Market Intelligence - 15.05.12
15/05/2012
The last two weeks have become much more active as far as the general economy is concerned. Elections in Europe have shifted the political centre of the continent further left, which may create a problem for the general strategies that were implemented to combat the debt crisis.
France, one of the biggest European countries, has voted for a socialist president, François Hollande, who has already spoken about higher taxes for the wealthy and for larger companies. As far as his programme is concerned he also favours a reduced austerity programme and more spending for growth. This will be an issue in the relationship with Germany as this doesn’t fit into the ideas and strategy that Germany had in place with the former president,Nicolas Sarkozy.
Growth has become the big word in Europe now. Saving is becoming out of fashion and growth is now the magic word and everybody understands it in a different way and uses their own interpretation. Although it is pretty simple, growth for the sake of consumption and financed by new debts led to the problems we are facing today. The fundamental problems of many economies in Europe are so deep that the simple tools of economic policy will not work anyway.
However, apart from the problems related to the debt crisis in Europe other markets are showing some signs of slowdown. China and India have reported substantially weaker results as far as retail sales and production are concerned and also in the US it seems that the economy is recovering a little, but generally still stuttering.
The commodity markets are starting to reflect these concerns. Investors are still positive about raw materials and commodities, but one has to question the positive statements they are making as possibly just a way of protecting their own positions. We all know that the commodity markets are inflated by the cheap money injected into the global economy after the crisis of 2008. Many people are sitting on investments and positions that are not backed up by any product need. So their intention is definitely not that prices should come down. The futures markets and investors can hold prices for quite a long time, because there is no need to take physical delivery. But the rules of the market will apply here also and so people will become concerned about realising the price projections made to support these investments.
People are talking about corrections and are trying to promote the idea that the decline in price levels will offer the chance for new investments. Very few voices are actually stating that we might see a general correction in raw material prices and the inflated price levels that we have been seeing for some time might be history. Oil prices have come down by almost $20 per barrel from their peak, which is good news for the consumer and for manufacturers.
On the currency market the European debt crisis is leaving its tracks and the euro has lost some of its value and has been trading for the past two weeks at levels below EUR 1.30 against the dollar. The European currency is definitely to be watched carefully in the coming weeks because a lot will depend on the next political developments on the continent.
Market intelligence
The hide market in the past two weeks hasn’t taken much notice of the deteriorating economic conditions or of the general slide of commodity prices and this leads again to questions over how much value we can give to published prices and reports these days.
Not to blame the editors and publishers as they can only write and publish what their sources are telling them and verifying prices is extremely difficult since the quality of information from the buyer’s side is not much better. Reporting and market information have become more and more a tool for interested parties in the trade and with a lot of the bulk leather business benchmarked it is essential for buyers and sellers to set suitable levels.
In addition far more raw control has ended up in the hands of the beef industry and consequently there is less trading. This generally reduces market flexibility and price finding procedures. We have discussed this in various issues and we probably don’t need to go over the point again.
We have been watching with great interest the situation in the leather pipeline. The performance of the emerging markets, the recovery of the old economies, cheap and excessive money supply and the great attraction of commodities in general have stimulated the ambition of the beef industry to increase their returns for their by-products.
The added value for certain consumer products made from leather has made the beef industry ambitious about increasing its share of the final prices. Some big players are of the opinion that their specific raw material is essential for success in the markets. As we know this applies in particular to leathergoods, automotive and products that are sold or marketed by exclusive brand names. The wealthy in particular in China and other emerging markets are brand-conscious and willing to spend in association with the rich in the ‘old economies’.
Exclusive and high-quality materials such as South African hair sheep, French premium calf, Norwegian or Swiss hides, premium deerskins (just to name a few) are hard to substitute and to be able to control their supply is a serious advantage against a possible competitor, something producers have now realised. Consequently these materials have become decoupled from the general market trends and have found their own values and even in more difficult periods their prices have suffered far less than those of the normal alternatives. Pulled by general success, more brands and retailers have been looking at leather as a material in the hope of benefiting in price by reflecting the shine of prestigious products and brands. The fashion for knee-high boots and cold winters had helped as well to keep leather demand and raw material prices high and even average-quality upholstery leather, which had lost some of its image in the old economies, kept moving.
This could have continued if the parameters had been stable. However, a warm winter, slowing general consumer activity and, most importantly, ongoing price pressure for standard consumer products have had a significant negative impact on tanners’ margins and since leather as a material for mainstream products is bringing no reward, the tanning industry has had to absorb most of the rising raw material, energy and production costs. In particular in the coastal regions of China labour cost and the access to labour have become an increasing problem.
