Market intelligence – 12.07.11
Macroeconomics
The past two weeks were pretty active as far as the activity in economical policy relevant to the financial markets is concerned.
At the beginning it was the approval of the Greek parliament for the austerity plans of the government. The positive decision paved the way for the next round of money transfers to prevent from the bankruptcy of the EURO member state. For the moment the financial markets took this as a relief and the EURO gained strength. As far the EU debt crisis was concerned however, it took until the end of last week to see the rating of Portugal falling to junk status. More rumours about the situation of Spain and Portugal had quickly turned the focus again on the EU debt crisis, which had sent the EURO back to the bottom end of the trading range between 1.41 and 1.45 versus the USD.
The ECB demonstrated their independence by increasing the basic interest rate by another 0.25% to 1.5% to curb inflation despite the problems of higher refinancing cost of the troubled member states.
The USA delivered mixed data but the final ones were pretty disappointing from the labour market which raised concerns again about the recovery of the US economy in general. Also the USA continues to fight with their debt crisis and the political competition prevents from any short term solution.
China’s economy seemed to slow down slightly with the purchasing manager index falling which left concerns about industrial activity in the second half of the year. More media reports are also seen talking about banks facing large amounts of bad loans and small and medium size companies complaining about higher financing costs and less and restricted access to bank loans. Inflation is a problem with June prices soaring 6.4% which increases the risk for social unrest due to sharply rising prices for food and other basics.
Investors were not too impressed by any of the negative news and possible effects on the global economy and were returning to investments into commodities. Oil, gold and other hard commodities returned at the end of the period to their levels which they had seen prior to the correction.
Other than that it seems pretty much that most people don’t want any big changes before the holiday period and just like to see things stable and steady before everybody returns towards the end of August to prepare for the trends for the rest of the year.
We still remain concerned about the status of the global economy. It does still not look safe and settled to us and we continue to believe that as of today the risks are outweighing the chances.
Market intelligence
This week is again one of those where the last issue could be copied since not really much new is happening in the leather pipeline. In Europe the industry is preparing for its annual holidays and from the second half of July to the second half of August most operations are closed and only some contract tanners or reduced staff are keeping a handful of productions open.
In Asia and the rest of the world the leather business is in the low season and this is reducing activities to the normal seasonal extent.
So far, so good. This is neither unusual nor really determining for a general market trend and so pundits and market players are now discussing and debating about the future of the market after the holidays when in September the normal production cycle restarts and the entire production capacity enters the high season period.
This discussion is more controversial than ever before and as we mentioned already in previous issues one sees two separate opinions about the market and the business for the rest of the year. Since we are not really too bothered about the presence and more interested to have a look into the future, let’s compare what both of them have to say to support their arguments:
The price optimists:
• The market correction since April is just a normal and healthy reaction after the sharp rise of raw material prices since 2009
• Stocks in the production pipeline are not too high and need replenishment rather than reduction to keep production level afloat
• Global leather demand remains stable and rising populations and the strong performance of the emerging markets plus China are more than compensating for any possible and smaller weaknesses in private consumption elsewhere
• Global slaughter is presently shrinking rather than expanding which will reduce raw material supply gradually and eventually increase the gap between supply and demand for raw material
• Production capacity expansion in many parts of the world as a result of the strong demand seen in the past year is higher than shut downs and will at least short term increase raw material demand to levels which are exceeding supply and will push prices to new highs
• In the world of high financial uncertainties with the confidence in the value of money fading the investment and the physical ownership of commodities could and will protect against any monetary losses and the cash price paid now is not important. Hold assets you know is far better than deposing of any cash resources.
The price pessimists:
• Leather demand is fading. Some sectors like the automotive industry are still working order books down, but they will not compensate for the reductions seen in other segments and the replenishment of the orders will decline.
• Fashion and designers have in response to the rising leather prices reduced leather in their product lines. Only the luxury brands still maintain a high level of leather consumption in their collections
• The leather pipeline has shifted stocks form raw to finished and due to the strong performance of retail after the crisis retailers and wholesalers are very well stocked for the coming seasons and will reduce replenishment activities for a while until they have confirmation, that the stocks will be cleared as fast and to the extent of their budgets and expectations.
• High prices for materials have exhausted financial resources of many players. Less financial capacity will convert to lower demand and tighter control of stocks along the pipeline. Nobody buys anything what is not clearly covered by
• Speculative money is leaving the sector. The period of easy money and low interest rates is ending and making raw material and semi-finished product investment less attractive. Payment failures along the pipeline become far more likely. Excessive money will turn into a lack of financial resources and cash is going to rule again.
• The tax investigation in China and the problems of importing hides into the EU for registration issues is reducing demand in particular from traders
• The outlook for the global economy is vulnerable. The debt crisis in Europe is far from over and nobody can estimate the risk which remains in the system. The recovery in the USA is very fragile and China is on one side tightening money supply to curb inflation and on the other side threatened by bad loans from the corporate sector in the books of many major banks
It seems to us that both opinions hold strong arguments and reading one without the other is pretty convincing. We are not willing to take any position yet, but following our worries displayed in the initial section we would rather prefer risk aversion and staying on the sidelines than actually fully betting on price advances too soon.
In the past weeks this was also the general attitude of the buyers. Trading activity was reasonably light and whatever prices reported from somewhere in the world they were steady at best and in most cases even a bit easier. Most suppliers are still reporting comfortable forward sales positions, which makes those who are still holding stocks confident about the value of their positions. So neither those who are sold nor those who have stocks are rushing to sell and take ambitious bids from their clients.
What has been a bit worrying and caught our attention were constant reports from visitors about physical stocks in a number of supplier warehouses in the USA and Europe. Sellers are pretending that all the stocks are sold, but suspicious people are believing that either the hides are not sold or were sold at much higher prices and buyers are now reluctant to accept shipment.
There are some rumours about exporters being in trouble with shipments to China as a consequence of the tax investigation. From unpaid shipments due to disappeared customers, to shipments being stuck for the same reason one gets it all. We tend to believe that there is quite a bit of truth in these stories and those who are involved in the issue will be another party not really interested in seeing prices fall as this would put their contracts into additional danger and reselling could become an expensive adventure.
From the split market we heard negative news. Our Chinese sources report about a sudden drop of interest for drop splits and prices suddenly retreating. As far as fashion and general output is concerned it comes as a surprise to us. It could be just an interim and short term seasonal issue, but we will now watch this market carefully too. Interest for gelatine and collagen related splits remains good which is helping the lime split business.
For the coming weeks the start of the next one is decisive. The market is very sensitive at the moment and finally it seems that the rumours about existing stocks and the lower demand for raw material due to the holidays and the low season will be dominant for the coming trend. Although the discussion about profitability has been a bit in the background in the past weeks, raw material prices still need a further correction to let tanners return to profitable production. We have seen the arguments of the optimists, but for the rest of the summer we believe that buyers will be successful to maintain control of the market. Generally tanners are not interested in any sharp decline of prices but a moderate slide of up to 10% would be pretty much in their interest.
Consequently we cannot trace any upward potential for the coming weeks while the downward potential is depending on the real size of stocks and status of sales combined with the courage, financial strength and confidence sellers can and will have about their chances after mid-August.
So, we still believe that tanners have the market and the situation on their side and for the next weeks sellers will have to take what they get or continue to hold out for better times and an increasing demand from the tanning industry. The next chance they might have towards the end of July when the Asian tanners have to decide on their inventories for September and a round of replenishment could ease the pressure.
