Market Intelligence - 24.07.12
24/07/2012
The financial markets in the past weeks have delivered little news. The European debt crisis is still in the focus of the media and last week the EUR100 billion injection to save the Spanish banks has been the major information supply and catching most of the interest of the public.
However, we are in an election year in the US and slowly but surely the campaigns are starting to gain pace and we have to assume that more of the interest in the coming months will be on who is going to be the next president of the US. Election years have traditionally been years of a strong US dollar and the same is happening in 2012, although possibly for different reasons.
Most people still believe that the outcome of the European debt crisis will be the key to the development of the economy in the coming years. Let’s face it, we are now already in year two or possibly three of Europe struggling to sort out a major economic crisis; the real impact on the global economy has been so little so far. In the meantime most pundits are starting to get a bit more worried but that is mainly because the strong emerging markets such as China and India are showing signs of weakness too. The optimists believe that this is just the process of general consolidation and that growth rates will still be strong enough to pull the global economy through the worst. The pessimists are much more worried and see the future of the global economy, for various reasons, as pretty fragile.
So far the weak performance of the old economies has not had the negative influence we have been expecting for quite some time. In the US we are facing sluggish growth and a weak labour market, Japan has never escaped from deflation and is still struggling to overcome the Fukushima disaster, and Europe is fighting deep economic tensions and the fact that a number of European Union members are actually in a state of bankruptcy. There are no solutions in sight to these problems in any of these regions.
Cheap money and high commodity and energy prices have allowed countries, corporations and individuals in certain of the old economies to build great wealth in the past few years and they are spending as well as the growing class of winners in the emerging markets. In the emerging markets some people have created wealth from low labour costs, protection and the chance to use individual qualifications to profit as economies grew. In total, this is quite a substantial number of people who have become winners. However, in particular in the western world, this trend has created social tensions that could eventually become a problem. Of the normal people in the street who are just generating their income from regular labour, an increasing number have lost jobs and wealth and, even worse, the hope that you can do better eventually by working hard and looking for a career with a rising income as the prize. With less perspective and a rising gap in income and wealth, the social and political problems and the risk for rising instability in the western world are rising.
The hope for further cheap money injections from the central banks to stimulate the economy has brought investors back into the commodity and financial markets. Although they blame geopolitical issues for the rise in oil prices, it seems much more that cheap money is the real trigger and the political situation is more of an excuse. In addition we see also corn and grain prices rising and this means that food prices have a good chance of going up in 2013. And if energy and food prices go up and incomes regionally or globally do not we will face a new set of problems.
So far the price for oil has rebounded by more than 10% from the lows and has totally ignored the cooling economy. Prices for corn and grain are close to their historical highs and the European debt crisis has put the euro back under pressure, falling to levels below $1.22 to the dollar again.
Market intelligence
The leather pipeline is entering the summer mode in Europe and the US. Asia, due to the longer lead times, is already starting its higher production season. At the same time Europe is seeing the seasonal low slaughter numbers while the US is still in the peak season of cattle slaughter.
Looking at the reports of tanners around the globe we still see those supplying the luxury accessory sector as being very busy and already talking about good forecasts for the rest of 2012. Automotive leather tanners are also busy but news of the future in that market is a bit mixed because it depends pretty much who and where you supply. Except for the premium brands, other manufacturers in Europe are facing serious difficulties as can be seen from the problems of the French automakers and also Opel, Ford and Fiat.
The situation in the shoe leather business is a bit mixed but in general rather depressed. The last winter seasons haven’t been good for retail and there are still pretty large stocks of unsold inventories sitting in warehouses around the globe. The shoe business is also regional and certainly sales are much better in the emerging markets than they are in Europe, Japan and the US. This explains why a lot of Asian manufacturers are complaining about export orders and some say business is down by between 5% and 15%. Reports about retail sales of shoes in China are a bit mixed, but represent what you see around the globe. The better and higher-end manufacturers and successful local brands are doing pretty well and are still quite happy about their business. No name manufacturers supplying the average and lower-end retail markets are complaining in China about their sales and many people say that business in this segment is down in double-digit figures.
The upholstery market is still in our opinion the weakest spot and only the higher end is still able to report reasonable sales and results. In the medium and lower end there some tanners might still be selling good quantities, but in general the present profitability in upholstery is the weakest of all the leather segments.
Summarising, we still see growth in production of automotive leather globally and there might also be a rise in the production of top and luxury leathers. What worries us a little in this segment is that despite all the growth and the rising sales, the price for premium calf skins for example has declined in the second quarter. If the growth for top-quality leather is as strong as everybody is saying, then the demand for calfskin should definitely be better. Not only that, with the added value in the premium segment one would have expected prices at least to be steady. But quite the reverse, some of the raw materials are declining in price. It will be pretty interesting to follow this market in the coming months to get a better understanding of how a growth in sales corresponds to the demand for and price of raw materials.
If one looks at the present situation in general the price trend in the market is not really rational. Our regular readers know that we were expecting moderate declines in raw material prices because the leather industry in the majority is not operating profitably. This is nothing new and has been the situation already at least since the end of the first quarter of this year. With low profitability, many tanneries have since decided to switch to a hand-to-mouth purchasing system rather than to run regular supply programmes. The only ones who can be excluded are the large operators running capacities for the large brand names or retailers.
