Market Intelligence—18.10.11
18/10/2011
At the moment the financial markets are still not reflecting a clear picture of the economic situation. Fundamentally nothing has change, at least not for the better. The dept crisis is not resolved, the economy in the US is not showing any signs of improvement; Japan is still stuck with the same problems as before and in the meantime we get the impression even from China that the government is starting to worry about being able to sustain the positive run of the past few years. Bank shares need to be supported by official share purchase programmes to destroy fading faith in the Chinese banking system.
Most attention however is still on the debt crisis in Europe. Most politicians around the globe are urging euro-zone countries to solve the problem quickly because they are afraid that a failure in Europe will make their attempts to solve their problems even more unlikely. However, good wishes and advice do not help much and EU politicians would prefer a convincing and realistic rescue plan. They are inventing and opening new rescue programs for Greece and other bankrupt nations, but nobody knows how these are going to be paid for and there is no convincing plan for dealing with the black holes in the problematic countries. Settling a debt and giving guarantees to calm the markets is one thing, but to stop the drain by balancing the budget is another. Income and spending in many countries are still not improving the way they should.
People’s anger is now finding a common target: the power of banks and the ‘turbo-capitalism’ represented by the ultra-rich. Well, a lot has gone wrong over the past years and there is indeed a lot to complain about, but our present crisis has in this respect little do with the problem of rich and poor, and a lot to do with the almost global incompetence of political leaders to find a balance between their promises and their budgets. ‘Deficit spending’ has been the mantra of governments and, as the 2008 crisis revealed, politicians have failed in their money management. The main problem is that there is still no convincing strategy and vision as to how the ‘old economies’ will address the problem of giving people their confidence back, with a job for everybody to make a living, and a better future ahead. For the time being we are seeing the average standard of living rising in the new economies and falling in the old ones. This hits the weaker part of society harder than the stronger, which creates bad feeling and increasing social tensions.
In the past two weeks the market has answered the situation with another roller-coaster ride. Week one saw commodity prices and stock markets falling sharply while week two saw them bouncing back at the same speed and sometimes to a higher level than the fall before. Don’t ask why and what makes investors take these decisions. We can see no change that would justify these moves.
In a similar way the US dollar rose sharply only to fall back; it ended the period back at almost $1.39 to the euro after shooting up to almost $1.31. Oil prices moved in sympathy and fell by more than $10 per barrel only to jump back again. Gold has left the regions of almost $2,000 per ounce and has eased back to levels close to $1,600.
Market intelligence
Most will agree that things have been pretty quiet in the leather pipeline in the past few weeks, but actually a lot has happened.
Since the spring when the raw material market for many products peaked we have been warning that that overpricing of raw materials for leather products would and could harm demand, and that brands would look to synthetic substitutes. Although many are blaming the EU debt crisis and the stuttering US economy for falling demand, products in the shops speak a different language. From upholstery to garments, from shoes to leathergoods everywhere one can see now that leather has been either reduced in the material mix or substituted altogether by artificial, cheaper materials. Also the theory that demand in emerging countries will outpace the possible flat conditions in the old economies has not held up. This is totally independent from the small segment of prestigious, luxury items and high-end automotive, which may be impressive but are not the big consumers of leather and raw material.
After the orders for last season had been fulfilled, production levels started to fall and demand faded. Optimists looked on this as a seasonal issue and were not worried when raw material sales underperformed, believing that tanneries were just trying to hold replenishment back in the hope of squeezing raw material prices down. They did not consider that demand could be an issue even though, despite existing production capacities and relatively low levels of inventories, more raw material was not needed.
What started slowly over the summer became more evident in September and now by beginning of October when the winter production season should be in full swing with strong demands for raw material for the winter, there is not much improvement. This is starting to worry those who thought that it was only a question of time until business would pick up again and the weaker trend of prices would stall.
In addition to the price issue and the question of raw material prices becoming prohibitive for leather consumption, two other problems are adding to the concerns.
We have been trying to explain for a while that the financial situation is a matter for concern. After the sharp rise in raw material costs and the inadequate margin situation in tanneries and manufacturers, cash-flow had to become an issue. Rising prices and quick turn-over quickly become a massive burden when business slows down and expensive raw material inventories can no longer be financed by high production levels and quick shipments. This is the scenario of the last months.
We have seen the bankruptcies in Wenzhou, where the Chinese government had to step in to prevent the problem from spreading too much. Also in Europe more and more people are reporting that payments are not coming in as fast as they should, making it difficult for many companies to feel their financial resources are strong enough and that they can be relaxed about deteriorating business conditions.
