Market Intelligence—25.01.11
25/01/2011
The last two weeks were a good example of how quickly the focus and consequences can change in today’s media-driven world.
The European debt crisis fell into the background and although nothing has changed or been resolved the focus has moved rather quickly to inflation, the visit of the Chinese Premier to the US and the consequences for the US-Chinese relations. On European debt, the conflict persists over who is going to guarantee and eventually pay the bill and what the weak partners of the group have to do to be sheltered.
While the media is still pessimistic about the solution of the debt crisis and the public excited, the markets are taking a different view and with the experts still seeing a further steep decline of the euro, the markets are taking a different view now on the situation, sending the dollar down and the euro up. Starting from $1.29 the rise went up to $1.36 on last Friday. Fundamentally nothing has changed, but investors are obviously betting that the strong recovery of the German economy and EU harmony will leave no option other than to find a solution for an extended rescue and sheltering programme at whatever price for citizens and taxpayers.
At the same time the US economy is showing further signs of recovery, but psychology rules as well. While most Europeans are obsessed by the strength of their currency and see meltdown coming when the rate goes below $1.30, Americans are much easier and see advantages in a weaker currency, although they pretend to favour a strong greenback.
This is no longer the key problem. It might touch the calculations of enterprises, but the real issue of today is the value of the renminbi. Although the international community is pressing the Chinese for a sharp and extended revaluation of their currency, they still favour the policy of a moderate rise. Already this global rise is strengthening purchasing power for raw materials for domestic use in China. With the bilateral arrangements the Chinese have concluded in many countries around the globe, China’s raw material control is already high, but a stronger renminbi is also making Chinese imports more competitive for local manufacturers. It seems that those who are asking for a sharp revaluation are not paying enough attention to this aspect. If higher production costs in China really bring jobs home it should also be considered that for manufacturing raw materials need to be imported. The battle for raw materials is also a battle of currency and purchasing power.
In the meantime the Chinese economy is booming again and the country’s gross domestic product rose by 10.8%. Inflation is becoming more and more of an issue and food prices are particularly worrying for the poor of the world. Inflation in India rose by more than 7% and in some regions of Asia food prices have risen by more than double. With energy prices also moving higher we are returning to the worries of the first half of 2008. The question of how the world handles resources and basics will be of great importance in the near future. Economically and socially the roads could become pretty bumpy.
Market intelligence
The past two weeks have been characterised by falling supply and rising demand. The floods in Australia and the foot and mouth disease in Korea have cut beef production regionally, but in a market environment that is already stressed by low inventories, small variations play quite an important role.
The leather pipeline has become pretty sensitive to changes in supply and demand and the psychological factor comes ahead of the physical situation between what the beef industry is producing and what the leather industry needs today to meet strong demand from consumer markets. It was already pretty obvious before the supply reductions that raw material supply in many segments of the market cannot meet the raw material budgets that many factories have for the year 2011.
For the time being productions are in most cases still covered for the short-term and there is little time to reconsider how the situation should be handled when prices have either gone too high or the raw material quantities are simply no longer enough to cover production. The old law still applies: more money doesn’t actually buy more hides.
The present situation has made the industry nervous. On one side it is supporting the tanners’ position in the negotiation for higher leather prices, but on the other side it is also putting the use of leather as a material in question because the future of supply is becoming unpredictable. The recent incidences of floods and disease have made many people much more sensitive to the dependency on raw material that has sometimes proved to be lacking in availability. Some still remember the effects of mad cow disease and foot and mouth in Europe; disease is still a threat that is always overhanging beef production. As long as there is enough buffer stock along the pipeline it can sometimes be balanced in the short term, but if one is dependent on a specific raw material or buffer stocks are not there to fill short-term gaps, the situation becomes pretty difficult.
Apart from the simple supply situation the increasing trend of consolidation in the leather industry is becoming another factor. It doesn’t actually affect the total demand for leather, but it makes life for medium and smaller size businesses increasingly difficult in periods when raw materials are in short supply. The units in the beef industry are growing bigger and so are the units in the leather industry. In scale and size both sides prefer to deal with equals than get into a position where sizes differ by far too much.
The news about further takeovers in particular in the automotive industry since beginning of 2011 are just confirming a trend that is new to the leather pipeline but not new to the global economy in general. Also the leather business is now in the final lap of converting from the small and medium-size company business to a mature global game dominated by big multinational companies.
