Macroeconomics

No matter what the real situation is, the financial markets are considering that the global crisis is easing and the risk for the economy is starting to decline. General economic indicators from Europe and the United States have been showing better than expected data and the start of 2012 is substantially better than it was in the last quarter of 2011. In particular the US economy is sending small signs of improvement with a reasonable labour market and rising consumer confidence.

Stock markets are rising and in particular bank stocks in Europe have made sharp gains, because investors see the risk of failure diminishing. However, looking at things in a little bit more detail the situation can definitely not be generalised. While in particular Germany is producing almost only positive data, the countries in crisis are still a matter of concern. Access to credits is becoming a substantial problem on a corporate level and a lot of companies mainly in Southern Europe are complaining that their financing with banks is facing significant restrictions.

However all financial markets are showing positive results in the first month of the New Year. Stock markets, commodities and other investments have been extremely profitable so far. Interest rates remain very low and there is no indication that access to cheap money will be a problem in the near future. This is good news for financial investors and should be good news for companies too, but that doesn’t seem to be actually helping entrepreneurs in many countries much. Access to credit is a problem with banks not willing to, or in a position to, lend. Despite all the pretending news that there is no credit crunch in Europe, many companies complain that getting the finance needed is a torture presently. This is supporting again all those who believe that the crisis is just helping investors and not producers and unproductive capital investment is more rewarded in actual hard work. Although this is pretty philosophical it is one of the key issues which has to be sold to the public. Without the support and understanding of the people on the streets it will be very difficult to handle the situation as such, to avoid social debates and political swings which will not be helpful in the long run.

With the hope for a settlement of the Greek debt crisis the Euro was able to rebound sharply and gained almost six cents against the USD just in a few days. Oil prices remain stapled around the USD 100 level for WTI or USD 110 for Brent which is hardly justified by the hard facts of physical supply and demand, but more the result of investor actions.

Market Intelligence

The past two weeks have been dominated by the supply situation. Sellers play a smart game and use sectorial shortages as the justification for a general statement of supply shortages. Well, presently they have the arguments on their side when we only see the present balance between supply (beef consumption) and demand (leather production).

Consequently sellers were taking their chances again and pushed asking and selling prices higher again. With the daily reports stating every day a firm market with rising price, one got the impression that hide prices had gone up by dollar a day and this for the past three weeks would make it USD 15.00 or 20% based on five working days a week. We are still far away from that and might have had a rise of USD 5-7.00 or 8-10% for the main and global standard hides which is still a lot, but so far not more than a rebound after the decline of the last quarter 2011.

So the reductions of slaughter which we see around the globe certainly are not producing enough raw material to satisfy all the existing production capacities for leather. Tanning capacities which are depending on just-in-time deliveries are certainly feeling the situation and have to run to get their drums filled and this leaves the impression of more demand than we actually can see in the whole picture.

In the end it doesn’t really matter who is right or wrong for the daily decision. Prices in January have gone up and tanners can chose today from a large and extended offer list every day. Consequently, those who have played the market for too long and still bet on further declines have lost this match and now have to pay for their short term needs whatever the offer is.

Since we are not so much interested in the moment and our regular readers know that we would rather look for the general trends, it is far more interesting to us to check if we are in a trend or just in a market correction. Although we have been recognising correctly for a while that supply issues will overtake the market, we did not believe that the demand would be strong enough to allow prices to bounce back the way they did. A lot of factors got together and in particular the lower kill, but also the rising willingness of beef producers to manage their inventories with more risk and intention than before. After the long market slide the big players in the supply market realised that it was time to use their market share to limit visible supply. Timing was perfect with tanners needing to replenish inventories, prices having reached workable levels for the tanning industry and the global weakness of beef demand paired with negative margins in beef production made supply not a threat to positions for the first quarter.

Consequently they were able to turn the market around and with the limited supply it was not a risk to play with the existing stocks. Most people today believe in the general shortage of material story; we don’t. The situation is more differentiated than before and everybody takes what suits.

Following our market observation, we see market reports which convert segmented situations into general market trends and indeed suppliers are today using the strong performance of some categories for the justification of the pricing for all. This works up to a certain point, but we don’t believe it will work in the long run and the market has to deliver more new facts to know what the final consequences are going to be.

The market for quality hides remains strong and the constant demand from the automotive and luxury accessory sector keeps demand higher than the present supply. Consequently prices rise and this is also justified with the extended added-value the final products offer. It is only if the big brands are willing to share the value with their suppliers, otherwise it would not help the tanneries much. However, fundamentally prices could still rise; this might cause a serious problem of profitability, but not a serious problem of valuation.