In Europe we know that inventories at a retail level are pretty high due to the optimistic outlook for the situation in the first half of 2011. Retail performance hasn’t been very good since June and the warm weather until mid-October has meant not enough people into the shops. If things do not change quickly the winter season will end quickly; only very favourable weather conditions can rescue the season. Then we have to watch what consumers will buy when Christmas shopping; it might be more electronic gadgets again, rather than shoes and furniture.
From the Chinese retail market the news is no longer that positive. This driving force of global consumption is also showing some fatigue and car sales, which were still high over the summer, are slowing down according to people familiar with the situation. More shops are opening still and reports are optimistic but many believe that for the moment business-to-consumer is not showing the performance expected.
While this is mainly a problem for the present and the recent past, we have to deal with timing problems this year too, which will have a temporary effect on the pipeline. The Chinese New Year festival and the Christmas holidays coincide this year, at least as far as raw material flow is concerned. Chinese New Year is in the last week in January 2012, so overseas raw material shipments will slow down from December when the European tanning industry is going to slow down for the Christmas and end-of-year break. This going to slow raw material shipments down for a period of three-to-four weeks if not longer and it would need a substantial upswing in leather orders to prevent tanners from slowing productions down to bring their financials back on track again, giving them a chance to influence raw material prices. We should be realistic. As painful as it might be, it will need a correction of prices to stabilise and encourage leather demand again, whether some producers like it or not.
This leads us to another subject: the structure of and consequences for the supply side. In past years the protein industry has been consolidating and the watchword and for their by-product business has been that size matters: more volume, more market share, more supply control and the big fish wanted to become even bigger fish in a smaller pond. Then the few big fish wanted to control all the small fish. This summer they wanted to use their control for the first time and tried to get the support for some of the big fish on the customer side, some more big fish to control all the small fish and in this way control price levels and movements. In our opinion they made one major mistake: the size of the pond. If we are correct and leather demand is still mainly driven by the price of the material and its alternatives, then the size of the pond is much bigger and the big fish become pretty small fish again. As long as the demand is stable and fluctuates only with seasonal changes the system may work, but with real and fundamental changes the system fails and the markets will just react with delays.
If this theory has some truth in it, we are now at a stage where raw material and leather prices have to find an adequate price level again to be recognised as a material for the coming seasons. Until then price support can most likely only be generated by a decline of supply and by stronger performances of some segments. Only when price levels of raw materials are in balance with the cash-flow resources of the industry will a safe ground be achieved again. There is no fixed scientific level where prices have to be, but we have the impression that at around 10%–15% below present levels a first level of stability could be achieved. However, the time until mid-November will be decisive because it is probably essential that the market display again some trust, which is fading because many people no longer trust the reported prices. If there is always a significant price spread between certain buyers it is getting increasingly difficult to create confidence.
In the meantime it will depend on the development of the financial crisis and how economies digest the social tensions and the endless discussion about the debt crisis, possible next steps, the reactions of governments and banks and the position of the media. What we see today is not really inviting anyone to shop and spend their disposable income unless one expects the money to lose its value or to be taxed away.
Floods in Thailand could have a short-term effect on the market with fewer shipments to that destination and if things get worse, the tanning district in Samutprakarn could be in danger. If the floods reach that area too it would be some weeks before another taker of hides could be found.
The split market is also starting to feel more headwinds. As with hides there are a few niches like heavy material and suede that are doing better. Standard products have a problem with the high uncertainties of the market. Just lime splits for collagen, related to the food and pharmaceutical industries, are still seeing steady demand and interest.
Concerns have also begun to be discussed in the skin market. Reports from Turkey over the past week have mentioned very quiet demand for leather and finished jackets. This might still be related to the warm weather in Russia and could change quickly when the first frost comes and the first snow falls, but time is passing quickly. Top-quality fine wool lambs are still finding buyers and as with cattle hides there are still the high-quality niches that are paying and absorbing certain specific product. But for the average type of skins, concerns are rising. Also from China more voices are heard about falling demand, in particular for nappa skins. The wool market is no longer as hot as it used to be and skin prices have climbed to levels where they seem pretty expensive. We would not be surprised if average-quality skins also saw increasing price pressure and price levels that need correction.
For the coming weeks a lot will depend on the situation in the financial markets. At the end of last week investors gained confidence and oil prices went sharply higher. Possibly they know more already, but for the moment there is still a high risk for the banking system. Whatever the solution for Greece, it will not be the end of the story and consumers across Europe will have to consider the possibility of a flat economy or a recession combined with the influence from the costs of the rescue programmes. The situation in the US is not much better and instead of calm we see more problems and conflicts, which are never good for consumption.
The next important step to value the market and the situation is the Lineapelle fair this week in Bologna where a lot of leather buyers are represented; it will offer a further impression of what they and their suppliers in Europe think about the present situation. Maybe we can get some positive feedback to support the situation. At this stage we are sceptical and expect prices to slide further in the weeks ahead, possibly influenced by local currency situations.
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