Market Intelligence—08.02.11
08/02/2011
The past two weeks have been determined by the turbulences in Egypt and the question of possible uprisings in other countries in the Middle East and the threat of violence. Despite a number of casualties—and one is too many—the wind of change has been reasonably peaceful so far. On a diplomatic level the world is trying to find quick and stable solutions for the changes that have to take place in many countries.
So far the business world has reacted in a pretty relaxed way to what is going on. However, the situation could quickly become much more complicated than many people think and this might also be the reason why international politicians are reasonably careful with any statement they make. The destabilisation of the situation in North Africa and part of Middle East would complicate the situation in the region. What is most obvious to normal people is that the supply of oil could be affected and that Suez Canal, which is so important for international transportation, could quickly become a tool of negotiation again. The consequences for international transport would be extremely intense and in times of globalisation the transport of goods around the Horn of Africa would mean a lot of change, cost and delay.
So let’s hope for the sake of the people in these countries, and for all of us, that the situation can be kept under control, that the leaders understand that their times are over and solutions can be found quickly to offer people the desired changes and freedom, and to offer the global community the stability we all require.
Apart from these political questions, most of the interest in the past fortnight has centred on the question of how national banks will deal with the threat of inflation. So far, all the big leaders of national banks in the western world are still playing down the risk of rising prices. In their statements they are talking about watching the situation, but not seeing any serious threat of inflation in the longer term. The national banks in Europe and the United States are pretty much trapped in the problem, that rising interest rates would cause a lot of trouble as governments try to finance massive national debts. Consequently, the US Federal Reserve and the European Central Bank are being very cautious with interest hikes because this could quickly return a number of nations into serious trouble. The debt crisis is not over yet.
People in the street and the financial markets take a different view of inflation. People are feeling the sharp rise of prices for food and energy already and the financial markets are still investing in commodities on the futures markets; they speak a different language. There is a widespread concern now about rising consumer prices. In countries such as China and India, which are today the engines of growth, inflation is already above 5% and in reality it might already be at double-digit numbers.
However, the good times of 2010 with low interest rates and good global growth are spilling still into 2011. Automotive makers are reporting fantastic results and have declared they expect record sales 2011. In the US car sales rose by more than 20% and the European premium manufacturers were pretty happy on seeing a 23% jump for Mercedes-Benz in January 2011.
Commodity and food prices continue to rise and the price of a barrel of oil jumped back to levels over $100. Climatic influences such as droughts, floods and hurricanes since beginning of 2010 have played an additional role.
The US dollar has lost quite a bit of its value in the past two weeks and is already expected to touch the level of $1.40 to the euro again, but was stopped just before by comments from the ECB and fell moderately back to levels below $1.36.
Market intelligence
The leather has also been pretty much determined by two major situations in the past two weeks. On one side we have had the Lunar New Year holiday, which kept a lot of players away from the markets and at home with their families. Modern communications mean people can still be connected, but in general everybody agreed that the activities were down on what we had seen in previous years.
On the other hand, we had the situation in Europe of one special section making the pace for the whole market. We were discussing the influence of the automotive leather demand, the kill of heavy good quality male hides and the high dependency on fresh hide supplies in the region. This has again become a pretty complicated situation. While towards the end of 2010 the kill of adequate material was still pretty high due to good export demand for beef, production had dropped by mid-January against all forecasts. Most pundits are expecting the kill to continue at high levels throughout the first quarter of 2011.
Due to strong demand from shoe tanners as well as from automotive tanners, available hides have been absorbed pretty well already in the last quarter of 2010 and that has left almost no inventory to cover the needs that remain high owing to strong demand from the premium automotive manufacturers. Week by week the situation has become more difficult and for the month of February it doesn’t seem that all the tanning drums can be filled with the raw material needed. The present situation is another good example of how tricky the dependency of two industries can become. In this case, supply and demand from both sides are not able to influence production.
The market logic is of course that raw material prices have to rise. Packers read newspapers too and realise pretty well, that their by-product has become reasonably prestigious again. Tanners as well as processors are all desperately looking for raw material supply and this is the best of all situations in which to ask for more money. Although there is fundamentally nothing to complain about as this is the market rule, one gets a funny feeling that in the long-term history is going to repeat itself.
You don’t need to have too much inside information to know that the leather industry, in particular in Europe, is facing big problems. Not only that raw material supplies are inadequate and prices for the same have exceeded critical levels, but at the same time production costs are rising. Whether it is labour or water, chemicals or energy everything in the budget for 2011 is climbing rapidly at the moment. To make things even worse all this needs to be financed as well and although interest rates are still reasonably low at the moment the access to extra finance is still not easy. In particular, when extra finance is needed for non-profit production. With most European sales still made on an open credit term, credit insurance limits have quickly become an issue again. The credit limits allow today half the volume today that they did in the season 2009–2010.
We saw a similar situation in summer 2010, but that was reasonably short lived with the higher kill seen in the last quarter of the last year. At the moment it doesn’t seem that supply is going to be the solution. In the first half productions are traditionally high and slaughter generally below average.
