Market Intelligence—02.11.10
03/11/2010
In the past weeks the eyes of the financial markets were mostly on the discussion in the EU on how to deal with countries that fail to meet the regulations of the stability pact, and on the US and the question what volume of quantitative easing the Federal Reserve will find adequate.
From a neutral standpoint, the thought of more US dollars being printed and poured into the system is frightening. One media report last week mentioned that the big US companies are already sitting on cash resources of almost $1 trillion for which they cannot find any adequate investment. This explains well that the US problem is not a shortage of money, but of options and alternatives for reasonable and profitable investment. So it is questionable if more cheap money can help the economy.
Not everything is brilliant and easy in Europe either. Following some media reports, one could come to the conclusion that the crisis is over and the EU is at the beginning of a bright future and an economical boom. Well, looking at the facts, we are far from anything like that. With the exception of Germany were the fundamental data is?thanks to exports?positive, the majority of the EU members are still dealing with serious and fundamental problems. The peripheral ones the problems are mainly with their budget deficits and high unemployment; for other core members there are more structural problems and there is a difficulty in convincing the population that serious reforms are needed (France and Italy, for example). Consequently, the labour market, with the sole exception of Germany, is flat in EU countries.
Also politically Europe is far from stable at the moment. At the most recent EU summit meeting of all EU heads of government last week most member states were not amused by the conditions Germany was insisting on, or by the arrangements France’s Nicolas Sarkozy and Germany’s Angela Merkel had agreed ahead of the meeting. Compromises were found and harmony was shown, but most observers had the feeling that some still went home with a bitter taste as the result of what had gone on. This might make future negotiations pretty difficult.
All this had an impact on the financial markets, in particular in the currency market where the US dollar took a break from its recent decline. The dollar traded against the euro in a range of 1.37??1.41, but stayed most of the time below the big figure of $1.40 to the euro. Speculators had loaded enough US dollar shorts on their backs and were not willing to push the greenback much lower for the moment. On the other had they were defending their positions pretty aggressively and whenever dollar buyers seemed to get the upper hand on the market the bears were willing to invest sufficient money to make sure that their positions did not turn sour. The Federal Reserve’s decision on quantitative easing could become decisive for the trends until the end of the year.
Commodities were still rising in general, with most commodity indices going up. Oil remained just about steady in the range between $80–$85 per barrel.
Market intelligence
The hide market of the past two weeks was almost perfectly steady. There were still talks about more pressure in the ‘European heavy’ market, but in the end there was more rumour and gossip than anything else. With the higher seasonal kill there might be still some more hides available than are actually needed, but we don’t think this will present any serious, sustained problem to the market.
This should not excite the optimists too much or make anyone believe that the market is ready for a turn for the better, but the massive pressure we have seen since the beginning of the summer has definitely faded. Hides had been overvalued for quite a long time and this overvaluation has been corrected in the greater proportion. The discussion today between the most important players in these markets is if the correction could continue until the market finds a solid bottom. We think that prices have room for a maximum movement of 10% to be fairly valued again. This would mean a decline of 10 or 15 cents from today’s levels and then the worst should be over.
With all the fantastic quarterly reports the automotive industry is delivering, it seems difficult to believe there could be any serious problem with raw material for the premium market. We have always said demand for leather is one issue and the price is another, but we tend to believe that the price for this particular specific product is not too far away from what we would consider to be a fair valuation. In addition we should not forget that the tanners who specialise in this particular market are not interested in seeing their preferred raw material move into the hands of other markets, as happened in 2009.
All other global markets have been pretty stable. In particular the benchmark, the US packer market, moved only within very narrow ranges. The fundamental trend in view of the weaker US dollar was very moderately up, but in reality other price changes seen in the past two weeks have been negligible. The steadiness of sales and shipments which can be read from the official statistics is impressive. Not only prices, but also the volumes of sales and shipments have been almost totally steady for the past several months. This means, in our opinion, that buyers and sellers have found the almost perfect balance of supply and demand, and also of the valuation of the hides.
With the US market still the benchmark for the rest of the world, all other supply origins have to try to find their valuation around these levels. This applies at least to all the standard grades and items, which are needed for the production of average consumer products. Whether this is shoes, leathergoods or upholstery does not really matter.
Leather demand globally isn’t showing any signs of fatigue. The flat conditions in the traditional markets are still easily offset by the growth in the emerging markets. From China the number of positive reports about rising domestic orders for upholstery leather is rising on a weekly base and Chinese manufacturers remain entirely positive for their domestic business well into 2011.
