Market Intelligence—24.01.12
24/01/2012
The past two weeks have been pretty active in the financial markets. The markets seem to believe that the EU debt crisis can be handled. Refinancing conditions for Italy and Spain eased considerably with interest rates falling to almost half of the peak levels seen already. On the other hand, there were many EU countries downgraded in their ratings and France lost its top-level rating. For the big problem, Greece, it seems that at least a temporary solution can be found in the financial restructuring that is on its way.
The fight isn’t over yet and the political disputes on how the situation should be handled are becoming more intense. The fundamental conflict remains spending or saving, and here the general conflict of cultures is coming into play, although the real question remains as to how much saving is necessary and how much spending is possible. One thing is obvious: without balanced budgets, political stability in the Eurozone cannot be guaranteed in the long term.
Short-term, the risk remains that the financial system could collapse, but what we consider to be even more dangerous is the high risk of social tension and unrest when unemployment and poverty increase as a result of the crisis. So far things are still under control and if the financial markets gain further confidence, the problems could be overcome and there might be a realistic chance that things are not going to be as bad as most people are expecting.
There is also better news from markets in the United States. The labour market seems to be a fraction better, consumer confidence is rising and the private sector seems to be seeing a little bit of light at the end of the tunnel. The coming month will show if this is a real trend or just a blip. The US is preparing for the next presidential election and this is traditionally a sensitive time for the economy.
At a geopolitical level, the tensions between Iran and the rest of the world could have a massive influence on oil prices. Despite falling demand and an uncertain outlook for the global economy, oil prices remain at pretty high levels and a lot of analysts and forecasters predict that they will rise further because of the risk that shipments from the Persian Gulf could be interrupted by Iran. Actually we are not as pessimistic, because there is no real justification for rising oil prices. It seems rather that price levels are being protected by financial investors and not so much by the markets themselves.
On the currency markets the weak euro has dominated the past fortnight, but the Japanese government is also pretty concerned about the strength of the yen. With the easing situation in Europe, the currency has been able to regain some confidence and after having seen levels close to $1.26 it has been able to recover to levels over $1.29 against the US dollar.
Market intelligence
As we anticipated in the last issue of Market Intelligence, the market has been supply driven over the past two weeks. In general most of the reports and pundits are calling the market conditions pretty firm, but it seems to us that this sentiment is more positive than the actual situation.
Currency played a very important role in many origins. The average European tanner’s prices fell substantially in December in expectation that the global economy would become significantly worse in the first quarter of 2012. These prices were not in line with international market levels and prices for dairy cows in particular fell too much and laid the basis for a sharp recovery in January. We would not call this adjustment in prices a firmer market.
In general we would prefer today to analyse market segments rather than generalise. We still have the situation today in the premium automotive sector that manufacturers need adequate supply to keep the supply chain and the production fed. European leather production is based on constant fresh supply and the regular slaughter periods of low kill are always tricky. This is the situation we see today with the present demand for beef, in particular for premium cuts, not allowing adequate production to satisfy the regular needs of automotive tanners. The situation has also come at the wrong time because we hear from our regular sources that large European slaughterhouse groups are trying desperately and successfully to concentrate and to control more production at the moment.
Limited supply in fewer hands is actually pretty critical for buyers, in particular when their options and alternatives are limited. As a result continental European abattoir prices jumped up sharply in January and in this particular market segment the slaughterhouses are in full control of production and prices.
In the female section the situation is a bit different, but with the same results in the end. As already described above, the situation in the Italian upholstery tanning industry is pretty poor at this moment. Orders are insufficient and margins even worse. Neither is there a good environment for the price of dairy cows in continental Europe. Here the situation is pretty much the opposite: suppliers could find enough homes for their fresh material in November and December and had to reduce prices to levels below those of the international markets. Since it always takes time until production facilities have adjusted and enough salting capacity is arranged, sellers have to bite the bullet for a time and take the fresh hides the market is offering.
The fall of the euro, the reduced kill and a flurry of interest from Asia made this period pretty short-lived and the prices in euros readjusted quickly in the past weeks. We wouldn’t consider this to be a firmer market; in the end only it is only an adequate readjustment to global price levels, which are still set in US dollars.
Some other issues made the market bottom-out and rebound in the early weeks of the new year: the low kill in the southern hemisphere, a certain need for replenishment of hide stocks, adequate price levels to operate profitably and the fundamental ambition of many sellers to regain control of the market after the long descent since the late summer. A combination of the above and a good old tradition of Asian buyers to buy and rising market rather than into a falling market late the base to what we have seen at the start of 2012.