As a consequence a number of the big players are already dealing with ‘worst-case scenarios’. The key players have to decide if they want to fight the battle with their wallets or if they want to find alternative solutions with their clients or competitors. Experience tells us that mutual and friendly solutions have hardly ever been found and so we have to expect that this time is also going to be the survival of the fittest. However, companies in the automotive industry would also be well advised to check their supply chains to make sure that all the cars that have been sold for delivery in the coming months can be supplied. It seems pretty unlikely that all the players can get or pay for all the material they have been requested to supply.
We should not forget that there are other segments of production that could need the same or similar raw material too. The specialised shoe tanners are also highly concerned. Although they have got through the crisis much better than their colleagues, they now have to accept the fact that they are in competition for raw material and they face the problem that their customers are hardly willing or in the position to follow the steep and quick rises of raw material prices by adjustments in the price of leather. The big problem is that the flexibility to change to alternative raw materials is pretty limited for all of them and many are dependent on fresh hide supplies due to production and effluent regulations. We think that the month of February is going to be determined by intense discussions about how the temporary problems can be solved.
Internationally the situation is a bit easier, but not much. Throughout the holiday period sales from the big supply origins were good enough to keep forward positions pretty much intact and the trend of incrementally rising prices day by day and week by week continues to be in place. The cyclone in Australia extended the supply interruptions from that part of the world, so that supply in general continues to be an issue.
On the assumption that leather demand is as good as we have been led to believe from all the feedback we can get from the markets, the present raw material supply cannot cover production plans. Rising prices may be the consequence, but they cannot be the solution. We know that in many parts of the industry people have this problem on the agenda and in a number of design shops those responsible are experimenting with alternative materials. Those who are not flexible enough are discussing the consequences for corporate results and finances. In the long haul we all know that supply and demand have to be brought back into balance, and they certainly will be.
Another interesting topic is the global supply of hides. In an easy world, rising consumption as a result of economic growth should also increase the consumption of beef. Rising wealth has almost always increased the desire and willingness to spend money on beef. However, to consume beef it has to be produced and farmers must be ready to raise cattle to have adequate beef supply. Many people are however presently not 100% sure if adequate beef supply is going to take place. Cattle feed is becoming increasingly expensive, the competition from bio energy (as a use of crops) is a factor today and in many countries the environmental and climatic consequences of beef production have a far from positive image. Farmers have alternatives and a number of them could really shift their investments and productions to other options. It seems that we are now at a junction over how beef supply is going to be secured for the timeframe we have to cover, which is not more than 24 months.
We should possibly also have a look at the demand side. Like we have said in the last months there are a lot of reasons why leather demand is so strong. We are seeing the consequences of the massive growth in many of the emerging markets and the global recovery in general after the crisis, but we think that the biggest influence on the present situation is the budget planning of big enterprises. Nobody was able to foresee the crash of 2008, but in the end companies have proved not to be flexible enough to adjust their budgets adequately in shorter periods of time. This is the consequence of mass production and long supply chains, but cannot excuse the rigid budget plans that have been made and followed in a kind of business slavery. Even worse, big players in the leather supply chain plan production and output for periods not less than six month and in most cases closer to 12 months. At the same time many of them and in many parts of the world have no budgets or procurement plans. They are just passing responsibilities on and feel free when they find a supplier willing to take the responsibility for supply. As long as it is just a money problem, it is a question of finding somebody to pay the bill; if it becomes a material problem it takes far too long for solutions to be found and decisions taken.
With the situation in the hide market, splits are seeing a sharp recovery, in particular for products where grains can be substituted by splits. This is increasing the demand and prices for splits. With the next change of the fashion seasons, we expect splits to make even further inroads into productions and one can only hope that users are willing to analyse carefully what kind of supply potential they can actually expect from this material. So far, the rising split returns are providing a welcome assistance for tanners to cover some of the rising hide prices.
The skin market is as undersupplied as the hide market at the moment. Prices for some specific materials like large high-quality fine wool skins continue to rise and have in the meantime reached levels that are hard to believe. We have no serious confirmation about reliable activity at these prices or of any trading at high volume. For other skins it seems that the market is just taking a break and we have to expect further gains in the weeks to come. The shortage and rising return for wool is helping in calculations as well.
We find it extremely hard to make any predictions for the market now. We thought that prices would take a break, but as we have explained above there are still some market segments that can’t take a break and prices are marching on. The markets can push prices higher and higher, but at the same time it will not generate more raw material and just develop higher risks. As strong as leather orders are, we have to be aware, that the whole business has to be financed and with raw material prices rising so quickly, more and more manufacturers are starting to lose money on their productions. This is going to have an effect eventually, but we cannot predict when this is going to be. We tend always to think it’s coming sooner than later, but many in the industry seem still to be able to manage their survival better and longer than we think. One way or another we are getting closer to decision-time. With the information one has today it doesn’t seem we are going to see anything happen in the weeks to come. Stocks are too low and demand is too strong. However, there are a lot of uncertainties around and risk management should be number one on the priority list for the near future.
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