In the medium and lower end of the quality line the situation is totally different. Price is the issue and retailers are still setting fixed price levels which have to be met. Also the ever repeated argument of rising purchasing power and wealth in the emerging markets has not moved material prices any higher yet, but producers and retailers have adapted material and designs to meet their price and cost targets. As a result raw material prices have had to correct after the boom of the first half of 2011. If the trade and sellers play the same game this year we might see in the end a similar scenario.

Markets go up and markets go down. That is nothing unusual. We should however, remember that this market has some specialities which make the logics a bit different. Firstly, the producing and consuming industries have no direct relation and the raw material is still just a by-product of beef production. We have so far never seen price levels yet which would actually tempt a farmer or a butcher to kill an animal for the sake of the skin. The price barrier is extremely high. So, supply is inelastic to demand variation and follows just and only the demand and the production of beef.

Secondly, the market is still almost free from investors. Almost all commodity markets today are facing investment money in the game which is not related to the industries themselves. So, the trade gambles and speculates almost entirely in itself and follows so much more the logics of pricing as a result of valuation.

The statement that no investor money is involved might not be fully correct. In particular in China a number of import traders are involved into the business and they are taking positions. They sometimes hold also purchasing organisations in various origins which buy locally and feed the system. Hides are turned into wetblue held in stock and money can only be made when the market moves and in this business concept, only when the market goes higher.

With reduced supply, tanners in need of replenishment and excessive volumes were taken control of by traders or held back by the big players. Suddenly the desired effect took place. The market moved higher. So far, so good and that’s where we stand today, with 5-10 % higher prices.

How sustainable is this trend? It all depends on how many people are willing to bet on further price rises and how many have actually no time to wait. It doesn’t need much at this stage to support the general optimism. While this may help for the short term it might be a problem on the longer run. Why do we believe so? Our main concern was and still is the financial side of the business. No matter how positive people may be, the delays of payments are more than evident. The biggest problem might be the upholstery tanners in Italy at the moment. Nobody wants to risk and to ask for problems, but delays of 30-45 days on open credits are common. The European debt crisis is there and not just in the papers and the news. Banks at least in Southern Europe are not in the position to lend the money the companies require. Higher prices, poor profitability and slow businesses quickly become pretty poisonous. It might be only parts of Italy today, but other parts of Europe are infected too. The epicentre of the tanning industry is in the Far East, but a bit here and a bit there can add to something meaningful too mainly because we hear also still about delays for L/Cs and deposits from China too.

Many may wipe these concerns away and a firmer market seems to many sellers a better insurance than a weaker or steady one, but normally the bill is getting bigger. We had these concerns last summer and the market reacted and we have the same concerns today with the only difference that today prices are still well below the peaks seen last year.

So, as long as the firmer prices over the past weeks are just a normal reaction on the constant decline, we are not at all worried and the market will just tranquilise again. If, however, the interested parties push prices higher, we are concerned. The logic is simple again. No higher leather prices, no higher raw material prices. The suppliers may try to hide more hides away, they might park them in wetblue state with the excuse that this will add value to them, they might find people with money who are betting on the strong performance of this commodity in sympathy with many other commodities, but in the end the consumer has to pay for it and the retailers have to ask for it. This is a rather seasonal question and not the trade of the day.

The split market still benefits from the firmer trend of prices for hides. The economical alternative. The collagen sector is also constantly demanding more supply which supports prices for splits and by-products as well. So, the market isn’t booming, but at least we see moderate price increases and constant demand. So, we believe that the split market will have a solid basis at the moment and possibly even some upside potential in it.

The skin market is reasonably steady. Top quality skins are in a similar situation as their counterparts in the bovine section. Supply isn’t enough at the moment and the added value is still big. The late arrival of the very cold winter in Europe has in the end brought some movement of the sales of leather jackets and winter (lining) shoes. This will not save the entire season, but at least it has made some stocks move and in Eastern Europe it has increased the turnover of jackets and eased a bit of the cash flow problems of suppliers in China and Turkey. We may not forget that a lot of payments are still made when the jackets are sold and this only money the spills into the supply chain. So, some of the worries around about the performance of the skin market were wiped away and we would call the market now safe and steady.

The coming weeks will certainly pretty decisive. If the providers of raw material can maintain control of the market by finding enough victims to push asking prices higher, this could mean something for the rest of the first quarter. The consequences and the long term risk we have explained above. We have a lot of leather being eliminated as a consequence of last year’s boom and we would not be surprised to see the same in 2012. We saw the weakest players give up and close.

Prices don’t change in a market like this from a week to the next, but the frenzy will run out of steam and prices will settle. We actually favour and believe in this option rather than in a repetition of last year’s market trends.

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