If one looks seriously at the extent of the correction, one can also easily determine that nothing spectacular has really happened. If we ignore some of the weak hands selling before Christmas and look at the prices at which the bulk of the sales are likely to have taken place, the difference with today’s price level is not really significant. After such an extended and long market descent a certain correction and rebound is absolutely nothing unusual.
We still think it’s more interesting to ask at what level raw materials are adequately priced. This is still in close relation to the price of the finished product, in our case leather. If one speaks to shoe manufacturers, upholstery makers and garment designers the impression is clear that for the coming months there is not much room for leather prices to rise. Manufacturers are not arguing about the potential for raw materials to go up in price, they are simply not in a position to follow higher price levels in their calculations for finished product. Brands and retailers are still not willing to risk sales and turnover by chasing more money from their clients. So if leather prices do not adjust to higher levels, raw material prices have to stay with a certain range.
So if we look at the raw material prices we have today we have to assume that so far nothing serious has happened and we are still within price ranges that are adequate for the tanning industry. This is also the reason why quite a number of tanneries have followed the early birds who had the courage to enter the market in December.
The key question is whether the leather industry is willing, and in a position, to let raw material prices climb further. As usual this is a simple question of supply, demand and existing inventories. Inventories—apart from tanners who live on just-in-time supplies—determine most of the market trends. The best indication of inventory levels are shipments. Looking at the available statistics and the information we are getting from our sources, tanners are not really desperate for more raw material and calls for deliveries and openings of letters of credit suggest that tanneries are not really expecting the big wave of leather orders in February or March.
If leather industry figures do not return from the Chinese New Year holiday and find their desks flooded with new leather orders, it is pretty unlikely that the strong production season in the first quarter is under-supplied with raw material. Rather, one has the impression that many tanneries are waiting to hit the bottom and to secure raw material at more adequate price levels than before.
Another worrying factor at the moment is the news about financial problems in the industry. Not that this is any surprise, but when there are serious reports about payment delays and even rumours about companies shutting down, we have to assume that the debt crisis and the bank problems are reaching the industry too. This applies in particular to tanneries in the upholstery sector in Europe, but also in China the access to sufficient cash flow is definitely not as easy as it used to be. Falling property prices absorb a lot of cash that industrial investors have pulled out of their businesses and invested in real estate.
Most of the above is pretty much a general statement about the situation in the raw material market, but the situation in the various sectors and in the related raw materials is definitely different. The premium end will continue to be far less affected as long as the wealthy in this world are still opening their wallets and consuming high-end luxury products. How long this will continue is anybody’s guess.
In the price-sensitive sector the situation is different. Here, leather is just considered to be one of the optional materials. Like we have said in many previous reports, the position of leather is protected by the rising prices of the alternative materials, but in general leather is still far more complicated to manufacturer and artificial products still have an advantage.
This might change one day when leather is finally labelled in all products as a natural material and as such rewarded with a price premium. So far this has been tried and mentioned many times, but seriously it hasn’t really happened. With the general crisis there might be a better chance to do so because at critical times consumers tend to go more for quality, basics and nature, which could lift leather to the next level of valuation if the industry makes the right decisions. However, this is all the long-term trend and is hardly going to affect the price trends in the coming months.
The split market is generally benefiting from the present situation. Manufacturers’ attempts to hold material prices steady make splits in many instances an attractive alternative product. Consequently, the demand for quality splits has been better recently and a number of suppliers report good interest. This might be just in sympathy with the rebound in the hide market, but we would not be surprised if splits have a decent market future in front of them. Rising food prices and better value for splits in this market segment will be supportive too.
The skin market has been a little better too. In particular Chinese buyers returned for lamb and sheepskins. It might be a similar situation to that of the hide market, that it is seasonal buying to secure raw material before it’s too late. With a general reduction of production in the southern hemisphere and the decline of slaughter in China last season, the total number of skins is moderately declining and supportive to the market.
For the coming weeks one can hardly expect any major change in the market situation. The Asian industry is pretty much closed down for the Chinese New Year holiday. The closure time differs. Some will return earlier, others will extend their holiday by a week or so. Generally we can expect production activity to resume at the beginning of February. Generally we have the impression that the industry is covered with raw material for at least until the end of March.
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