Market Intelligence - 12.06.12
12/06/2012
Well, the financial markets are back in the focus again and the past two weeks have been pretty hectic. The EU debt crisis remains the main problem. Poor news from the US economy, which would normally be in the foreground, has been on the sidelines.
China and India are reporting slow growth. India’s economy is growing at the slowest pace since 1999 and the Chinese government has lowered interest rates, which demonstrates concerns about the status of the economy. Where, some months ago, the concern was about inflation, today there is concern about the outlook.
If one considers oil as an indicator, we have seen oil prices plummeting and even a moderate recovery after the Chinese decision on interest rates lasted only a few days before the downward trend took over again. The level of $100 for a barrel of Brent had been the strong defence line many had expected; oil is now trading below this magical mark.
The situation in Europe is seriously deteriorating. The Spanish banking system is now in the limelight and although the government there is trying to get away from European Union controls and support, one has the impression that it will take much longer for the required action to be taken. The European hardliners, under the leadership of Germany’s chancellor, Angela Merkel, are losing strength and are being pressed by other members of the European Union and by public opinion to get away from saving and control of budget deficits to stimulation and tax increases. The first signs of surrender are being seen. We know there is little chance of avoiding it, but in the end, fertilising concrete has never made a green field and has only led to the loss of the cost the fertiliser. You have to prepare the soil for the season, then you have to sow, then you may fertilise and finally you may harvest, if the weather conditions are right. Ask a farmer how it works. Politicians still believe that just buying fertilisers and feeding the system with the last remaining security stocks will stimulate demand and increase returns. And the majority of the public is still happy to believe this because this represents a good outcome for the majority.
The markets are now looking for further monetary easing and have been disappointed that Ben Bernake, the chairman of the US Federal Reserve, has given no indication of further money being pumped into the economy. In Europe, meanwhile, the main players expect another cut of interest rates in July.
The EU problems have been reflected in the currency market were the euro fell to levels just below $1.23 before recovering a bit. When people talk about a ‘weak’ euro today, one has to be surprised that it is still trading well above the start-up level of $1.18 and does not (yet) confirm that the market expects the monetary union to break apart. We will see over the summer what the market opinions are. Economic gurus are offering a wide range of opinions, from four weeks to never, about the collapse of European monetary union, and so far it is only people in the Mediterranean who are pulling their money out of the banks and shifting it abroad.
Market intelligence
Things are not getting any easier in view of the increasing turmoil of the European debt crisis. The main concern in the leather pipeline is how the level of European consumer spending will be affected in the coming seasons. The next question is if any decline can be compensated by growth in emerging markets, provided there is any growth there. This leads finally to the question of how much the rest of the world is going to be influenced by whatever the outcome of the European problems is.
For the time being most players are preparing for the summer break, which means that in Europe factories are going to wind down production pretty soon and from mid-July until the end of August very little production is going to take place. This is the case every year. Company owners and managers have closed the books and finished their production plans already and only those who either need to remain open because they have certain supply commitments or those who need to do maintenance and renovation will refrain from a total shut down.
For the vast majority of the leather producers in Europe the break is coming at exactly the right time and it seems to us that quite a number of companies will use the break to analyse the situation and think about fundamental management decisions for the rest of 2012. Independent of how satisfying the first six months of the current year have been, there is hardly anyone denying that the decisions to be taken this year are much more challenging than before. Everyone is pretty clear that the future of the European Community and the euro will also be pretty decisive for the leather pipeline. As nobody has a crystal ball it is hardly possible to make any forecast and so it is most likely that people will try to develop different scenarios for whatever happens.
For the European tanning industry the situation is a bit easier supply lead times are so much shorter than for the tanning industry in the Far East. Tanners in the Far East have to decide more or less now how they are going to handle their purchasing programmes and shipments for the second half of the year to make sure they have the raw material in the factory on time. European tanners, in contrast, can wait and take decisions eight or 10 weeks later (if they are using European hides) than their colleagues overseas. We assume that tanners in Asia would be extremely pleased if they could also postpone their decisions until the late summer and possibly know a bit better about what to expect for the autumn and winter of 2012. Suppliers are benefiting from this. Knowing that for a number of tanners the inventory situation will not allow too much delay, they are quite comfortably leaning back and wait week by week for those who cannot wait any longer and need to take decisions. Some claim that this is enough to clear their current production and keep them comfortably sold and holding prices steady.
This is the poker game that we have been experiencing for quite some time in this market. Our regular readers know that we consider this to be a pretty challenging game and in view of the global uncertainties, the markets might be much more fragile than many people think today. Who was expecting the collapse of 2008 before August that year? Let’s face it, the current situation in Europe could actually trigger a pretty similar scenario and this one would not come without warning.
