Market Intelligence—20.09.11
20/09/2011
The financial markets are still totally dominated by the European debt crisis and pretty weak economic news from the US. The government there is trying to support the weak labour market with a new stimulation programme. This is going to cost another $450 billion, but most experts are sceptical as to whether it will deliver the results Mr Obama is hoping for.
In Europe the endless discussion on if and how Greece can be rescued does not end. No matter what is decided, the question remains: should the arsonist command the fire brigade? In other words, can the politicians who actually created the mess by running their countries into these problems also be the people to manage the rescue plans properly? This applies not just to the countries in trouble, but also to those who asked to be rescued.
Fundamentally, we are seeing a typical situation: the ones who are drowning really don’t care how and by whom they are rescued.
The situation in Europe is pretty serious. The other members of the euro community can bail Greece out either by issuing euro bonds and accepting full liability or by direct rescue plans. European politicians are scared of the consequences. Most favour postponing the problem in the hope that the austerity programmes will help bring Greece back onto its feet. With the economy shrinking by more than 5% for the past three years, the industrial base almost completely destroyed and the public sector not at all in the position to manage the country properly, it’s hard to believe this is possible.
There is hardly any chance that things are going to get better without very serious and problematic decisions. Greece and possibly also other countries have to question themselves as to how they can become lean and efficient economies again. Politicians do not like to hear that, but an inefficient and corrupt public sector is paralysing society, slowing down growth potentials and scaring away foreign investment that is desperately needed.
In the meantime Italy has to ask China for more assistance in its present difficulties. The Chinese have played smart and indicate cooperation but one knows their tactics. They would rather deal with 27 separate countries than with a block consisting of all them together. So China will play its cards carefully and anyone who believes that it will be an easy white knight will be disappointed.
In the past week stock markets have rebounded a bit from their sharp declines, but confidence is still not back. National banks continue to pour more liquidity into the market, easing some of the short-term pressure. However, we still see little confidence between the private banks and in Europe large amounts of liquidity are still parked with the ECB instead of being lent to colleagues.
Despite the concerns about the global economy, oil prices remain pretty stable. Even with a civil war ending in Libya and the announcement that Libyan oil is going to be supplied to the markets again in about two weeks investors still consider it a good investment and the safe heaven. Gold couldn’t break the magic $2000 mark in the end and is waiting for further news to benefit from being another safe heaven investment.
With the problems in the EU, the euro lost quite a bit of it value and fell to levels around $1.35 before rebounding a bit to finish the period at $1.38.
Market intelligence
It’s already a week since the end of the All China Leather Exhibition in Shanghai. This has offered time enough for us and others to digest and to evaluate the trips to Asia and the meetings held during the show. Anyone expecting magical changes or dramatic conclusions has to be disappointed.
Those who were visiting leather producers around Asia saw a number of tanneries pretty active and busy, but an even bigger number have cut production. This is not just because of a lack of interest for leather but the result of missing profitability. Tanners still see the price for leather to be pretty inflexible and the attempts to raise price levels have not been successful. But at the same time raw material prices are not really coming down sufficiently a lot of producers have decided. It’s much better to do less rather than to lose too much money on production.
Despite the global economic problems, consumer business has not decreased much. The material gap between production six to nine months ago and production in the past quarter had to be filled in one way or another. Looking at new collections, checking what has been displayed at recent consumer product shows one can easily see what has happened. In shoes one can already determine the decisions by watching what has come into the shops for this year’s winter season. Ladies’ boots in the vast majority are no longer knee-high or higher; you see more and more ankle boots suggesting the consumption of less leather. Men’s and boys’ shoes follow the trend; PU materials are making more and more inroads into collections and shops.
In upholstery the lower price section is almost leather-free already and has been substituted by textiles to a great extent. That has kept leather prices pretty much under control.
Even at the recent automotive show in Frankfurt a lot of visitors were reporting more artificial material than ever before. However, the automotive industry remains still a very bright spot in leather production. Car sales from January to August 2011 rose in most major markets significantly and only Japan, with a decline of 28%, could not perform due to the nuclear disaster earlier this year. The order books at all main manufacturers are still very well filled and the wealthy buyers in the emerging markets are supporting the premium car manufacturers in western Europe. More expensive cars are traditionally seeing a high penetration of leather and this is keeping demand for better selections of automotive leather high.
Although premium car manufacturers are still pretty optimistic and expect rising sales for 2012, the dynamic growth of sales is already slowing down. Serious voices are also talking about increasing risk for next year as nobody knows at this stage how the debt crisis and the lingering economic problems in the United States are going to affect consumer spending in the year to come.
The high uncertainty of the economic future hasn’t kept the consumer away from stores so far. In particular big-ticket items are selling much better than one would expect under present circumstances. Increasing wealth is the main reason in the emerging markets. In the old economies where things look pretty grim at the moment it seems that the wealthy consumer is willing to spend rather than hold onto money because he isn’t at all sure where to invest safely or if his money will still buy anything further down the line.
