Market Intelligence - 17.04.12
17/04/2012
The last two weeks have been pretty uneventful in the financial markets. Only towards the end of the period did people to start to worry about the trend in the global economy and the fall in stock markets.
In particular news from China has been pretty negative and most of the news from Europe was not particularly inviting. The debt crisis in Europe has become the focus once again and those who thought that the problem would be under control by now had to accept that in particular Spain and Italy remain on the list of great worries. In particular Spain has had to pay more to refinance its debt and many people wonder if sooner or later similar problems could also become a factor in Italy. In the US small signs of recovery can be seen, but many people question the statistical data since we are close to the next presidential election, which has often been a period of sweetened news.
Commodity prices seem still to be pretty much influenced by financial investments and not really by the reflection of supply and demand. In particular one can see this in oil prices, which are stubbornly holding high levels despite the fact that all statistical data is proving that there is rather oversupply than shortage at the moment. Threatening conflict with Iran and optimistic budgets for the growth rates in the emerging markets have lifted the oil price and invited speculators and producers to push prices higher without any real justification.
The political situation in China is also becoming increasingly worrying as there is obvious tension in the leadership of the Communist Party. People are fighting for their positions in the next round of elections. Popular leaders have been jailed and inside mainland China the public has become much more cautious with public statements.
In China the growth rates are still impressive, but are lagging behind expectations. The published growth rate of just above 8% may also be exaggerated. Production figures in many industries for January and February were down and failed to meet forecasts. So far the optimists are relating this to the Chinese New Year break, but a lot of insiders are reporting that domestic demand cannot offset the sharp decline in export orders. One can also sense that the cost of production in China has significantly increased and more and more export business is moving to other countries.
Apart from the pretty sharp correction in stocks, cheap money continues to support many other financial markets. This can be seen particularly in the commodity markets where the access to cheap money is still inflating raw material prices.
There is also pretty worrying news from the shipping business. In particular in Europe we see a large backlog of so-called heavy payload containers and many exporters are reporting that they cannot get equipment and freight space before mid-to-late May and even then a firm booking is not securing the shipment. After the years of high excess of shipping capacity with very low shipping rates, shipping lines have made the decision to cut capacities below demand and have increased freight costs substantially.
The currency market has never been as stable as it has been for almost two months now and most currencies are trading in a narrow band hardly exceeding 3%.
Market intelligence
In the first week of the last period most eyes were focused on the fair in Italy. The Lineapelle exhibition almost directly following the APLF trade show in Hong Kong at the end of March and was expected to give more understanding of fashion trends and the prospects for the luxury industry.
Those who came to Bologna for the sake of collecting information about the situation for luxury accessories and high street leathergoods will not have been disappointed. The stands of the top-end manufacturers for luxury brands were intensively populated and we haven’t met any tanner who has complained about business or the size of their order books. The luxury industry is still expecting a very strong performance for the rest of this year and many are even seeing further growth for a great number of the big brands.
The Italian tanning industry demonstrated once again how creative it is and why it still remains the centre of fashion and creativity. This year there were fireworks of beautiful leathers, fantastic and intense colours as well as creative new ideas. Nobody who loves the material could have been disappointed by what was on display on most of the stands. Those that are possibly not fashion leaders might draw a less enthusiastic conclusion. Standard products and standard articles are having a more and more difficult time at this particular show and even more so in times where price is playing a more and more important role in the discussions.
A few upholstery tanners have been talking more about their problems than about any positive news from their business. The exceptionally high raw material costs, the rising cost of energy, increases for chemicals and the inability to achieve higher prices for finished leather are the main subjects for discussion. Most in this field are also complaining about the problem of getting access to acceptable finance rather than looking towards the future with optimism. Most of them are just working down their order books and are not reporting many new orders from their customers.
Another general subject for discussion was the endless question about the supply shortage. The majority of suppliers are using supply as the main excuse for a sharp rise in raw material prices in the first quarter and their expectation that prices will continue to advance further, albeit at a lower pace than what we have seen so far in 2012. We haven’t met many people who doubt the story of reduced slaughter and consequently less availability of raw material. Even many tanners have already surrendered and are just shrugging their shoulders when it comes to the discussion about raw material supply.
There are a few voices however who are not following the general trend and are at least trying to analyse the situation in a bit more in detail. What everybody has to accept and admit is the fact that the raw material market is not well balanced in the various segments. There is no question that for certain articles, in particular in Europe, the shortage is evident. With a situation that a lot of the preferred hide types are actually going straight from slaughterhouse to the tannery after only a short period of chilling and hardly any stocks being kept, the reduction of cattle slaughter has simply created supply problems, because substitutions are not readily available the next day. With the automotive industry running for the past 15 months at full capacity in the premium sector, there has not been a moment in which to take a breath.
Very high prices for cattle and disappointing sales of beef are also making slaughterhouses struggle for profitability and they simply haven’t been able to get the cattle at the price they needed or they haven’t been able to get the price for the beef required to pay for the cattle. While the supply chain for better-quality central European hides is hardly ever a buffer, the declining slaughter numbers have come absolutely at the wrong time with leather demand from the automotive industry and for the high-quality shoe sector running at full speed for the current season. There might be other supply sectors where similar stories could apply but the real question is if the supply problem is really evident for the whole market and can be generalised for cattle hides on a global scale.
