Market Intelligence - 06.03.12
06/03/2012
In the past two weeks the subject of interest in the financial world has not changed. The main focus remains on the European debt crisis. Endless discussions about austerity plans, investments, financial aid and so on dominate the daily headlines. It is still the big conflict about how the situation can be handled and whether saving is the issue, or spending.
Whatever the politicians in Brussels finally decide, in the meantime the ECB continues to flood the market with cheap money. Another half a trillion euro have been pumped into the banks and one is really questioning if all this money is needed to save the Euro and the EU community. Most of the money flows directly into government bonds.
There are still a lot of opinions about what is right or wrong. Only time will tell us what the final consequences are as history can’t really help much in this particular case. In any case one still continues to have an odd feeling that boosting the money supply cannot be the solution to the problem.
Also in the USA Mr Bernanke has confirmed that he is going to continue the policy of easy money. We still see economical risks despite some signals of recovery, in particular the labour market of the United States.
The consequence of the above remains the same. The cheap money is used by investors to boost commodity markets and in particular the price for oil continues to be very firm thanks to the tensions between Iran and most of the rest of the world. The physical supply and demand balance does not actually justify the price levels which we have reached in the meantime.
Gold and other precious metals saw a bit of a rollercoaster ride with prices heading higher to almost record levels before seeing a serious correction at the end of last week.
Some people are of the opinion that the Euro was firmer, but we tend to believe it was just the classical deal buying commodities and selling the dollar that made the money.
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At the moment we could actually just stop bothering about the leather pipeline. Everybody is of the same opinion anyway and so why spending any time on analysing it. In the past two weeks raw material prices continue to climb and sellers were dictating the volume and speed of the market trend. Asking prices were hardly negotiable and consequently buyers had to decide if they were accepting or staying out.
There is definitely no discussion that the global slaughter of cattle is lower than what it should be at this time of the year. In some regions we are dealing with climate issues and in others it is just the profitability of beef production which keeps the numbers low. Beef demand is just not good enough to allow all the abattoirs to run at the capacities they would like. This seems to be mainly a problem of price, with live cattle prices being much higher than what can be obtained for peace products in the consumer markets.
With such a big problem in the core business of packing plant, the by-products have a significant importance to the calculation. Being so much in the focus and being the only item with possibly better revenues, beef producers are now razor-sharp and playing the market very well. The numbers one can obtain do not reflect any brilliant business in the volume of hides, but the story of the low kill is driving the market. Sellers control their inventories very efficiently and are smartly filtering into the pipeline only the quantities which are sufficient to keep product moving but not hurting the story of limited supply and shortage of raw material.
With tanners not really having the security stocks they would like, they continue to be easy victims and there is always somebody who needs to buy and has to confirm even for just limited volumes the asking prices which are getting higher week by week.
So in the end sellers are managing the markets very well and to their benefit, and by keeping prices on the move it is almost the perfect world for every producer and every seller.
For the time being a lot of producers are getting support from a number of traders and speculators. Hides and skins are considered to be a shortage product and this means that they are also an interesting investment for people who are not directly and closely linked to production. It is not really an independent enterprise; it is money which is given to people in the business. We are talking mainly about China and we all know that Asians and in particular Chinese are great players in rising markets and love to see their investments gain value.
What is indeed frightening for many of the pundits is the fact that almost everybody seems to know how long the trend is going to persist, when it is going to end and what is going to happen after that. Speaking to most people one gets the same replies: we will see the firm market trend to continue until the leather shows in Hong Kong and Italy, and by mid-April the prices will descend a little. Well, we haven’t really frequently experienced that things exactly happened as the majority expected.
But what are the options? The trend could stop early, the trend could continue and last but it also could just stay as it is. Most of our readers know that we are of the opinion that in the end the cash resources will dictate. Producers of hides and skins and sellers will not stop their ambition to raise prices until they realise that their product will remain unsold. This can either happen by purchasing decisions of the buyers, but also by refusal to honour contracts or by the inability to pay invoices.
