Market Intelligence—11.01.11
11/01/2011
First of all we would like to wish all our readers a very happy, healthy and prosperous new year and wish you a lucky hand to deal with the challenges of the leather pipeline in 2011.
Finally the long break due to the season has come to an end and slowly systems are starting to work again after the beginning of the New Year. In Europe a number of enterprises took an extended break, in particular in the south where January 6 is also a holiday.
The new year is starting on a positive footing. The US economy has pleased the markets with positive data since mid-December making many believe that now the economy in the States is also finally getting out of the doldrums. The job market improved with more new jobs been created, real estate prices seemed to stabilise and the main driver of the economy—private consumption—saw very good Christmas shopping and people spending more money than even before the big crisis. To complete the good news, the ‘big three’ in Detroit reported robust sales and orders making them believe that car sales will increase in double-digit numbers.
So, as far as the private sector and consumption are concerned, the news and data are good. Most companies are also taking a positive outlook into 2011. All this is superficially generating the positive feeling around. The corporate sector remains quite optimistic, but it seems that the threat from the government sector is not really impressing the public much any more; even the comment from the US Secretary of the Treasury, Timothy Geithner, that under present conditions the US is close to bankruptcy, did not impress many (yet).
Since positive sentiment about the economy in the US is dominating, the US dollar was able to benefit and rose in the first week of the year back to levels below $1.30 against the euro. Oil prices tested levels well over $90 and were said to move close to triple figures before correcting moderately last week as a result of decent stocks in consuming countries.
2011 could be the year of the return of inflation. Many deny it but the facts are different and paint a picture of danger. Prices over the last two years were influenced by the uncertainty of the global recovery. However, the strong performance of consumer spending in emerging markets and investor speculation in the raw materials markets lifted commodity prices sharply in 2010. Many are trading at record levels and others are at least back at levels of the pre-Lehmann times. Most manufacturers have long-term raw materials contracts or hedging strategies that have so far kept a lot of the raw materials price factors out of calculations. This is now starting to expire and a number of calculations will have to be adjusted to the present price levels, and product prices with them. Foodstuff and energy prices, considered to be basics, are already up and so are essential metals such as copper. These are all materials that are pretty close to the consumer’s wallet and if that is not enough, labour costs in China are also rising, at least for cheap labour. Due to better order books, manufacturers and retailers are no longer shy about asking for more money and many shoppers are already reporting higher levels in the shops.
Taxes and governmental services are rising too and it is questionable at best if income can compensate. The euro zone was already reporting a 2.2 % rise in prices for November and we would not be surprised to see more of the same into 2011, with the speed accelerating in the second half of 2011. We think that inflation could become one of the key subjects of economic discussion later in 2011 and in particular higher food prices could become a problem for the poor again.
Market intelligence
Although the dates of the holidays this year were producer-friendly and left enough working days to keep production open, most European manufacturers decided to close, many for an extended period of time.
It was certainly not the lack of orders that made them opt for a longer break, but much more the general organisation and the agreements with labour organisations. It may also be that, in view of very good order books, a lot of maintenance operations needed to be carried out for tanneries to run at full speed in the first quarter of the new year.
Consequently trading was pretty light and most people were talking about reduced operations, activities and sales. This might not only have been caused by the holidays, but possibly also by the fact that everybody in the pipeline preferred to lay back, take a break, analyse the situation and to postpone any further decisions into the new year. The situation applied not only to buyers in the pipeline but also to sellers. As we mentioned in the last issue before the end of the year people have to deal with the problem of how to handle the general circumstances at the beginning of the new production year.
The situation has substantially changed. A year ago the production pipeline started with a high level of uncertainty in the global economy and the possibility of a double-dip scenario. Raw material prices were still pretty reasonable and the optimists were taking the chance to fill inventories and went out to discuss with their customers as much business as possible. Others were significantly more cautious, believing in rather more negative scenarios, and were not willing to replace inventories actively and just took business on as it came in. The economy, in particular in the emerging markets, continued to improve and in the second half of the year there were clear indications that there was a good chance of recovery in the old economies too. And so it came.
A lot of sectors that traditionally use leather as a material source have had sales exceeding budgets by significant percentages and they have been forced to raise production levels to satisfy their clients’ demands. The luxury leathergoods business has led the way, followed by the strong performance of shoe sales; last but not least the automotive industry has rebounded strongly and demand for raw material continues to be strong and persistent.
This has led to a constant rise of raw material prices and although, due to regional short-term volatility, the year 2010 ended on substantially higher prices for raw material then it began. Rising production and sales meant in most cases shrinking contribution margins and only high levels of production gave some in the industry the chance to reach reasonable financial results at the end of the year. This did not apply to everyone and those who got it wrong might have been caught again in the old trap of losing more money the more leather they produced.