Many explain the stability of the raw material market with a certain reduction of beef production around the globe. We have regions like the US and some parts of Europe where the cattle slaughter this year is down by 3% to 5% versus a year ago. However globally the declines are definitely less than that and consequently one cannot really explain the high price levels from supply reductions only. One can understand this situation with hides that are predominantly preferred by the automotive industry. Automotive tanners are traditionally not very flexible in their raw material use and technical specifications, and keep them pretty tight with the raw material they know best. The growth in automotive leather production has definitely also taken hides away from other segments, but we doubt that this has been enough to change the general balance between supply and demand. There must be more and this is also confirmed if one looks at the balance of production, shipments and sales of raw material from the various regions in this world.
In the market analysis of suppliers, leather demand has not shrunk and consequently a small reduction in supply is the explanation as to why prices have been able to hold so well and why they are convinced that prices will also not have any room to decline. As a matter of fact suppliers from the dominant supply regions have been very successful in the market and they have been able to keep prices significantly higher than for example a year ago. Since buyers have not shown any serious fatigue and high purchases and shipments have never been interrupted, all the market threats such as the customs investigations or the rumblings of the financial markets have been easily handled and never had any serious impact.
Looking at the currency market and realising, that the US dollar has gained versus many other currencies it is even more impressive that prices in US dollar have only made a very moderate correction since their peaks at the end of the first quarter.
This is all history and one has today to watch and analyse what this could mean for the rest of the year. Despite all the negative rumours in expectation for the global economy, prices in the last two weeks have at least been stable and in some cases they were even able to gain a little for selected grades. While this can be explained for example in Europe by the currency market, it is indeed surprising for the US. Converted into other currencies US hides are looking pretty expensive at the moment. However, the packer industry in the US continues to claim to possess a very comfortable forward position and this seems true for the majority when it comes to cured hides. This is again showing some parallels to a year ago when we had a similar situation with a steady and well sold raw material market, but reasonable stocks of wet blue hides. Since tanners in Asia not only prefer raw hides but still see a significant cost difference between their production and the cost of production in the US, it is not a surprise that they are still trying to buy raw material first and are not willing to pay the asking levels for the finished product. It is essential for producers to push the raw material levels as high as possible to obtain adequate prices for the wet blue hides.
If we consider this to be the strategy then we can at least find some kind of an explanation as to why the market is still trading at the levels it is today.
This leads to the next essential question of the analysis. Is the tanning industry in its majority operating profitably at present raw material prices? Or are tanners losing money on their production? Well, the usual story if you ask the tanners is that they are losing money, and if you ask the suppliers they say they don’t believe a word. They believe it is not the raw material price that is too high, the problem is the tanner’s inability to get the right price for the leather to justify the price level for the raw material.
What makes one believe that the tanning industry is not making money is the purchasing pattern. Except for a few big players, tanneries are just buying very short term, mainly only against existing leather orders. The programme of raw material influx against business expectations does not really exist. The main buyers have been wet blue traders who took advantage of the hand to mouth purchasing strategy and the insufficient raw material stocks many tanneries were running. That made wet blue traders profitable because for short term deliveries and smaller quantities with prompt supply they were able to charge prices that left them a decent profit. If one looks at the operations that have been really busy, then very quickly big names of wet blue traders in China, but also in Italy, are mentioned. As poor as the situation for many tanneries might have been recently, most wet blue operations were pretty happy about their business this year and consequently they are today the biggest partners of the beef industry because they have very little interest in any serious price correction for the time being.
Where does this lead us for the future? It is pretty unlikely that without any serious problem deriving from the financial markets the supply side will lose control of the market in the very near future. Again we come back to the statement we have made already a number of times: this is a lot similar to 2011. A clear direction would be to come back from the summer vacation and find that retailers have to put their cards on the table about their expectations for the business in the retail season to come. For us, the automotive industry will have a big impact too as it traditionally reacts pretty late to any variation in demand.
It seems that the hide market is linked to the general situation in commodities. With the cheap money still pouring into the global economy many if not to say almost all commodities have seen sharp rebounds in prices as financial investors put a lot of speculators’ money into the markets of basic commodities. This might not yet directly apply to the raw materials used for leather production but indirectly it seems that players in this market are influenced by the trends in the general markets.
The split market saw some signs of improvement in the past weeks. Splits are still the cheaper alternative to expensive hides and with the hide market being pretty stable a lot of interest has again been redirected to splits. Also the automotive industry is using more splits these days, keeping the demand for splits reasonably steady and production easily absorbed. In addition we can only repeat the strong performance of splits in the production of collagen and gelatine and the added value in this sector and the demand from the food industry are preventing the price for splits from going down.
The market for skins has definitely hit bottom. In particular those markets that had been seriously influenced by the problems of the customs investigations in China seem to have cleared the stocks they had been stuck with after their clients in China where neither willing nor in the position to take the expensive contracts. It seems a lot of money has been lost all over and there might still be a number of sick containers which are sitting in Chinese ports or warehouses. However, this is mainly raw material shipment from questionable sources and origins and the regular suppliers are all reporting slowly but surely a return of interest and prices have definitely stopped falling after the sharp declines that we saw in May and June. It is too soon to say if this is the beginning of a rebound. The only thing one can say is that the gap between bovine prices and ovine prices is far too wide at the moment and will be closed sooner or later.
For the coming weeks we expect that the supply side will continue to dictate the situation. We do not believe that they have the courage to test the market much higher. Some people are still remembering what happened a year ago and so it seems to us that many are pretty happy to put a firm tone into the market, but rather prefer to stay in very narrow trading ranges until the summer ends. A serious interest in any sharp price variation cannot be expected. For the next two weeks we are in the peak vacation period and this also makes us believe that there is not enough activity to justify major changes in the price trend.
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