A large part of the beef industry has failed to realise that there are different segments of the market, meaning that they are struggling to accept a real and fair value of their raw material. They seem to have formed the opinion that controlling the raw material will produce the ‘right’ price. So big producers from around the globe have been looking jealously at small, quality suppliers. Their ambitions were high, but they were rewarded until the beginning of 2012 with conditions that were pretty favourable. Run by management decisions, price adjustments were only made on the upside. Raw material was made available to the market in the volume requested, but with some tanners hoping for a market correction and running short inventory positions, it was an easy game to control the market price from the supply side with consistent demand throughout the season.
Independent of the question of all tanners paying the same price regardless of their purchasing programmes, the price for a number of types and articles just went just too high. With falling leather demand and leather prices not moving enough, many tanners ran into margin-squeeze and the first victims in Italy and recently also in China have come to light. It is hitting the upholstery tanners most, but it seems slowly also to be moving into the shoe section with orders for many tanners falling way back due to prices and the insufficient sales of shoes last winter. There might be some who say that this is compensated by rising sales in other markets, but we tend not to believe so.
At first glance, customs investigations in China have nothing to do with the demand for leather, but we have to realise that the Chinese authorities have finally and quite successfully for some time closed a loophole for imports that were not only supplying tanners without import licences, but also reducing the cost of raw material for tanners and allowing the production of leather at prices that made it attractive to the Chinese domestic market. With the present situation, quite a large volume of leather production is suddenly getting substantially higher in price. This is hitting many raw materials suppliers who have been focused on this market and one can see already that price pressure is mounting for cows of all kinds and also for the sheepskin market. Hebei is one of the main centres of fell-mongering and nappa production.
If we think about the average saving on imports being $5-$7 per raw hide the difference only for the raw material is already in the region of 10 US cents per square-foot, which needs to be compensated for either by higher leather prices (unlikely at this moment), an adjustment in production costs (unlikely too) or the reduction of raw material costs, which seems to be the only realistic solution in the short term.
Monitoring the raw material markets one also has had to realise over the past weeks that the classic standard items (steers) seem to be hardly affected at this stage and suppliers that are mainly producing these kind of hides have not even recognised the problems in this part of the market. Others are having to face up to the problems directly and those who were dealing with the prosecuted companies and agents in China have had to resell, redirect shipments and contracts and to find new buyers, which in this market is not easy at all.
In Europe too the demand for high-quality hides is still good and is clearing up the production of the beef industry. However, sales for average-quality materials are far from satisfactory and the standard upholstery leathers are the worst performers. The beef industry might still hold contracts to be shipped, but no one believes that it will be enough to hold the market at present price levels into the summer. It is only six weeks until the tanning industry packs up for the summer holidays and it would require compensatory levels of sales and shipments to Asia to clean the summer production up. So, we believe that the price structure we see at the moment in the market will not remain intact and adjustments will need to be made to reflect the real situation in the global tanning and leather markets.
The split market is not being affected by the situation. In particular rising capacities and demand from the collagen and gelatine industries is holding prices high and firm. Demand from leather production is also still decent because many producers (including automotive companies) are using split leather this season to reduce material costs. With production just being stable and no additional volume of splits coming to market, prices remain steady with only some complaints out of China (Hebei province again) that split prices are showing some signs of weakness.
The skin market has entered into troublesome waters. The situation in Hebei province and the traditionally inflated price levels towards spring have had a strong impact on prices and in many markets serious price corrections have already happened. Price adjustments of between 20% and 30% from the peak have already occurred and only spring lambs, which are still in limited supply, were able to escape moderately from the trend. It seems that for the coming weeks there is very little that can actually improve the situation. We are heading into the hot summer season and the nappa business is said to be pretty weak. There might still be some interest for high-quality double-face raw material in Europe, because producers need to buy the premium merchandise now in the hope that demand after the summer for finished product will be good, but this is the usual bet on the future.
We think, that this market has to sort itself out. We have thought for some time already that the raw material market in various segments was not reflecting the present unrealistic valuation of the situation in the majority of the segments in the leather pipeline. Absolute premium and top-quality hides benefit from the strong demand in this segment and nobody can actually argue about the price levels they are obtaining. They can hardly be substituted and their prices are really not a threatening factor for demand. For the mainstream products, the situation is different and in particular for upholstery-related hides and materials for the average-quality section we remain pretty pessimistic. The adjustment is already overdue for a while and we would not be surprised if prices were to correct themselves by between 10% and 15 % in the summer.
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