As an example we might take the situation in the skin market at the moment. Six weeks ago prices couldn’t rise high enough and all the fundamentals of supply and demand made no one think the decline and steep correction we are seeing now was on the way. We all know it just needs some kind of the interruption in the pipeline flow and the whole situation looks totally different a few weeks later.
What worries us much more than anything else is the news we are receiving from many leather markets around the world. A lot of tanneries are admitting that they can only sell and deliver leather at the moment if they extend credit terms. Open credits, drafts and other kinds of finance have become pretty common again to move material out of the factory. Those who have been in this business a bit longer will remember the disastrous results this can have when demand and cash flow do not improve in the way expected. Suddenly, people realise that turnover was not real, but just generated with a big pile of unpaid invoices.
Reports from China, but also in the Turkish and Russian trade all mention this problem and suppliers, in view of low interest rates, are much too willing to accept these deals. In other parts of the world and in particular in western Europe we learn that payment morals are deteriorating again. Even big brand names are letting their suppliers know that they expect them to accept extended payments by 30 or even 60 days in addition to the original agreements. Looking at the financial results of these companies it is pretty hard to understand why they should have a lack of cash flow to pay their suppliers on time. Either their growth is much bigger that their financial resources or they are just using it as a tool to put more pressure on price negotiations with their suppliers. Whatever it is, it is definitely not good news.
Normally we have a small paragraph dealing with the skin market. We will leave this paragraph out this time and deal with this market in our main section. Most readers will have realised that many origins delivering skins have seen serious set-backs in prices since the end of April. As a result of the customs investigations in China, expectations for demand came to a halt. As a consequence, prices that had been driven far too high on the basis of price speculation started a pretty severe return. We would not say that this is a result of any major change in the supply and demand balance because the fundamentals, that lamb and sheep slaughter around the globe is declining, are unchanged from a few weeks ago. However, the prices paid for raw material were never actually justified by the finished product business and some traders and tanners built up inventories that have become pretty expensive.
It just needed the interruption to shipments and payments as a result of the customs investigation in China to put a number of players in serious trouble. This triggered a reconsidering of the real situation. On the supply side a lot of shipments had been effected on the basis of a certain deposit and against documents before arrival of the goods. Many suppliers ran into trouble with goods on the boat and no customer available to pay and to receive the material. They were hiding away from the authorities or had been put in jail. To make it worse, good volume of spring lamb production in Europe had been piled up for shipment to Asia too. While Turkish and Polish tanners were still fighting in Europe for skins from this season, the thunderstorm was already on its way. Murphy’s Law (that if something can go wrong it probably will) applies – as usual – and at the same time some of the larger double-face tanners in China realised that the orders they had planned and hoped for from Russia, Europe and the US wouldn’t come anywhere close to the volume budgeted and so they pulled out as well. Consequence: the market has gone into freefall and various origins have corrected by about 50% already. We still don’t see any market and demand that could stabilise prices in the coming weeks. It will require some time to regain confidence and to get buyers back into the market.
We may remind everybody at this stage that it is definitely not bad to buy slowly in a falling market and, if the financial resources allow, it has never been bad to own cheap raw material.
Why are we talking about this at this stage? Well, on the condition that prices for skins do not rebound sharply, we have to consider that sooner or later cheap lambskin leather will come to the market. One cannot substitute bovine leather with lamb and sheep in many sectors, but in garment, some women’s shoes and also bag and accessory leather it can be a competitor and depending on the article it could quickly substitute anywhere between 10% and 20% of bovine leather. Even if it doesn’t, it will have an influence on prices in the market. It could reduce demand for bovine leather and price targets of buyers for the coming season and could be the corrective factor many have been waiting for quite some time.
So despite all the talk about lower cattle kill, cash flow problems, and the slowdown in consumer demand as a consequence of the European debt crisis, it is the decline in sheepskin prices that could trigger a price correction for cattle hides. We are aware that this is only one option, but this could happen later in the summer.
The split market continues to feel some of the stalemate we are seeing in the hide market too. However prices are fluctuating very little because the main driver in the market remains the non-leather sector. Gelatine and collagen are independent of the economic problems and are still in decent demand from the food and pharmaceutical industry. The declining soakings during the summer are limiting supply and this is preventing prices from suffering any serious decline so far.
Our regular readers know that we are hoping for a moderate price correction just to get the whole leather pipeline onto safe territory. However, commercial business doesn’t always react in keeping with our vision so we have to continue to deal with the situation. The beef industry continues to defend itself well against any price decline. As long as they can hold on to any surplus produced they may remain in control of the market.
We believe, that it is very important to watch any risk deriving from the financial markets, the cash flow situation and potentially from disappointments in leather orders for the coming seasons. On the positive side there is very little to mention at the moment. We indeed do not have any indication of a collapse, but we would recommend that everyone remain on high alert because of the developments in the financial markets and the unstable outlook for leather demand after the summer.
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