Market Intelligence—16.11.10
16/11/2010
In the wide field of global economics the US Federal Reserve decision regarding the extent of quantitative easing (QE) and the G20 summit in South Korea were the expected issues of the past weeks. Suddenly a third one was added when the European Union debt crisis returned to the agenda with Ireland, Portugal and Greece producing bad news, sending their bond yields substantially higher.
Two weeks ago the world seemed crystal clear to many and they were convinced that the global economy was back on track. Emerging markets were booming, Europe was out of the crisis and recovering, with the US economy lagging behind. Investors were happy and assets rose. The only questions surrounded how much money the Federal Reserve would pump into the system and whether world leaders would find a solution for national interests that could possibly hold the global economy back. The media picked the issue up and belligerent phrases like ‘currency war’ started to circulate.
In the end everything was different from what had been planned. Investors had taken positions against the dollar betting on extended QE and they were right when the Federal Reserve announced a new $600–750 billion buy-back programme. Investors saw their bets against the greenback winning but most other countries were not particularly happy and comments on the Fed’s actions were almost all negative with other countries fearing a further devaluation of the dollar or a revaluation of their own currencies. So far, so good, but suddenly bad news from Ireland and Portugal were hitting the markets and it was back to the EU debt crisis. This was garnished with some better than expected economic data from the US and suddenly investors were not so happy about their short positions on the dollar and decided quickly to unwind them, especially after realising that the G20 summit in South Korea was likely to bring no big changes.
The USD gained quickly in value. From almost $1.43 to the euro it rose almost all week and finished at levels of around $1.37.
The international ranking is shifting and the rise of China is accelerating at the moment. Not only because Forbes ranks China’s president top of the list of influential people in the world, above the US president, but also because of its financial capabilities. While the US is fighting with its budget deficit, China is travelling the world with pockets full of currency reserves to spend. All this shopping and investing is making a lot of China’s trading partners happy and in many nations the US is no longer the top trading partner. The world is still changing quickly and it will be a challenge for many in the old economies to understand that new rules may apply.
Commodity prices have also reacted to the situation and most are rising. Precious metals are rising mainly as a protection against inflation fears while in other cases it is more a result of excessive liquidity and a lack of investments alternatives. Towards the end of the period fears about rising interest rates in China and a slowdown of industrial activity sent commodity prices a little lower again. The main commodity for the industry, oil, is trading now in a higher range between $85 and $90.
Market intelligence
The market traded in pretty narrow price ranges again. Business is presently on short notice and neither suppliers nor clients in the leather pipeline are willing to commit to any extended periods and quantities. The weaker dollar until last week kept prices in non dollar regions under tight control and US suppliers were again wise enough not to try to take any short term advantage of the situation, holding prices pretty steady. Tanners are not in such a desperate need-to-buy situation that the could have been an easy victim in this market. And tanners are not so confident about the next year that they would be tempted to take any early raw material position at the present prices levels. If they were sure about rising leather prices in 2011 some would be tempted to take inventory positions today in preparation for later on like we saw it in late 2009 for 2010.
The stories told are still the same with leather prices not moving upwards and tanners everywhere still complaining about low or not existing profitability. Productions today are suffering not only from the problem of leather and raw material prices, but also from the constant rise of costs. Transportation, energy, labour costs in some areas and also chemicals have all gone up and are burdening the calculations too.
Manufacturers of leather products see the writing on the wall too. So far they have been able to fight against sharp upward moves of leather prices, but they are aware of the situation and take precautions. In view of the upside pressure on leather prices companies experimenting with cheaper origins, substitutes and less leather in the models already intensively. While it is easier for shoe manufacturers and they have more options, the situation for upholstery manufacturers a bit more .
Even after the financial crisis when raw material and leather prices were really low and attractive, upholstery leather was still considered too expensive in many places. Well, one can imagine the situation today. Although the prices for corrected and cheaper upholstery leather are still not really high the escape to artificial alternatives is very obvious in the shops already. A lot of what used to be corrected grain leather in the past has changed now to artificial material and what is even more frustrating is the fact that retailers do not even seem to regret that leather is declining. This is a clear signal that leather today is no longer a prestigious product, offering any additional margins in retail.
The situation is certainly still a bit different in the medium and higher end of the market, but the volumes are not really high and have less impact on the mass markets. The above applies mainly to the traditional markets in Europe and the US; the situation in the emerging market is still certainly better for upholstery leathers, but we all know how quickly the emerging markets tend to adopt European and US trends.