The raw material price trends have remained up in the last two weeks. The speed and extent of this was a bit different from market to market and from product to product but have not been able to trace any raw material related to the leather industry with prices falling since the beginning of January.
Currency has become a factor again and might have caught one or two European players on the wrong foot. The euro, which looked so vulnerable two weeks ago, made a sharp recovery and gained almost 6% on the US dollar. Consequently a lot of calculations turned sour and possibly some of the hides bought at the abattoirs for customers in Asia have become pretty expensive. Many were just lucky that the general market trend was still up, so that part of the Euro gain was compensated by the market. Leading bovine origins rose incrementally in US dollar terms and in the meantime we have reached levels that can actually be considered close to or above the historical highs of the past. If we exclude certain periods that have been influenced by disease, we are now testing how far the raw material price for cattle hides can be pushed up without seeing victims along the leather pipeline.
For the time being interest rates are still low and due to the very low inventory positions the cash flow situation has not caused any further victims so far. With inflation now going up, raw material prices are significantly higher than a year ago and cash resources will now become a pretty important factor. It’s not only about the access to money but also the price of borrowing could become a problem for the leather pipeline. As usual it is going to be a game of survival of the fittest, with big units the most likely to come through. Those who cover more than just one production have an advantage.
Producers for the luxury section can also be optimistic. Although high-quality raw material is also extremely expensive, there is still room enough to offer everybody a living. Tanners complain that big brands and prestigious retailers press them hard on price, but there is still enough room to allow the necessary increase in prices if cooperation is the basis of the relationship.
The situation in the automotive leather industry is very interesting, particularly the high-end section that is still dominated by European manufacturers. Price is one problem, but it is more a question of how present budgets for full grade high quality leathers can be met. There is a lot of ambition to reduce leather content and to make buyers believe that they are getting more leather than they are, but even so, present budgets for production are exceeding the raw material available, regardless of price. Since certain raw materials can hardly be substituted, the battle is on between the supply chain in the automotive industry and the consumers of high quality, high substance leathers for the shoe industry. Both of them produce pretty high-value products and it will not be easy to handle the problem if both sections have got the ambition and the resources to maintain their positions.
Will the consumer, in view of rising prices for almost all products, continue to spend money on luxury and big ticket items? Since the rich are getting richer and the problem is touching rather the low income population, most likely the demand for high-priced products might not suffer, despite rising prices. Quite the reverse: there is a chance that wealthy people would rather increase their spending if they see hardly any reason to save or any opportunity to invest. Since most of the wealth is at the moment in emerging markets or the places where the raw material comes from, the outlook remains bright.
The situation could now quickly become critical for those who are in the crossfire between the big retailers and the rising raw material markets.
Fundamentally most traders are of the opinion that apart from the raw material situation there is hardly a cloud in the sky and business will be strong and good for the start of 2011. A strong and firm market is a good market. Let us see if this remains true.
The split market is following the positive performance of the hide market, with splits also in short supply. This relates mainly to some suede and heavy type materials. With food consumption and prices rising, the demand for collagen is increasing.
The skin market is taking a temporary break. Not that things are bad or deteriorating, but after the steep rise of prices, related to the firm conditions in the wool market, tanners at the moment are taking a break. The Chinese are still in search of full wool skins in Europe, Turkish tanners are looking to see if there are still some double face materials around and all are missing the big supply from Australia. Wool is short all over and even the big producing countries are trying to import today because they don’t have enough material to keep all their scouring and spinning operations running. This situation will last for a while and will support the skin business as well.
For the next two weeks we should see not much change. We don’t think that the steep rises are going to continue in view of the Chinese tanners now winding down for their new year holidays. They will definitely take a chance to travel around to check what their suppliers around the globe have for them, but we have to assume that their buying activity might be a bit reduced. Automotive tanners however, will have to continue to make sure that their supply is stable so we expect that the market for the appropriate material will remain under-supplied and firm on prices. We have to assume that the currency market will play an important role around the globe again and everybody outside the US dollar origins will have to watch carefully what that means for business. We believe that in the coming weeks the general discussions about the future outlook of the business are going to intensify. We have a feeling that a number of people should start to think about Plan B. For the short term the trend in the market will be moderately higher.
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