Market Intelligence - 18.09.12
18/09/2012
The big news over the past two weeks is the approval of the German high court for the EU rescue programmes and the decision from the Federal Reserve in the US for a third quantitative easing (QE) programme there, which will pump up to $85 billion monthly into the US economy in the attempt to stimulate the economy and to support the weak labour market.
There is a tremendous difference in opinions about the decision in the US, while the EU decision was mostly welcomed except by those in Germany who had opposed it. The majority still believes that the established rescue strategies are without any alternatives.
The QE3 programme announced by Federal Reserve chairman, Ben Bernanke, had a more mixed response. While in the US the reactions are more related to the present election campaign and opponents are trying to work out who will benefit the most, experts and analysts are mixed in their conclusions. The main difference of opinion is on whether more money will really leda to more jobs and a recovery of the economy; QE1 and QE2 had none of the desired effects. Investors were celebrating and asset markets started a strong rally right after the publication. The US dollar fell sharply, which might have been a desired side-effect to aid the competitiveness of the US economy.
Will more money really be the solution? Well, investors love it. More money to play with, more ammunition to take onto the financial playgrounds and an easy way to generate profits in the money and financial markets. Short term, you can possibly sell the story and if more money really is a trigger for more investments and consumption then you can be happy about it, but from all the financial stimulus we have seen since the crisis of 2008, very little actually converted into serious economic recovery in the western world. Some say this cash was enough to avoid a second crash, but the best one can say is that the second crash has not happened yet.
Despite the different views one can have on the subject it seems that the balloon is just being inflated further and people wonder when and how to take shelter for when it bursts. For normal people the rise in commodity prices like energy and food means less money. For companies it is similar, because rising costs can be converted into higher prices, and if they are it means inflation. Both options are uninviting.
Another issue of interest are the riots and attacks of western consulates and embassies in many Muslim countries related to the weird video on YouTube. The background of the video is still a bit mysterious, but it shows how sensitive the situation remains in the region and even after the Arab Spring and one can only hope that the riots and attacks spread no further. It would not be good for the needed stability and development of the region.
In the meantime the euro has risen to a level above $1.31 and as the US dollar falls, commodity prices rise. So, the game from the first months of the year is back. Oil is rising although there is no fundamental reason for it to rise except speculation. It is close to levels of $120 per barrel, depending on the type of oil. This is not good news before the winter season starts in the northern hemisphere.
It is going to be interesting to see if the markets believe the European debt crisis to be solved, because only then could the market prices, currency exchange rates and commodity values be justified.
Market intelligence
Owing to our publication schedule we had a week to digest the results and conversations from the long awaited All China Leather Exhibition (ACLE) in Shanghai at the start of September. Including us, there were many people travelling to China with high expectations and awaiting clarity over the question marks that developed over the summer.
Regarding serious new information, ACLE proved disappointing. Although the number of visitors and exhibitors was totally satisfying, there was not very much insightful news. As far as raw materials were concerned suppliers and buyers were just exchanging the same kind of positions they had been taking for quite a long time. In particular the beef industry representatives at the fair were quick to stress that raw material will continue to be in limited supply, supporting the opinion that raw material prices will not come down and the tanning industry should not expect any serious support for calculations deriving from the purchasing side. Most of the leading global raw material suppliers are still playing the supply card and paint a pretty dark picture about cattle slaughter in the medium and long term.
After that, sellers’ positions became clear in the first three hours of the show and it became possible just to wait for the reaction of tanners. The purchasing side was not paralysed. There was enough interest and need to buy raw materials for buyers not just to be able to turn around and walk away to let the sellers sit alone in their booths. Consequently we experienced pretty active traffic in the aisles and pretty busy stands with people talking to each other. The show in Shanghai is traditionally not so much the place to sell leather, except for the domestic Chinese trade. International exhibitors showing leather see ACLE as a place more to present themselves to the market than a serious opportunity to sell leather. Consequently it is a place to meet and chat and if one can return home with a few new business cards and potentials, most objectives are actually covered.
After three days we saw hardly any really disappointed faces. Almost everyone admitted that it had been a busy event and the majority mentioned that there was not enough time to meet and talk to everyone. So far so good: the real pessimists were calmed down and those who expected a sharp decline in leather demand or to learn about serious problems in the leather pipeline has no confirmation. However, the hard-core optimists constantly expecting leather demand to be strong and prices just be driven higher by reduced supplies needed to cool their hopes too and so very little actually changed during the event as far as raw material prices were concerned.
The price variations were minor in the end and no new price trend, which is sometimes triggered at this kind of event, was established. If there was any direction, prices were fractionally lower because sellers were not willing to stimulate more demand by lowering prices; perhaps they did not need to. So officially prices were said to be 1% to 3% down for the main categories. We believe that there have been sales in private a bit further down, but generally public reports spoke of nothing more extended.
It was very difficult to get a clear picture of the situation in the leather markets. There are many different opinions about leather orders that can be expected for the rest of the year, but maybe volume is not the only key problem for many; it is much more about profitability. It is extremely difficult to obtain a clear picture of who is making money and who is not. The tanning industry is famous for complaining all the time anyway, a little less when profits are really healthy and a little more when business results are not satisfactory. At the moment it is very difficult to judge what the position is at this stage.
Most Chinese tanneries are still pretty unclear about the situation for the winter season. Export sales for Asian tanneries are down and the expectations are not high that this will change soon. About domestic business the opinions are different. Some expect the Chinese consumer to be more active when the leadership structure in the government is reorganised and stable after October. A number of people in China expect the new government to start its turn with further stimulation programmes to boost local consumption. This would be good news because domestic sales are lagging behind budgets. From our discussions we feel that this is the current hope driving many producers in their plans for the next season.