Anyway, even with shoemakers experimenting with lower qualities, the upholstery industry shifting into artificial products, the automotive industry holding leather prices down and so on, the basic demand for consumer products is strong enough to keep most tanneries busy and the supply of raw materials absorbed. There is little indication, that this is going to change soon.
However, having mentioned the automotive industry we have also to realise that despite the sharp gains in sales and global production at the high end, the industry is not willing to let the price for leather increase. A lot of people are very surprised about the massive price pressure on raw materials specifically destined for high-quality automotive leather production when at the same time production and order books are at very high levels. In addition to the general sharp competition in the automotive supply industry, prices for automotive leather have fallen significantly during the period of the crisis in 2008–2009. With the sharp recovery of raw material prices since then leather prices haven’t followed. After the sharp gains in spring 2010 tanners had to take serious decisions to act against the margin and profitability squeeze.
With the automotive industry not following the price rises, suppliers had no choice but to find production and raw material solutions that were in keeping with the price they were receiving from their customers. As much as customers and qualities allowed, tanners shifted to other, cheaper origins and managed their inventory positions better. Knowing that the higher seasonal slaughter in Europe would come, they reduced their purchasing with good timing and took care of the over-supply that triggered the sharp (and necessary) correction. The question today is if tanners are now willing to take similar precautions for the time when the kill declines again and the balance may shift.
If the automotive industry can carry its brilliant 2010 results over into 2011 the supply and demand balance could shift quickly. A lot points in the direction of cycles developing as usual. With the sharp rise in price of high-quality materials (including calf skins) the industry is shifting to cheaper materials. We have already seen a reaction on heavy bulls in Europe and we would not be surprised to see other hides facing more pressure while cheaper materials enjoy better demand and stable or firmer prices. The wide price gap will close. The prices of sheep and lambs was still very low at the beginning of 2010 until they were discovered by designers and the industry, not only in the classic productions such as garment, but also in other segments like footwear. With the help of the shortage of wool and rising prices, skin prices have risen strongly recently. A similar pattern could be expected for bovine materials even when we are facing persistent strong demand in general: moderately falling prices for top-quality material and incrementally rising prices for cheaper resources.
A determining factor will be the issue of the substitution of leather. If the trend continues and more leather is substituted for price reasons, consumers will become more used to alternative materials and if price remains the determining factor in the next season, the cap on prices could remain intact.
The split market is already starting to benefit from the trend to hold leather prices steady. Splits are appearing again in design studios and suede will become prominent again. PU splits might not benefit from the situation, because their cost per unit is barely competitive with fully artificial materials.
The skin market remains extremely firm. Strong demand for wool and a good season for garments and shoes have pushed prices higher and higher over the past months. There seems to be no stopping the trend and in particular Chinese buyers are grabbing whatever they can get hold of. Some items have gone up by between 50% and 70% since the second quarter and we strongly believe that prices are going to overshoot as usual. This might carry on for a while with prices still supported by the wool market, but when the production season ends the trade could figure out that skin prices are overvalued. Most people are still convinced that there is no end of the trend in sight and still see demand as being much stronger than supply.
For the coming weeks we expect business to slow down a little. We have the impression that European tanners in particular have already done what they needed for 2010 and will not take any further big decisions until the end of the year. If the kill remains as high as many people are reporting it could become a bit tricky for suppliers. Although sales and demand in Asia have been enough to compensate for some time now shipments towards the end of December could be affected by the Chinese New Year holiday as well. With a high kill, European tanners cutting soaks starting from week 50 and possibly reduced shipments, it could become difficult for those who do not have the necessary resources to handle material at that time.
It might still be a bit early for many to think about it and possibly we are too cautious, but it is at least a scenario that should be considered. With the market actually run by Chinese demand at the moment, it is advisable to have an eye on stocks and demand out there. So far, there is no cloud in the sky and business looks good well into 2011, but a certain level of attention is advised. The key factor for the trend into 2011 will be the expectation of inflation. We have always been and we still are of the opinion that with inflation and consequently rising consumer prices, further room for prices would be given. If inflation remains moderate and consumers see no reason to rush to buy in expectation of rising prices, the chances of raising prices in the pipeline are limited. For the short term we don’t expect any great potential for prices to fluctuate a lot. Anyone taking risks before the end of the year will face potential trouble from the financial markets and a threat to stability for the weeks to come.
Share this story:
