Market Intelligence - 04.09.12
04/09/2012
There is no question that the global economy is facing a more gloomy outlook than some month ago. Governments and officials are trying to camouflage the problems so as not to make the situation worse. This is also to do with the political situation in many countries where elections have just taken place or are on the horizon.
On the other hand we are dealing with simple economic issues. The debt crisis in Europe and the economy in the United States are starting to become not only a problem for the regions themselves, but also for the global economy. If there are any countries that are still not touched by the present situation it is the areas that are exporting raw materials. Most resources are still enjoying a pretty high price level, as everyone can see at the gas station, for example.
However the negative effect is definitely wider spread; China is starting to feel a reduction in export orders that cannot be completely compensated for by increasing domestic demand. This is starting to a new discussion about the possible overcapacity in production worldwide. To keep production running raw materials are needed, but finished product prices and manufacturing levels are not increasing at the same level because final consumer demand doesn’t match the existing production.
Simple production demand will not justify the high level of raw material prices we have been seeing. The balance between supply and demand is additionally faked by investors’ money looking for investment opportunities. With manufacturing being reasonably attractive and risky, a lot of the excessive liquidity money is entering the financial markets and we are starting to see similar bubbles to those of some years ago. The quality and the product of investments are different, but the consequences and results are likely to be the same.
Critical political decisions in the past are now adding to the market problems. This can be seen for example in the sector of bio energy with the ‘food or tank’ debate. Since tank has been the more attractive option (financially) in the past few years we have seen farmers producing crops for energy rather than for food. With the massive drought conditions in the US this year, the balance of supply and demand is quickly going to be destroyed and speculative investment will extend price trends.
Consequently the world has to deal presently with rising energy prices plus rising food prices, which is possibly the worst that could happen for the budget of the ordinary family. Although the media is already discussing this as news, we should keep in mind that the real consequence for wallets are always delayed by a couple of months so we have to wait to see if the present prices will remain valid and if we should bother about 2013 or if corrections will take place.
The markets in general seem to believe, that the European debt crisis can’t be too bad. As we indicated a while ago, the value of the Euro can be taken as an indicator of what the markets think about the situation of the European Union. We indicated the possibility that the currency could return back to levels close to $1.28 and we have seen levels of $1.26 at the end of last week. Oil prices have been shaken by the situation in the Middle East and further news about the nuclear programme in Iran, the conflict in Syria plus various tropical storms are keeping prices high independently of the real supply and demand situation. Food and corn prices are setting new records and becoming an increasing worry for farmers.
Market intelligence
Nothing fundamentally has changed in the past two weeks, but the suppliers of hides have seen a few cracks in their pricing strategy. Many of the big suppliers in the main supply regions departed pretty early this year to visit their customers in Asia, in some cases in an effort to be earlier than their competitors to get there, in others in an attempt to gather quicker and earlier information.
The big boys still deny this, but the facts speak for themselves. Although it might be premature to draw any conclusions before the All China Leather Exhibition in Shanghai (September 4-6) has taken place, it is possible to look at a few facts before the show starts.
For the majority of leather production leather prices have not increased to levels that would be needed to justify the present raw material price levels. The tanning industry is trying to escape from the problem by using lower-quality and lower-priced material. The leather business in total is not at the same level as a year ago. The outlook for the global economy is definitely deteriorating. Production and transport costs, related to energy prices, are significantly higher in 2012.
All of the above does not lay a very solid foundation for the raw material market. We know all the arguments about declining supply, rising wealth, rising global population and so on, but in the end this is all nice theory while in practice businesses have to make money to justify their existence and to pay their bills.
We have made our statements already some time ago: we see the real situation in the leather pipeline reflected in the finance and cash flow situations of the companies involved. The worrying fact is that cash flow is getting tighter everywhere . However, banks look at the results of the tanning industry and do not find it in many cases too inviting for extending credit lines or even to hold them steady. This is not only the case in the problematic countries like southern Europe for example, but also in China it is becoming obvious that money is becoming an issue for many.
