Market Intelligence—21.02.12
21/02/2012
The past two weeks have not delivered too much new information, but nor was there anything to celebrate.
The European debt crisis remains unresolved and the tensions between Greece and the net payers are rising. The next bail-out package is still in doubt and the EU administration is far from happy with what the Greek government is trying to achieve. The markets are quite confident that the situation is going to be settled soon and the next money transfer is going to be released. Well, like everything else it is just a gamble.
As far as general economic data is concerned we see a moderate recovery in the United States with news from the labour market gradually improving. It is definitely still far too early to believe in a strong and sustained recovery, but at least things are not getting worse at the moment. We continue to be worried about the tensions and problems in the Middle East. Civil war is causing a lot of victims and whatever the final result, it is definitely going to destabilise the region. The interests of the west and also of China and Russia are a factor and appear to be in serious conflict. The situation for Israel and the problems with Iran are possibly more serious than people who are far away from this region think today.
For the moment people only see the problem at the gas station with prices for petrol and heating oil rising constantly. At the same time the price for natural gas has been falling and is pretty low, which leaves the impression that the price for oil today is not just the result of physical demand and supply. However it is affecting everybody’s daily life and definitely not positively.
In China inflation is still at pretty high levels and was recorded at more than 4%. It is in particular the basics that are causing headaches and with the announcement that the Chinese government will raise petrol prices by 3% to 3.5%, energy is adding to the sharply rising prices for food. This is going to cause the government renewed problems sooner or later with the poor majority.
The euro still benefits from optimism that the EU crisis is going to be resolved soon and any temporary weakness seen in the past weeks has been wiped away quickly.
Oil and other commodity prices rose further as did most stock markets. Investors are still dealing with excessive cash and are throwing it into the markets wherever short-term gains can be expected. Some say it is another bubble and this might be true.
Market intelligence
Our hope that the market would take a rest and settle a bit was unfortunately not realised. The purchasing frenzy continued and so did the rise of raw material prices over the past two weeks. Sellers remain in total control of the market and their only ambition is to achieve price rises.
Supply remains the determining factor in the market. A lot of the standard raw materials are in short supply and with this situation already going on since mid-December 2011, a lot of the old inventories are being cleared. There are still hides, but as usual in such a market situation it takes a little while for buyers to switch from their favourites to less-appreciated alternatives.
In the meantime we are just seeing a classic bull market. All the different actors are on stage.
On the buying side we have buyers who have to purchase just-in-time and cannot escape from their regular need to replenish. We have tanners who bought right and in time and who see the value of their inventories rising every day, and we have buyers who missed the market and have now to run to get what they need. Finally, we have the ones who will just think that investment in commodities is a good idea at the moment and buy just for the sake of speculation.
On the selling side we have sellers with inventories who will see their values constantly rising, sellers who have not trusted the firm market trend and sold forward, sellers with no material in hand trying to scare customers away with high asking levels and those sellers who would think that such a firm and undersupplied market is a great chance for some.
With such a selection of actors on stage a great drama can be written. In particular because backstage there are still some more characters waiting for their appearance. We have still the banker, the leather buyer and the final consumer waiting for their appearance in act two or three. For the moment however we are sitting in the audience watching to see what the play has to offer us at this stage.
Since the market remains pretty much supply-driven we are all watching for any indication that beef demand and consequently global slaughter might improve shortly. Actually there is very little that could change the trend in the short term. Climactical issues, high prices for milk, insufficient demand for beef and consequently for margins for the slaughter industry are against any short-term increase of cattle slaughter. It seems we have to wait for the second quarter until there is a fair chance that the situation could change.
This is crucial because the leather industry has its peak production period in the first quarter, despite reduced leather demand. This means that at least for another couple of weeks tanners will have to rush to cover their raw material needs. They are still running pretty blind because nobody knows how the situation is going to continue with regard to leather demand and leather prices for the rest of 2012. At the moment they have to buy what they have sold and they have also very little possibility for manoeuvre. Whenever prices are not enough to cover the present raw material prices they have to bite the bullet and take the losses.
What concerns us most at this moment is still the financial side of the business. Cash-flow needs continue to rise and at least in the old economies tanners still have to see their bankers to get their business financed. The strong players may still be able to manage this, but for the vast majority the situation is getting increasingly difficult. We can see that already in numbers. For a long time our sources in Italy have been telling us that the affluent plants are running at scarcely 70% of capacity. Talking to some pundits in the area they say that a number of tannery owners are actually thinking of shutting down. They simply do not see any positive future and before burning any more money they would rather hang on to what they have left.
In that part of the world it is not only the result of the temporary rise in raw material prices, but it is also the consequence of all the tax issues that we have seen in the past 18 months. A lot of the competitiveness in the northern Italian tanning industry was just maintained on reducing costs in keeping tax payments (illegally) low. These opportunities have gone and with the real cost of running a tannery in the EU a lot of mass production cannot continue. From other parts of Europe we hear the same story and that leaves us with the opinion that we are right in front of the next round of restructuring for the industry in this part of the world.
