Market Intelligence—20.03.12
20/03/2012
The past two weeks have been pretty quiet as far as big events in the financial markets are concerned. The rescue programmes for Greece have passed the institutions and the money has been released. This has taken the situation in Greece a bit out of the limelight, but actually the problem remains unresolved. Most pundits expect new problems in Greece towards the end of the year. The problems in other countries remain to be discussed and the euro zone is still far from the final solution for the debt crisis.
The US economy seems to be on a slow track towards recovery. Unemployment is beginning slowly to fall and consumer confidence to rise (recently to a four-year high). We are in the election year and so one has to be a be careful with official statistics.
Commodity prices have stabilised and paused in the continuous rise we had seen for some time. It is pretty difficult to get a fair reading of numbers because it seems that, in many commodity markets, a certain percentage of the price level is just owed to financial investors and not to the physical equation of supply and demand. Many investors are still pouring money into raw materials, because they still bet on an endless hunger for raw material from the emerging markets to keep demand and prices high.
There is a growing number of reports from markets that see consumer demand dwindling and the effects of higher energy costs and food prices on general consumption being constantly discussed. In the western world heating bills for the winter will be sent out soon and could deliver a shock for family budgets.
Interest rates remain low and the national banks continue to flood the markets with cheap money. This has worked well so far and inflation hasn’t been an issue, but the cheap money has pushed up raw material and food prices everywhere and sooner or later we are going to see the effects of this , either in inflation or in the wallet of the consumer. It is hard to believe that a period of cheap and almost unlimited money supply can have no effect on prices and the value of money.
Oil prices have remained on very high levels ($124-128 or $105-110 depending on the figures one follows) and any negative news is totally ignored by the market, while positive or supportive news is quickly snapped up to justify further price increases. The US dollar has been trading in a very narrow band and it seems that the markets are pretty happy with a range between $1.30 and $1.33 to the euro at the moment. The big money hasn’t decided yet which way to go next.
Market intelligence
The last two weeks have seen two completely different trends, perhaps an indication of a general change in the situation in the leather pipeline.
We have been worried for quite some time about the steep rise in raw material prices that began in December even though there seemed to be no real justification for it. We had the supply card played by many and indeed there were some small pockets in the market with, for various reasons, an imbalance of supply and demand. However we never really found any reason why this should have been transferred to the general market. Nevertheless, the prices for almost all types and grades have moved substantially higher without any significant support from the finished leather markets. Everything was explained by lower kills and the endless appetite in the emerging markets for any kind of consumer product. With the market trend, and no better explanation, one had little option but to believe that a decent amount of scepticism remained.
About ten days or so ago the hype suddenly slowed down. At first it seemed that this was the usual break prior to trips to Asia for the APLF exhibition in Hong Kong (March 28-30) but it turned out to be more than that. Renewed customs investigations in China have caused a lot of confusion. Offices of hide agents were visited and price information collected and some tanneries have been investigated about the import prices declared. As usual when such things happen buyers disappear like cockroaches when the light is switched on and they wait until the dust settles. Import costs are rising; people close to the operation are saying the rise may be between $1 and $2 per piece.
A side effect of the situation is that some importers and tanners have totally disappeared and interrupted their operations. This could mean that the payment flow for shipments will be stopped for some time and if containers arrive at the port and the documents are not be paid they could quickly become available for re-sale as we have seen on previous occasions. This is never good for the market. It is certainly too early to judge how big and influential the issue is going to be; travellers this coming week are certain to collect more news.
In Europe the situation is different. The business situation is clearly defined. Automotive is still pretty active and productions are running full. Following recent information from the premium car industry they are also extremely optimistic for the rest of 2012 in particular due to strong demand from the emerging markets. This is a bit in conflict with the information one gets from the market itself where numerous people are talking about stocks of cars in the dealerships and decent discounts on premium models. This might differ from market to market, but at least in China car sales for January 2012 were down by 1.4 %. This was explained by the early Chinese New Year, but the number have to be closely watched, because in Europe car sales are sluggish and wouldn’t compensate for any decline in export.