If there is solid consumer spending, it is in China. Tanneries in the mainland are complaining about export business but they are also admitting that local consumption is pleasing them and keeping business up. Those factories that have good domestic sales infrastructure are taking full benefit of local inflation and the rising value of the renminbi. Local prices for leather and consumer goods in China are performing much better than the ambitious price negotiations manufacturers are facing with export customers. The gap between domestic prices and export prices continues to widen and there are a number of players saying that sooner or later export buyers will have to accept massive price increases if they want to be supplied again.
As already described above most retailers who are supplied in big volume from China are at present trying to escape from the price pressure by changing materials or trying to diversify their purchasing activity into other countries. However the alternatives are pretty limited. China still has the most developed manufacturing base and those looking for large quantities and safe infrastructures find it extremely difficult to shift production. In particular in the coastal regions labour costs are rising rapidly and the government is busy closing polluting industries. The answer for some is to move inland, but that is creating other complications and cost-rises too.
Returning to the present situation in the leather pipeline we have to deal every day with the problem of profitability. Raw material costs are traditionally a major factor accounting for anything between 30% to 50% of the total cost. While 2010 for many leather producers was a reasonably successful year based on raw material cost, the first six months of 2011 have been pretty difficult. On average raw material costs have been 20% to 30% higher than in 2010 and with existing leather contracts at fixed prices these increases could not be absorbed. Any price increases for leather have been minimal and have not covered at all the increase in raw material and other production costs.
With the demand for leather still reasonably stable, a rise in automotive leather production compensating for declines in upholstery and steady conditions in side leathers, raw material suppliers had no need to adjust prices significantly. Decline in beef production due to regional and individual problems (climatical issues in Africa, beef demand in Japan) jas kept supply pretty much under control. Further concentration in the global beef industry and an increasing trend for vertical integration has made pricing for raw materials far less elastic than before. The general opinion of raw material suppliers is rather pointed towards controlling supply to manage prices and that has reduced market volatility, but much harder than ever before to let raw material prices adjust to realities.
So far this has been answered by cuts in production at tanneries around the world. This doesn’t apply to the entire quality range of leather production, but in particular to the medium and low-end segment. Tanners have had to decide to cut production rather than run production to the full and lose more money.
This is now at a breakpoint. In a great number of leather producers emergency meetings are being held week by week. Sales people are ordered to raise leather prices and so far they have to report that their customers are either innsisting on contract prices already agreed or not showing any willingness to raise leather prices to any reasonable extent. Production people are ordered to find solutions to use cheaper raw material to meet the same high quality standards of the clients. They have to report that many things are possible but not miracles. The raw material purchasing department is ordered to buy cheaper material.
And so things keep on running. As usual it is going to be the survival of the fittest. Entering now the high production season it means that those who can’t escape from the problem will burn more money than ever before. This is going to have consequences.
The split market has shown some strength again recently. Non-leather demand is rising seasonally and the increase in food prices is supporting split prices as well. As a cheaper alternative and with a certain return of suede in fashion the demand for suitable splits is good for the time being. With tanneries’ output of suitable raw material being limited, prices have been able to maintain their level pretty well and in some cases even to go up.
The lamb and sheepskin market also showed some strength during the Shanghai leather fair. The demand for double-face lambs was pretty good, as seen by the attempt of many suppliers to push prices somewhat higher again. In part this was successful and in particular for those suppliers from the non-US dollar regions the sudden strength of the greenback lifted prices in local currencies. Many buyers, in particular from China, are relating good demand to some late orders for Chinese New Year consumption and sales. Consequently most of the sales were on the basis of pretty quick shipments, arriving by the end of November at the latest. Also the wool market is staying high and seeing shortages. This is a supporting factor to skins.
The coming weeks will obviously continue to see the serious problem of suppliers and the industry having ideas of raw material prices that do not meet. Suppliers believe that there is a general shortage of raw material and consequently it is only a question of time until buyers have to give in and to accept asking prices or close to them. Buyers are presently answering the situation with experiments with alternative and cheaper raw materials. The biggest problem in getting a clear picture of the situation is definitely related to the question of how many stocks are sitting along the supply chain. As a consequence of the high prices, the low profitability and the problems with cash-flow, most tanneries have reduced raw material inventories over the past quarter. This means they can’t stay out of the raw material market for too long and every day somebody turns up to buy something. This makes suppliers pretty confident that for their stocks there is very little market risk. Most leading suppliers are pretending not to have any significant unsold stocks, but we doubt that this is true. Some categories might still be easy sellers, but there are others that are pretty much stuck. There is a wide gap between asking prices and the reported levels and price realities being concluded every day on the market. There are premium products for the high-end market that are still facing more demand than supply, but in the mass-production segment the balance between sold and unsold is definitely not completely healthy.
However, it doesn’t seem that the market is in the position to sort this out. The opinion about the future of the leather business and production between the producers of raw materials and leathers are drifting too far apart. It seems that the market will still need a bit of time to find a solid and acceptable base for both sides.
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