The opinion of the few is indeed a bit different. And indeed they have pretty good arguments based on the kill numbers, sales and shipments, which may not be correct for the purpose of creating price levels; the story of supply shortages has at least to be questioned, they say. Looking at the production numbers, in particular of the main tanning centres in Asia, it has to be noticed that they are running well below the levels of 2011. Considering the declines in slaughter in some countries, one cannot really see a serious shortage that would justify the present price rises. Having said that the ones who are not swallowing the supply story are mentioning too that supply is not equal to production or slaughter.
Supply in the market sense is actually not what is produced by the beef industry, but what is actually offered to the tanning industry. What these people want to say is that they question that all the hides that are produced are actually being brought to market. The opinion is that slaughterhouses have changed their policies from (forward) position before price, to price before (forward) position since the last sharp and short decline of raw material prices in 2008 and 2009. The truth is that in private moments a number of packers admit that they deeply regret their lack of courage and infrastructure, which has made them dump their valuable raw material onto the markets. The short-lived price decline in the last quarter of 2011 makes them believe again that demand and price for leather are far more stable than the leather industry makes out and consequently it is totally wrong to lower prices in times of better supply, but preferable to hold prices and reduce availability to support values.
This kind of strategy is run in various commodity markets and the cheap money policy of the central banks supports the situation too. With the lack of investment alternatives, even niche commodities seem attractive; this would support the theory we mentioned in our last issue, that outside money could have funded the recent price-rise too.
The policy works reasonably well within the seasons. Within the long supply chains production is pretty inelastic and follows the budgets. The 2012 budgets had been optimistic and that kept fundamental demand for raw material high. Tanners on the other hand are limited in their financial resources and saw their profitability rising with the falling raw material prices in the last quarter of 2011, and fading again with rising prices in the first quarter of this year. Some tried to answer by purchasing less raw material at the beginning of the year. Realising that this failed to have the desired effect, they had to step in again and sellers were successful in their bids to hold prices up. Even if there was a temporary decline in interest they were sure that production needs would bring demand back soon enough. Considering that the next real season breaks are set for the summer and early autumn, one has now to analyse if this policy is going to work for the rest of the year.
This brings us to questions about the stability of leather demand. We have indications that the second half may see some slow-down. The global economy is not yet in safe shape. China’s growth is slowing, the US is recovering only slowly and the debt crisis in Europe is back. Energy and food prices are up and all this is bad news for private consumption. Companies such as the premium car manufacturers are still painting a rosy picture of their business and expectations, but we know from past experience that these statements are frequently just public relations and an attempt to impress the competition. The fact is that in various markets around the globe car sales are not meeting expectations and budgets any more and discounts are back to keep sales moving.
In the shoe industry the warm winter in 2011-12 is having it effects and the high prices for leather have increased changes in materials for the coming season. Upholstery is sluggish anyway and at this stage we cannot expect any serious increase in leather and raw material demand for the second half of the year. This raises questions about how raw material sellers and tanners are judging the situation themselves and how they will act over the summer.
Fundamentally a lot looks similar to a year ago. Raw material prices are high, the leather business is slowing down, leather prices have to be negotiated again and the question is if the price level of leather that has to be achieved in view of the raw material prices, higher transportation and production costs will have a further negative effect on leather demand.
The split market is still benefiting from the high price of hides. However, from China people are reporting declining revenues for drop-splits, which is weighing on tanners’ calculations. In Europe we still hear about very strong demand from the collagen industry, and prices for butts, shoulders and bellies are still increasing and have reached almost record levels. This market continues to see high demand, over-capacity in production and decreasing supply for the summer. Consequently we expect the gap between leather-related splits and wet blue splits to widen.
The skin market continues to be a bit mysterious while demand from China diminishes and everyone is waiting for the start of the new season lamb production in Europe. Reports from European skin suppliers suggest strong interest from Poland and partly from Turkey for skins, and prices that are significantly higher than players in the international markets are willing to pay. In general however it is fair to say that demand for skins in general is not meeting the levels of hides. In many of the main sheep producing countries, production and slaughter are down and in particular in China sheep slaughter has declined significantly. Some regions of the Middle East are also reporting shortages due to declining slaughter.
The weeks ahead will bring little change. Suppliers still consider themselves to be in control of the market and they will not change their minds about the value of their raw material. Attempts to drag the market lower will not be considered. The supply story will continue to dominate the market and it will need more weeks of low sales or external factors like the custom investigation in China to change their minds. At the present it seems it will take at least until the summer before anyone has a change of mind. Unless, something serious happens in between. We still have the debt crisis in Europe hanging over the financial markets. Freight space could influence the supply chain or turmoil on the financial or commodity markets could be one of the external factors triggering changes.
This might be a risky game for the longer run, but for the short term the supply side still runs the season and is not willing to consider any longer-term consequences.
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