So, with demand remaining good and leather business stable, supply is just facing seasonal changes and the markets are presently in balance; price levels are representative of the value of the leather content in the finished products. This can be nicely seen in the case of light and top quality raw materials, which are still selling at levels that would not even have been considered in relation to other grade some years ago. The boom in the luxury industry has changed that, and there is no end in sight.
This leads to another topic of discussion. The valuation of raw material. More than ever before, the raw material price is being determined by the value and price of leather, or to put it another way, by the price and the value of the finished product it is sold for. This is changing the classical valuation of hides. European heavy bulls are again a good example. They always sold at a large premium. The question was only about how large the premium would be. Today things have changed for the better. There is no premium any more, just the value of the hides in relation to other alternatives. With automotive tanners facing massive price pressure from the automotive industry they have no room for any product preference; they just have to pay for the raw material that can actually meet the price and quality requirements of the client.
This makes the valuation of hides more and more interesting. In the past certain hides were just reserved, with the price determined by certain productions. Heavy bulls in Europe for automotive leather or French cows and bulls for sole leather are examples. Today the heavy bulls are used in shoe upper or leathergoods and at the same time certain French cow hides have become popular in China for the production of upholstery and bag leathers. This is all the result of the valuation of raw materials being based on the real value; this is becoming the only parameter for market prices. Traditions are less and less of a factor. It is also the result of globalisation; new markets start without any prejudices in the pipeline and just try to find the best value for their purpose.
In Europe, a change in the structure of the trade is also occurring. Like in other continents the industry is changing and the slaughterhouses are taking more and more control of the market. Directly or indirectly they are marketing their hides to the tanning industry and the buffer function of the processor or trader is being steadily eliminated. Slaughterhouses are not really willing to hold any stocks and their interest and attempt is to keep a forward position. So, they try what their colleagues did in other continents many years ago with a strategy of ‘position before price’, adjusting prices quickly in every direction when market imbalances exist.
Apart from the supply-and-demand balance to determine the market price we in Europe still miss a willingness to deal with the valuation of the raw material. Most suppliers are still of the opinion that the market price is only determined and found by supply and demand. This is scientifically correct when the price of the moment has to be found. If you want to find more sustainable levels, you also have to deal with ‘the affordable price’ and the willingness or need of the buyer to spend available resources.
In the past this was more difficult to analyse, because markets were far more fragmented, products were more plentiful, prices had many more levels, stocks along the supply chain were common and information was not as easily available as it is today. The situation has changed a lot and today certain products are so uniform in their quality and price that we now have price levels that are fixed for large parts of the leather production for a longer period of time. This is also reflected in the raw material market and is more obvious in the standard raw materials than in the specialties.
The market mover is the consumer product market in China and in some other emerging markets. Retail in the ‘old economies’ remains flat and is not supporting the demand at the moment. The global economic situation outside China is presently being talked up by interested parties to spread optimism and to support the recovery of the global economy. Statistically global growth is back to close to pre-crisis levels, but the reality is that the quality of the growth is different and it is not spread evenly. The strong demand and growing wealth in China, which is pushing German premium car exports and contributing to the strong recovery of the German labour market and economy, is an example. This should always be taken into consideration in the general evaluation of the leather pipeline.
The split market remains in good shape too. In particular suede leather articles are in good demand and the interest for suitable raw or finished material is strong. Collagen remains another strong factor in the split market and the pressure on finished product prices is keeping splits still in play for many leather-related productions.
The skin market remains a very strong performer. Garment fashion, the recovery of the Russian market for double-face products and?again?the strong demand for consumer products in China, including leather garments, are among the reasons. If we add the strong demand for wool we understand the strong demand for skins in general and why prices have been rising recently and also against the trend in parts of the bovine sector. With skin nappa and suede back in fashion collections?as a result of the attractive price levels of 2009?we now see the demand with all manufacturers forced to cover for the orders and demand. The extreme weather conditions in 2010 have cut into the flocks of lambs and sheep in a number of countries. Those who expect a rise in prices to continue should be aware of what has happened in the central European bovine market. The same rules apply to skins and a thorough calculation of value under the present conditions and parameters should be made.
For the coming weeks we still think that the leather pipeline is in search of ‘what comes next’. The chance of further stability is pretty good. There might be some segments that still need to adjust and to be shaped into the entire picture, but generally supply and demand and prices are pretty close to what can and should be expected. We are now heading into the final lap of the calendar year and without any intentional manipulation or speculation we believe that most of the pipeline has little interest in major fluctuations. Upward moves would be a great threat to the profitability of leather production and so higher prices for raw material have successfully been fought against by the tanning industry for quite a long time now. So, one has to assume that the prices will remain in pretty narrow ranges and only financial or political issues could trigger major movements.
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