The other positive sector are premium brand leathergoods and here further news can be obtained in Bologna when Lineapelle opens in early April. The luxury accessory sector may be the strongest and most stable of all.
The shoe sector in Europe has been restructured already. Strong and successful companies are almost the only ones left. They are struggling owing to high raw material prices, but generally their set-up is reasonably safe. This statement holds in spite of one of the larger Spanish companies looking for protection from its creditors. We wouldn’t say that this is representative for the sector.
We observe serious problems in the upholstery business. A larger operator in the North of Italy is said to be facing serious financial issues and some pundits are quite sure that a negative outcome has to be expected. This is not a surprise because upholstery tanners are the ones suffering most from the steep rise in raw material prices. The market for upholstery leather is shrinking in Europe, price pressure remains very high and selling prices have not been sufficient for a long time. In this environment tanners were not even able to buy sufficiently in December when prices saw the last extended correction. They have been caught badly when the market went sharply up and they had to replenish inventories at even less favourable prices.
Independently from the market developments of the past months, one has to be prudent and cautious. Most players imply that rising prices are a synonym for good business and this is also how the beef industry understands the markets. Well, we still believe that one is best advised to think cyclical and in this trade you have to bother more about the pipeline and the future than about the present and the past. We think it is still absolutely essential in the coming weeks to get a serious feeling about the status of the supply pipeline from raw to finished. There might be a few congestion points along the road that aren’t visible at the moment.
It seems that the late winter hasn’t cleaned up as many winter shoes and jackets as retailers wanted. Also the car industry might have more vehicles in the pipeline than they want and in upholstery the demand has never been the way it should have been in the past months.
As far as raw materials are concerned, some of the overhanging inventories have moved along the pipeline, but we fail to believe that they are actually meeting order books. This is not equally true for all markets and enterprises, but there seem to be clusters of inventory at the moment in various markets while stocks are not really high in others (without the leather business being good enough to explain the shortage).
That leads us to the question of how the market could have reached the levels we have seen recently. One theory is that some larger conglomerates and players with access to significant funds, in combination with traders with large resources of their own, decided in a coordinated action at the end of last year to enter the raw material market and to buy excess material to push prices higher and to take a serious long position. In a relatively small market like hides it doesn’t need any excessive amounts of money to do that; hedge funds in other sector would laugh about the investments needed to make this market. If traders and investors take enough excess hides off the market, tanneries and real users of the hides will need to cover themselves and traders won’t need to worry about marketing any more because they will be able to sell whatever they have. The only critical point in this strategy is that cashing in the profit from the speculation still needs an end user of the material who is not just in need to buy but also in the position to pay and this is still related to the finished leather price. At this stage it seems useless to discuss any other reason why the market moved so high and so fast. The coming weeks will definitely offer more ideas and insight into what has happened.
The split market has lost a bit of steam and we have to admit that we are pretty surprised that in particular in China demand and prices for splits have shrunk. With the hide market the way it is, we were quite sure that split prices would still have a positive time ahead. The coming weeks will show if fashion trends are likely to have a negative impact on splits.
The skin market remains pretty steady. In Europe one can still find interest for decoration skins while many are waiting for the start of the new season of lambskins. The upcoming Easter season should increase lamb slaughter and ease some of the supply issues we have seen recently.
Our opinion is that things are working out differently from what most in the leather sector will have planned. The dream of many was that hide prices would just keep moving until APLF in Hong Kong and that everything would be easy and smooth, but there may be some cracks appearing. It is certainly premature to take final decisions but it seems to us that the easy time could be over for some time. We still believe that cash flow issues will be the main factor. The supply card has lost a bit of its shine and it remains to be seen if this is an early correction in the market. People would normally expect such a correction after APLF. Instead, what we are seeing now in advance of the event may just be a triggered break. We would not be surprised to see the market set back for some time.
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