This leads us to another result from our Asian trip that we think is worth a mention. We were actually pretty impressed by stocks of semi-fished and finished leather, as well as the finished products we saw in many places. This was not the case everywhere, but in many tanneries, manufacturers and wholesalers volumes of inventories are impressive. This relates mainly to producers who are not related to brands as a fixed part of their (the brands’) supply chain. Leather and product sales in the ‘no-name’ segment and along the wholesale chain in China have been far less than expected and a lot of inventory has been congested in 2012. The above would explain the controversial information we have been receiving for some time. While big players on the supply side and on the demand side report pretty regular business and product flow, the smaller players are obviously being fully hit by the downturn in demand and the underperformance of consumer activity. This applies to exports, but also to domestic sales in China.
Another issue mentioned a number of times during the Asian trip is the influence of the production and retail of wet blue. A lot of people report significant stocks of wet blue being held in China, adding to the stocks people talk about in the US. We have two problems that are related with this business. Firstly, this business absorbs more raw material from the market with high uncertainty about equivalent demand. While some suppliers are playing this strategy to hold raw material prices up, the entire market is being driven by inflated raw material demand to fill beamhouse capacities. Secondly people involved in the business are complaining heavily about the unbalanced demand for wet blue selections. While top-quality material always finds enough demand and low selection can be sold because it is cheap, average selections are difficult to place. They are not good enough to qualify for the high-end market and they are too expensive to qualify for the commodity and mass market.
A number of players we talked to in this field admitted that since the first quarter of 2012 neither demand nor calculations fit. In most cases half or more of the production is being carried into inventory and less than 50 % is actually being sold. What looked not too problematic in spring with hide prices being high and stocks expected to find homes due to the price and supply situation, has now become a serious worry for some because the sales have been missing for some time now and stocks are growing while cash-flow declines fast.
The logic of this business is and was, that either raw material prices will fall and the average price of the stocks adjust accordingly until it is competitive again, or prices of raw material will go up so that inventory value adjusts and built stocks can be sold at a profit. After the rise of prices in the first quarter this year price levels are high and movements since then have been pretty limited. With an extended portion of production stuck in inventory and prices not moving either way, cash-flow is becoming an increasing issue and some of the larger players are starting to worry how the problem can be resolved.
This leads us to another issue mentioned a number of times around many tables. Price! Raw material prices, production costs and the price for finished leather are not in a profitable balance. For many tanneries profitability is a serious issue and results, productivity and production costs offer only a limited chance to improve calculations in the short term. Raw material costs still account for 30%-50 % of the calculation and remain the largest factor, unless the price for the finished product can be improved. The question of how far the price for leather can be increased has been discussed with great emotion. Standard comment from every tanner is that the price for leather cannot be improved and buyers show stubborn resistance to any attempts.
While most of the suppliers are of the opinion that there is enough demand for leather at adequate prices to meet the present raw material levels and to absorb the hides produced, a great part of the tanning industry denies this and is pretending that the consumption of leather is fading from season to season, either due to substitution or due to a reduced use of leather in the finished product. In the market logic, this would eventually reduce the demand for leather and hides until supply outstrips demand and prices fall back.
Recalling the situation of wet blue and leather inventories, the demand may already have fallen with surplus material being parked along the pipeline. The split market is still pretty much driven by the strong demand for collagen products and the shift to more economic material in leather production. Both situations help the demand for splits and this market remains in a fair balance with steady prices and clearance of production. There is little indication that this is going to change soon.
The skins market, which had been depressed for such a long time, has become much more lively in the past weeks. On the international catwalks much more garment leather is being seen, in particular in women’s fashion, so that high-quality lamb nappa might see some increase in demand if retailers follow the trend and put leather garments back into their collections. With the reduced prices of raw material at least the material price will not be prohibitive.
The next weeks will be pretty interesting. It is obvious that we are approaching the next market junction. So far suppliers still control the situation and are making sure that prices remain stable. No matter how good or bad the sales position may be sellers are not willing to let the market slide, except for some minor concessions here and there to keep the flow intact. Whatever doesn’t move is stored away. Suppliers of premium-quality hides are not concerned as they are constantly meeting enough interest for their production.
Now and in the coming weeks the next programmes for leather purchasing will be established. During the winter season the production of upholstery leather normally increases and we have to see if this converts into more demand.
For European suppliers, the recent rise in the value of the euro is a great headache. The currency advanced by almost 8 % over the past four weeks while international hide prices in US dollars have not changed much. Abattoirs in Europe have not taken any notice of the situation and continue to ask same or even more money for their hides. Even if they play it hard and take advantage of the low summer kill and the decent demand from the premium market it will be difficult to sustain the levels reached.
We have to wait and see if the QE3 programme in the US stimulates consumer demand and if the re-organisation in the government of China has a similar effect there, but we don’t expect that consumers in these two big economies will open their wallets too much. The strong rebound of the euro might give the impression that the EU debt crisis is under control, but far from it. The situation is no better and even a strong performer like Germany is seeing growth slow down, with increasing risks for the labour market.
High energy and food prices plus instability in the Middle East are not good news either. All this is not really a solid foundation for a positive mood among international consumers. The beef industry may be able to defend itself against any market pressure. Packers have been extremely smart in handling the situation so far. For the short term it doesn’t seem that they will lose control and change strategy, but we will continue to watch inventories closely as well as the cash-flow situation of the tanneries.
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