The other option is as usual the increase of supply, but except the seasonal slaughter in spring and summer and the United States, there is very little sign of any significant increase in beef consumption. In this respect we also have to think about the influence of rising energy prices. Even then we believe that the economical crisis in Europe is easily compensated by the rising wealth in the emerging markets, and we cannot deny that in those countries higher prices for fuel and energy eat into the disposable income and somewhere else the budgets have to be cut. This can be for expensive food, but definitely also for standard consumer products.
Whatever the final result is going to be, the balance between supply and demand will be achieved eventually. The question is just at what price level. We don’t need to repeat the analysis we had already made numerous times in the past. In the vast majority of leather consumption, prices are a very sensible issue and we continue to believe that the time has not yet come for a serious revaluation of the material price.
Consequently we still believe in our value theory and we have the fundamental impression that with the recent price rises we have seen we are again pretty close to the critical levels which we tested last year. The only differences we have today are higher cost of production of the price for energy and chemicals being higher than a year ago.
Traditionally we are entering with the second quarter, the lower production season in the leather industry. Tanners and manufacturers are starting to produce for the next spring-summer season, which usually consumes less leather then for the autumn-winter collections. Also the upholstery industry is not in the hot season despite the temperatures in summer. So, it is all left to the shining sectors of leather accessories and automotive. With the sharp rise of fuel cost we are not anymore excited about the outlook for expensive and fuel-consuming cars. Car sales in the old economies are pretty flat and even the recovery in the United States can hardly balance the declines we had seen before. So, everything continues to depend on the boom in the emerging markets and here in particular in China. Possibly the high energy prices will pour more money into the Middle East and Russia, but many other markets will suffer rather than gain.
However, the above shows very clearly that one has the option to be either optimistic or pessimistic about the car market.
For the rest it is difficult to make any kind of predictions. The very low interest rates seem to trigger more consumption and the saving rates in many countries (where they are still possible) are declining. The fear of inflation and the almost inexistent returns on saving investments for normal people mean that many people hold onto money which could have less value today. In some countries people would rather spend today before the governments tax the money.
The unknown factor today is the question of how the consumer will react to higher material prices. Retailers say that they know they will immediately buy less. Because they strongly believe that they do literally everything to keep product prices stable and any increased and cost has to be absorbed by either cheaper manufacturing or cheaper materials.
However, this has been possible now for many years thanks to cheap labour and cheap transportation costs which we have seen. One as a result of globalisation, the other as the result of the large expansion of capacity. It doesn’t work so well anymore. Material prices and energy prices are rising and as a consequence, so are production costs. Shipping lines are working hard again to lift transportation charges and one seriously wonders how prices for finished consumer products can remain unchanged later this year. The only option at this moment can only be cheaper material prices and before big retailers and brands are going to surrender, they will do anything to keep their product costs stable. This is in our view not really that good short term potential for higher leather prices and consequently not any serious justification for higher raw material prices.
This will not refrain sellers from asking more money and the timing question of when the market is going to react is something that is the only unknown factor in the business along the leather pipeline.
The split market starts with the usual delay to benefit from the massive increase in raw material prices. Most people are reporting better demand and more manufacturers are again experimenting with cheaper alternatives in their products. So, generally the outlook for split prices remains pretty positive and with their valuation there is still a decent possibility for further price rises.
Skins have never adjusted and so their potential for recovery was not as large as it had been for cattle hides. Prices did also not react very much at the beginning of 2012, but now the situation is changing and in particular the specialty products for high quality lining or double face production are seeing serious jumps and price levels. The situation is pretty much the same as for cattle hides and producers are pushing the by-products pretty successfully higher. Also here the critical price levels are quickly tested and the seasonal slaughter of lambs in Europe in the coming eight to 10 weeks will actually give us an indication of how much the market can really absorb and how much the tanners are willing to pay.
The coming two weeks will actually be pretty much a repetition of the previous months. Sellers will push and prices will go even higher, but we are convinced that the volume of trade will significantly decline. There will be still one or the other victim which has to have short term needs, but fundamentally we think that the real players have covered what they need. If everybody is of the same opinion then sellers will carefully try to push the market higher and get the best prices before the turnaround. Buyers will now slowly reduce their purchasing activity, because they should be convinced, that they will get raw material cheaper in the second quarter.
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