If cash flow is going to be restricted or even interrupted, it would have serious consequences for raw material prices and this is something we have seen already a number of times before. So far everybody wants to prevent quick and sharp price corrections because they are not in the interest of anyone. The big suppliers of raw material around the globe have taken over the function of controlling the price developments and so many have realised there is a need for some kind of a moderate correction phase. A number of prices have started a moderate decline and only some specific items are still stubbornly resisting the trend.
The important issue of the moment is to keep any market movement moderate, limited and under control. Suppliers are not too worried because they have seen every sharp decline in prices (2008, the end of 2011) quickly answered by a strong rebound. From this experience they are totally convinced that there is no need for fear and panic now and so they are taking the present situation easy, holding prices for the public reasonably steady and moving product discreetly behind the curtains at moderately discounted levels.
There is a lot of sense in this policy and as long as sellers as a group and buyers as a group can handle it this way the only discussion has to be made about how far this correction can and has to go. As usual it is not easy for suppliers and customers to reach agreement on this question, however, the good intentions are definitely there. As we stated above we see the main risk for this policy in the cash flow situation.
Apart from this big picture, people are discussing at the moment the potential effects of the drought conditions in the United States and parts of Europe. General consensus has been for quite some time that cattle kill will be restricted due to insufficient beef demand. Nobody knows what rising feed prices and the decisions of the farmers trying to deal with the situation will mean for the kill in the end. For the moment the numbers are rising and many believe that farmers will continue to reduce their herds and not replenish. This could become a supply issue in 2013. For the short term however it could mean that the balance of supply and demand could be seriously disturbed and if supply outpaces demand in the coming months we will see how serious suppliers are about holding product until the kill goes into decline again.
Since we do not expect the demand for raw material to increase seriously, any excessive supply would need serious management as far as warehousing, quality and finance is concerned. This situation is mainly related to medium- and higher-quality hides and does not apply to all supply segments. If the premium car industry continues its current performance and if luxury items continue to be what wealthy consumers in emerging markets want to buy, it will not touch the premium sector of hide supply. For the short term it might only be a problem for the overvalued raw material origins and we could even see a shift from the more expensive to the cheaper and this could mean that what is a problem for central European and US hides could become a positive for cheaper raw material origins.
Anyway, the above shows us how excited most people are now about going to Shanghai to meet suppliers and customers in one spot and in a radius of a few hundred metres. People will be able to exchange opinions, facts, theories and information even quicker than on the internet. As usual the most important thing will be to read between the lines; we believe that this year it will be even more difficult to obtain real facts. The leather pipeline is like many other businesses at the moment, much more interest-driven than fact-driven.
The split market is feeling the changes. Strong demand for protein collagen and gelatine is becoming more and more a factor for this by-product of the tanning sector. For many tanneries the return from non-leather segments is constantly getting better and more and more splits are finding their way into these markets. Due to the trend to use more economic raw materials, the demand for semi-finished splits in the leather industry is expected to rise again. Consequently the outlook for the split market is certainly more positive than for full hides. If leather production suffers due to lower demand the situation could be even more pronounced. Before drawing any final conclusions we would like to see what the trends in fashion and articles for the coming seasons is going to be.
The skins market remains in critical condition. It had bottomed out, but it doesn’t seem we are over the cliff yet. The kill has been lower in the summer, which has helped. Some markets were not burdened like China with high-priced skins from the first quarter so they took the chance to replenish after a gap, but China is still the main factor in this market and it is not showing any serious improvement in business. The wool market is not reflecting this, except for the really fine, top-quality wools. Standard quality lamb and sheepskins, despite their attractive price levels, are not yet seeing any strong or regular business conditions yet. Here too the trends directions will have an effect. Fundamentally the outlook for skins is not negative.
The next week will be focused on impressions from the fair in Shanghai. We are far less interested in what people call business, but much more in the general information one can obtain at these events. What is the future trend of articles and materials? Will leather be substituted more frequently? What is the cash flow situation in the industry? What is the inventory situation in raw, semi-finished and finished products along the production chain? Will the trend of the re-location to areas for cheaper production continue? And will we see a return of production to Europe for example, to create jobs and to save on transportations costs? Will we see unexpected changes on the supply side? These and many more are the real questions to which we hope to find answers.
As far as prices are concerned we do not believe that buyers will become so desperate next week for raw material that the present levels will change.
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