Macroeconomics

First of all we would like to wish all our readers and friends a very Happy New Year and a lucky hand to manage the challenges of the year ahead!

We had a long break since our last issue and whoever thought that we could start the New Year with a clearer situation on the financial markets, or more stability, was unfortunately wrong. Yes, it has been a bit quieter in the last few weeks, but this is rather owed to the season than to stabilisation in the (EU) markets. 2012 will be a year of elections in many countries in the world and this has also proved to be a difficult time in the past.

The EU debt crisis continues to dominate the market activities and the headlines in the financial media. Greece doesn’t make any progress in managing its debt crisis; Spain had to inform the public that its targets to reduce debts were missed. Just Italy was able to get cheaper money, but the next few weeks with a lot of new refinancing needs of EU countries will show us what the market really thinks.

While the EU crisis remains in focus, issues with debt in other countries are also starting to be a concern. Namely the debt in Japan and the USA are causing concerns and it is openly discussed whether those debts could ever be repaid and how the budgets could ever be brought back into balance.

Consumers are reacting in different ways. In countries which are hit hardest from the crisis (Greece for example) consumption has collapsed, but in many other regions the consumer has decided to spend. In the expectation that governments will (as usual) eventually not see any other option than to increase taxes on income and wealth, they would rather spend their money than save it. With the option of seeing their money either taxed or losing its value, they have decided to please themselves instead of keeping it in such uncertain times. That was good for retail business and strong season shopping, but proves how scared the public is even in better performing countries.

In general we would say that the situation isn’t good, but still much better than the general portrayal in the media. Media and governments are falling over each other to predict difficult times or even catastrophes, but the private sector is much more relaxed about the situation. This might be fatalism or better knowledge, but experience indicated that the public sector hasn’t been able to manage the situation in the past, so it might not be able to do so in the future. One is better advised to take care of his own matters rather than hope for the politicians to handle it. Governments in Europe don’t like to hear that, being busy castrating civil rights and private responsibilities with the argument of the crisis. This is obviously backed by those who depend on the state anyway, but a fatal trend however.

A bit in the background are the tensions between Iran and the rest of the world, which has made oil prices sharply rise again. The end of the war in Libya was supposed to restore more oil supply and ease prices, but the threat to close the street of Hormuz and an oil embargo on Iran has lifted prices sharply again.

This leads to a look at general commodity prices and they have stopped their descent and stabilised or turned around in general. Despite the negative news businesses in general have started to moderate their outlook and many realize, that more than 7 billion people have to cover their basic needs despite the big game played on the financial markets and its uncertain outcome.

The EURO slowed its descent and continues to oscillate around the $1.30 mark. The sentiment for the currency remains entirely pessimistic. Rising oil (commodity prices) and a weak EURO will have a negative effect on the economy eventually with the cost of living, mobility and comfort rising. Fortunately it was a warm winter so far.

Market Intelligence

The moderate market option we had described in the last issue in mid-December turned out to be the right one. A combination of some replenishment buying from Asia and sharply declining slaughter allowed the market to settle and some were even trying to paint a rosy picture with a firmer tone.

To call the market firmer is definitely a bit of a selling strategy rather than describing the facts. The market certainly bottomed towards the end of December and the decline has come to a hold, but to call it firmer just when prices are consolidating on a lower level and settling in a wider range of prices is too optimistic yet. Just because some having sold a bit too cheap and then getting a fraction more to return to market levels doesn’t make a market firm.

However, the bargain hunting time of the Asian tanners to replenish some of their (low) stocks and to secure raw material for their production after the Chinese New Year break has created much more confidence on the supplier side and the low kill in many regions added to their positions. All the sellers who had been willing and able to reach in the weeks during the season reported good and healthy interest.  European sellers also got support from the currency situation and overseas exports were their Christmas present after the EU markets proved to be pretty dull since beginning of December.

Also US suppliers were finally seeing a light at the end of the tunnel and the big packer raw material market also steadied or went up a fraction. A big question mark remains behind the wetblue stocks still being reported from this part of the world. Despite all calming statements from the main producers one has still got the odd feeling that the positions are simply not cleared yet. Apart from tanners just basing their productions on semi-finished material, wetblue sales always need extra demand to justify the extra costs and to satisfy short term or speculative interest or demand. None of the latter we can trace at this stage and it might need a further uptick in demand or a longer period of lower kills to get wetblue medium or higher priced wetblue hides back into play.

Some of the ‘odd and old’ stocks which were sitting in EU warehouses since the summer, however, seem to be cleared now. There are rumours about some Chinese import traders travelling in Europe before Christmas, checking and negotiating on these stocks. At the beginning there were some good bargains to be made, but when sellers realised that there was enough serious interest around, they got more confident about their position and cleared the remaining positions at close or even on market levels. They were also helped by the regular suppliers who were decently cleaned up and not willing to extend position any further.

Fundamentally this has created a solid bottom to the market and a lot of the market concerns have now faded.

The raw material and in particular the hide market react traditionally to sensible and volatile conditions. Sellers traditionally prefer a firmer hide market and while most of the global market control has shifted towards the butchers, this has become even more emphasised in the recent past. Consequently the consolidation and the outlook for lower kills have already turned the sentiment of many raw material suppliers from ‘fear to greed’ again.

Starting a new year it might be worth having a look at how justified and realistic such a sentiment is.