The beginning of the year 2011 is making the situation for most manufacturers much more complicated. Raw material prices are not cheap by historical standards and for some items and origins they are at or close to record levels. Even those who decided their budgets for 2011 in September have possibly had to revise them already and hope for higher prices from their customers or a correction in raw material prices to get their plans for the coming year right again.
The tanning industry at least is in a pretty complicated situation. It is certainly true that inventories might just cover weeks, but certainly not months. This is a general statement and will as usual not cover everyone. Traditionally the first quarter is one of the most active production periods of the year and if our assumption is correct that leather orders are good, the industry will need raw material to keep producing. At the same time the beef industry in 2010 also had the chance to move product quickly. With more beef companies marketing their hides now directly to the tanning industry or even becoming tanners themselves, buffer stocks in the hands of processors or traders, speculative or not, have far less chance of building up. And with the constant and reasonable demand for raw material in 2010, the new year started with reasonably empty warehouses on the supply side. This means there is not much raw material sitting waiting for buyers to clean up. Everybody is pretty realistic about the fact that price levels are high and although the memory of 2008 is fading, the numbers willing to take high risk are certainly lower than before. Sellers are analysing their customers’ situation carefully in an attempt to make sure they will be able to pay the bills eventually.
If the start of 2011 is challenging, the outlook for the coming months is even more so. Everyone has to check the supply chain carefully to get a clear picture about the possible risks. It seems to us that the automotive supply chain in particular could become a problem again. A limited number of articles, pretty much set at inflexible price levels with long-term contracts will potentially become high risk when prices of raw materials rise too far. Without price concessions the answer under the present conditions will be to reduce the leather content in the vehicles.
The furniture upholstery industry has already found solutions. In the medium and lower price section less and less leather is being consumed and like in the accessory business it is becoming more and more a luxury item. The shoe industry is possibly already the one working hardest on the reduction of leather in design and material mix. Together with accessories, they have the best leverage in their calculations when it comes to the cost of material.
The supply side is also something to look at. The first quarter, as already mentioned, is one of the highest production periods in the leather industry, but it is also a time when beef consumption is not at the highest levels. The seasonal kill in Europe is over; the seasonal kill in other origins hasn’t begun yet so no short-term influences—such as Muslim festivals—can influence productions positively at the moment. With the market being in balance, even short-term and interim incidents, such as the floods in Australia, can become a more important factor than it usually would. Even the dioxin scandal in some food products in Germany is starting to influence beef exports.
So, it all depends on buffer stocks and the plans the industry has made, otherwise there are not too many options left. More money doesn’t buy more raw material if raw material production is unable to match finished material demand; some manufacturers and retailers might need to alter their budgets and material mixes. One thing remains true: most leather products have critical price levels and when those are exceeded, or the supply seems to become an incalculable risk, retailers and manufacturers will walk away from them and it would probably take some seasons for the demand to come back.
The split market is still benefiting from the general situation. Demand for all kinds of splits remains good and this is supporting the market too. One can see already a number of products made from split back in the shops and the consumption of splits in collagen and gelatine is also good.
The skin market continues to be firm. The price rise has come to a halt for the moment but demand is still exceeding supply. The steep rise of raw material prices in the second half of 2010 needs now to be digested. This market is pretty much driven by speculation and traders. Due to seasonal influences, they have to take decisions to buy material when it is available and hope to be able to bring it to market when it is needed. The fantastic clearance of winter garments during the season has emptied stocks in many production areas. In particular Turkey has been able to use up a lot of the stock that had been around for quite some time, making buyers there much more ambitious about replenishing stocks. They know very well, that they are in direct competition with other markets today to obtain the raw material they want and that their time of dominating the double face market is over. Many Turkish buyers are trying already to secure raw material supply sources for when the killing season starts again in the second quarter of this year.
The next two weeks will show more clearly the real direction things are likely to take in the first quarter of 2011. As we tried to explain above, the fundamentals of the supply chain at the moment are set for a steady market in price levels. A lot of industries have to take decisions now about their product and material mix for the next seasons and this means also that budgets for raw material supply have to be made. At the end of January a lot of people will travel to India and the India International Leather Fair in Chennai, which will give the world the first indication about the decisions that are going to be made. The winter season orders for 2011–12 have to be placed already and this first gathering of the global leather industry will give us an indication of how much and what kind of products will be required.
This is going to be followed by the Chinese New Year break. It seems pretty likely this year that due to the critical situation in the raw material markets a lot of tanners in China will take an extended break to stretch their inventory positions. If leather prices rise substantially—which is what they need to do—we will be interested to see what this means for leather demand in seasons ahead. Most likely it will take well into February to get better information about what is going to come. By the end of March the get-together in Hong Kong is going to take place and it might be the time then to draw the bottom line. Aside from the small problems of a small industry like leather we still believe that it is pretty wise to watch the bigger picture too and keep an open eye on the developments in the general economy, National budgets, interest rates and of course the currency market.
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