As hard as this may be, we have to accept the fact that there are not enough hides available to supply all the drums looking for them. Apart from the problems of the cost of production, tanneries in Europe are also suffering from the fact that the markets in their part of the world are not expanding and the domestic markets in emerging countries are not only far away, but also more difficult for them to serve than for the local competition.
The main driver behind the firm market at the moment is the domestic demand for leather and leather products in the emerging markets. In mass consumer-product production local players are in the position today to deliver acceptable quality at lower prices for luxury products and only the premium manufacturers in Europe can take advantage. Medium-low-end raw materials are being sucked up by the tanning industry in Asia and, at the top-end, automotive and luxury accessories can still play the game in their European manufacturing plants.
One should not form the impression that this means that all the Asian tanneries are operating profitably and their life is fine. The Asian tanning industry, too, has a lot of operators that are presently writing their calculations with red ink. However, they have more options and better ways of handling the situation it commercially. The threat they are facing is rather from governments and environmental issues. Speculation and mismanagement could be a problem too, but looking at the entire size of the sector out there it is far less a problem, with enough capacity around to balance any failure.
For the time being tanneries in the Far East have market advantages on their side. This is not really a surprise as we all knew where the industry was heading and with the rise of the purchasing power of the Asian consumer the market powers have shifted as well.
Last but not least as the recent rise in the raw material markets also told us, the export business that has been definitely shrinking for the Asian manufacturers has been pretty well compensated for by the rise of local consumption. It might have been difficult for manufacturers to move from only export to domestic, but demand at home has balanced out the decline of the export of leather products.
Reflecting the recent past it is pretty obvious that Asian tanneries have been able to deal with the profitability problem much better than their competition abroad. Many of them have bought well and booked enough raw material when prices were convenient and so they are able today to act according to cost, making it much easier for them to deal with the recent price rises than others. Of course this doesn’t apply to all, but to many.
Now, at the end of February, many are asking if we are going to see the classical market trend with prices rising to a climax until the end of March when the APLF exhibition takes place in Hong Kong and after that the usual decline into the summer. A lot is pointing in this direction, but what scares us a little bit is that if everyone thinks the same, it normally means something different is happening. Consequently one has to deal with the second alternative, which would be that prices are not going to decline into the summer but rather continue their ascent.
Many of our regular readers know, that we see a certain correlation between the price of leather, inflation and the oil price. A lot of the leather alternatives are actually based on oil products and with oil being expensive their prices are rising too. Not at the same speed, sometimes not to the same extent, but fundamentally there is no escape. With oil prices continuing to rise too, with a lot of speculative investment money poured into that market, it seems that some big players and strong hands are already betting on rising prices for leather in the second half of the year and so booking raw material in advance to run from stock.
It is certainly a gamble as it is based not only on the assumption that leather demand will remain good, the EU debt crisis will not spread and damage the global economy, the recovery of the US economy will gain strength and any other global issues like the stability in the Middle East will not harm the situation. However, it is an option and if people feel their money is well invested in raw hides and skins they will just continue. We also see the other side of the coin. Higher oil prices absorb a lot of purchasing power too and people have less money in their pocket to spend on other consumer products.
We don’t think, that raw material purchasing should be a gamble, but cannot deny that it is.
The split market continues to benefit from the situation. Suede is facing a fashion boost too and so are splits in general and are a good option at the moment. From the collagen and gelatine market demand persists too. Tanneries producing splits as a by-product should at least have a bit of relief from that side.
The skins market has also benefited from the general situation. In particular the cold, but late winter this year has cleared up a lot of stocks and poured cash back into the pipeline. Jacket manufacturers and tanners are pretty lucky that things turned out better at the very end of the season. On the other side we have a supply problem in the skins market too. As in the hide market, it is mainly particular items like fine wool or top-quality Nappa skins that are finding very good demand at very high prices. Other grades are actually moving rather more in sympathy and as a substitute than as a consequence of strong demand. Anyway, the supply of lamb and sheepskins is presently not enough to satisfy the interest of the tanning industry and prices are rising too. The new season of double-face lambs is starting soon in Europe and with tanners having only a limited time window to buy them. They also have to buy them pretty much before they know how the customers are going to react for the coming winter season. Generally one has to be pretty optimistic for prices in the coming weeks.
The trend is your friend and we cannot find any reason why suppliers should even think about lowering prices or even holding them steady. Yes, everybody says they would prefer the market to take a breather and to stabilise, but when it comes to day-to-day business every seller will still try to get the best possible. For the time being it seems that there are still enough buyers around who need, or are willing, to follow. By how much and for how long this cycle can be driven we cannot guess. However, it seems that sellers are presently so comfortable that even some weeks of reduced activity would not change much. Most people seem to have decided already how the market is going to develop, at least until APLF in Hong Kong. We can only continue to stress that it is always advisable to look at all options rather than automatically to reach the same conclusion as everybody else does.
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