The key question is whether any other fundamentals have changed? Well, from what we can trace and analyse not really. Leather demand is still pretty much the same as before. Retail sales have not been as bad as many predicted, but they are also not as good as to expect any major influence on the raw material demand. Tanners are just replenishing, because the prices have been attractive enough to cover the next period of production without any or too much loss. A sizeable rise in raw material prices (except the specialties) would in our opinion dry up demand quickly again.

Without an uptick in leather demand, i.e. consumer sales, brands and manufacturers have to accept finally that higher leather prices and sustained raw material prices cannot be expected. Again we have to stress, that raw material levels are not ‘cheap’ and consequently inviting for tanners to increase stock levels.

Until the end of the first quarter a lot of trade fairs for all kind of goods made from leather are taking place and will give us a better picture about the situation in the leather market, plans, budgets and calculations of the pipeline. We still believe that the market is solidly bolstered on the downside by reduced supply and by the high oil price. Leather alternatives might still be more attractive for many items, but their advantage is fading after the price correction of raw materials. So, the outlook for leather as far as prices are concerned is less grim than it was mid-2011.

However, it is important again to check what the price structure of the market is.

Except for the luxury section of the market, price is still an issue and to keep sales of consumer products high retailers are still extremely price oriented. There is a clear indication that finished product manufacturers are still checking every option to lower material cost and this means leather substitutions as well as cheaper raw material alternatives. The idea that only supply could save the market and permit a return to higher raw material prices could be pretty risky and optimistic. To challenge the market with higher prices just to learn that prices will not be obtainable could become a dangerous strategy and in our point of view not really advisable at this time of the year. Taking short term hiccups, gain from currency fluctuations is certainly an option, but to bet on sustained and a longer term market rise seems to us at this stage premature.

On the positive side we just have the lower supply and the price for oil. Good, but on the negative side we still have a pretty vulnerable international situation on the financial markets, we could see lower consumption in Europe, credit to run factories and business are as well not safe for 2012 and if late this year the emerging market could also become a victim of the boom and the problems in their export markets cannot be excluded.

Everybody has to make their own decisions, but too much ambition could be critical and 2011 might have been an experience for some.

Much more can’t be said at this early stage of the year and in the coming weeks most of the Asian industries are going to close for their New Year holidays. It seems that most of them have already closed their books for the production needs in February/March and can take a relaxed break before bothering about raw material procurement again early February. We think that only bargains will actually attract them in the weeks to come and they will try to switch from one market to the other following the currency fluctuations and trying to keep prices under control this way.

The activity should now shift back to the other markets. In Europe tanners in their majority will return next week. They had been pretty aggressively pushing prices lower and in many cases they were successful. However, some ideas were too ambitious and so the trading volume in particular for cows was pretty limited. On the other hand sellers will not mind, because the present price levels obtainable in Asia are way better than the prices bid by the Italians since beginning of December. A similar scenario we see now for ox and bulls. The Asian buyers try to avoid US winter hides and with the recent weakness of the EURO a lot of European origins look pretty attractive now for Asian quality tanners in their price quality scenario.

This will disappoint a number of European buyers. When they have to come back to buy and secure their regular supply they will have to accept higher levels. Not really because the market has gone up, but just that the short term weakness as a result of higher kill in November, the concerns about the credit crisis and the upcoming holidays gave them a nice, short and successful window early December to squeeze suppliers down to levels which today will not be accepted anymore. Asian markets remained better and more steady, did not follow the dive and the currency has made a 3-4% difference too. So, the buyers should enjoy what they got in December, but not expect the same for January. This will not be easy to explain, with all fundamental difficulties most of the tanning industry has got in Europe at the moment.

The split market was very quiet during the season. Lime splits were interrupted due to the holidays and wetblue splits were also a bit lacklustre. However, in the past days there is rising indication that demand starts to pick-up and this might be in correlation with what we discussed above. Price is an issue and economical materials are discussed and needed. In particular in China there is a shortage of cheap local alternatives and the reduced tanning has also slowly reduced the supply of splits locally too. We will monitor the situation carefully and watch if this is a trend or a blink, but we would not be surprised to see a brightening situation for splits in particular when hide prices are trying to climb.

The skin market is pretty flat for the time being. This is mainly related to the Chinese market where buyers obviously had built good stocks and gambled on better local supply after the Muslim slaughter festival. This might fade now, also because the numbers had been falling well behind expectations. However, the winter in the Northern hemisphere hasn’t been too cold yet and so the sales of jackets and wool lined boots are not meeting hopes and expectations. Wellington boots were the better deal so far. Skins for decoration and other uses are in better demand than for garment, but we believe that supply is going to be an issue and we think that skins prices have also, after their moderate adjustment in the last quarter, now found a reasonable level. Also the wool market seems to be stable which is a factor for nappa skins.

For the coming weeks we expect the markets to fluctuate in a narrow band. Sellers will definitely test the upside and we can only hope that they will not be too aggressive. As usual this is nice talk, but we know there is no mercy and everybody is afraid to miss something. So, in view of a lower kill and more confidence, it is in the hand of tanners how they decide and what their real needs are going to be until March. We are only 11 weeks away from the HK leather fair which is normally the turning point of a firmer market in the first quarter. If price fluctuations can be limited until then we might have the chance for an easier and more stable year for the leather pipeline.

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