to a certain value the hide can achieve and it might be the temporary reason why revenue is significantly lower or significantly higher, but that can last only last for a limited period of time.
This was the case in Europe over the summer. The low kill and the strong and consistent demand for raw material offered the slaughterhouses the opportunity to achieve inflated values for their by-product. This gap was already there before the US dollar started to decline, but the reduction in the value of the greenback has widened the disparity so much that companies active in the market have absolutely no chance to bridge it. It took bankruptcies and plummeting currency values to give buyers the courage to admit their problems and to stop accepting certain price levels, despite the good order situation most of them are still holding. And indeed it is not a problem of insufficient interest; it is only a margin problem.
Everything would have been different if the US hide market had been able or willing to take advantage of the present situation. Of course it’s not just about one origin declining, others can also go up. However, in this case leather prices came into play allowing further increases for raw material, and the benchmark is still the US market. It seems that the US packers have played well this time without surrendering to the temptation to try to make a quick buck from the situation in Europe. It seems that they had some kind of understanding with their big clients that, for this season, not much more money for raw material can be spent. That kept weekly sales on a pretty steady level and made US hides constantly more competitive while European hides started to face problems after the summer break in finding enough homes and buyers. Without the failure of two tanneries in northern Europe this might have even continued further.
Another factor in Europe is definitely also the focus on the supply of fresh, chilled hides, not a product one can actually keep for too long. If you are not willing and in the position to salt and to store material in the hope either of finding better buyers outside the standard European customer base or at a later time agreeing a better price with your buyer to move the material. Some see the way out by contract tanning the material and putting it into stock as wet blue to be sold in the better times ahead. This might ease the market pressure for a certain period of time but will not actually solve the problem of the real value of the material in the market.
As far as dairy cows are concerned the situation is different because this material is much more related to the international market. Although most sellers still prefer to sell material fresh into the Italian customer base, the influence of and dependency on the international markets play a much more important role. In addition the European market is still in a period of transition between being a processors and traders market to a market that is run and dominated by the packers themselves like we have already in almost all other leading raw material origins for hides and skins. Processors are still fighting against the trend and are exploiting themselves in the hope of staying in business.
The second and possibly much more important event was the leather fair in Bologna. The Lineapelle exhibition remains the trendsetter for fashion and quality in the leather world.
There were a lot of different opinions about the attendance at the show. The first and the last day were much less crowded, but that says nothing about the quality of the attendance. Most of the exhibitors we spoke to were pretty pleased with the numbers and quality of their visitors and there was definitely not much complaint about the activity. The second day was pretty busy with a lot of foot traffic in the aisles and people rushing around.
The general consensus was that the results of the show were positive. Considering that Bologna is generally an event for the high-end shoe and leathergoods business one had to be impressed. Despite all the concerns about the global economy luxury products continue to sell well and this is also supporting the top end of the leather industry. Tanners and manufacturers supplying the top brands of the world are extremely busy and many of them can’t actually meet the delivery times requested. There are no signs of any crisis with the wealthy of this world. The majority of the brand names have order books for as long as six months or more at the moment. However, the situation is not brilliant for everyone. Some smaller brands might still support smaller manufacturers, but in general it is never enough to entertain productions of a certain size. This is making life hard for a number of good quality tanners who have just had the bad luck not to be the supplier of some of the successful names.
Apart from that the show confirmed what we have been dealing with for almost the whole year. There is no problem with demand for leather, the only problem is the price. While at the high end the price might still be only a secondary item it still dominates the argument for the mainstream. Retailers are not willing to pay more for product and they are still not impressed by the rise in price of raw materials. They are totally inflexible regarding price negotiations and only a handful of manufacturers have been able to achieve moderate increases.
This has continued to keep raw material prices pretty much under control despite the fact that demand remains strong and there is very little stock in the supply chain. For standard items the situation is reasonably stable. Buyers are stubborn in their ideas and sellers don’t have much reason to compromise on theirs. As a result of the price problems some producers are now trying to escape to lower quality products; in particular in China materials from Africa, Central and South America or the odds bits and pieces from other areas are back in fashion.
The split market has regained some interest again. Again, price is the reason for this and in some cases also the continuing fashion for suede articles. Demand has remained pretty steady and for some articles supply cannot meet demand at the moment. This applies mainly to heavy substance or to high-quality suede materials.
The skin market remains in a pretty strong state. Demand is good and in most categories we would even say that supply is too short. Prices are firm and there is no indication that this will change in the near future. The Eid al-Adha festival around mid-November should ease the supply situation a bit with a higher kill in Muslim countries, but fashion in shoes and garments remains the driving force in this season.
For the coming weeks we expect adjustment moves in the market rather than any real new trend. We are not at all pessimistic. Domestic consumption in China is still rising fast and consumption in the rest of the world is pretty stable. Shoe sales are good and some early cold days in the northern hemisphere will boost sales further. With shoe stocks after the last winter season being pretty well cleaned up we are hearing already about some good re-ordering activities all over. The luxury business is also strong and with the Christmas season and Chinese New Year sales still ahead of us things look reasonably good at the moment. Chinese manufacturers are even betting on rising consumer prices in 2011 with at the same time a stronger renminbi making import raw material prices more attractive.
So, we think that the raw material market is rock solid at the moment, but not yet ready for any break-out for prices. However, looking into 2011 inflation could finally become an issue and this would open the way for higher raw material prices. For the near future rising prices would be a threat to the cash situation of many tanners and cause further short-term trouble. For the moment prices should stay within narrow ranges, but a careful analysis for the next season would be wise.
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