Market Intelligence - 30.10.12
30/10/2012
The financial markets are going through a period of good and bad news at the same time. Financial data delivered from the US and China have been a bit of a mixed bag and you may pick whatever suits you for your own expectations.
The US gross domestic product grew at a rate of 2% in the third quarter, which beat expectations and the previous quarter results. However the growth is still not strong enough to show the strength of recovery needed to bring the economy back on track. The housing market delivered somewhat better results and consumer confidence was not too bad either. However, everybody is now waiting for the outcome of the US elections in early November to get a clear picture about what the policy of the White House is going to be in the next presidential term. We still have to wait for another week, but by our next issue we will know who won the race.
In China we have a somewhat similar situation. Retail sales for September have been good showing a 14% increase. Also the purchasing manager index rose to levels just above 49 which was an increase of almost 2 points. However still not enough to get into the 50 range which is normally considered to represent a solid expansion of the economy. The GNP in China is expected to grow and a figure of slightly above 7% whereas 8% is considered to be the level needed to prevent social tensions and to create enough jobs. Also in China we expect the implementation of the new leaders in the coming two weeks, although here the successors are already named and it will take some more time for us to understand how the new leaders are going to act to support the Chinese economy.
In Europe we are still dealing with a number of problems related the debt crisis. Greece is an endless story and although it is politically desired that the country remains a member of the euro zone there is very little improvement really in the economic and debt situation. Spain is also producing pretty bad news and unemployment has gone up to almost 25% and the economy continues to shrink. In Portugal we see more social tension and apart from the discussion about economic policy the threat of serious social conflict is substantially rising. The problems of the European automotive industry will certainly also feature in the general economical future because too many other sectors of the economies are related to this industry in many countries.
The financial markets do not seem to have too much concern about the euro zone and the euro was able to hold its value pretty nicely around the $1.30 mark. With the situation in the US not being brilliant either, neither of the two options is attracting the financial markets at the moment. However, we are convinced that the rest of this year will still deliver sharp moves on the financial markets, possibly including surprises and turbulence too.
Although the global economy is not actually giving an outlook that is too positive, oil prices and other industrial-related commodities are holding their price levels stubbornly high. We consider this to be far more related to the investments of hot money than the result of physical supply and demand and we would not be surprised if these markets offer a number of surprises of their own before the end of the year because they tend to react far more to speculative news than to market facts.
Market intelligence
The past two weeks saw a large discrepancy between the markets in Europe and in Asia. While the leather business in China and other Asian countries continued to be good, Europe was dominated by increasing worries about the general economies and some leather-related industries in particular.
Most of our regular readers will have followed the news about the European car industry and the rising problems in selling enough units to keep the factories busy. A number of brands in the medium- and low-price sector are in serious trouble and losing billions of euros in their production plants scattered over Europe. As a consequence, a lot of factory shutdowns have been announced in the past weeks and many workers are going to lose their jobs.
The premium car industry, in particular the big three brands in Germany, have been trying to convince the public for quite a long time that they are not being hit by the European crisis and their export business is strong enough to keep productions running at full capacity levels. This was a lesson about modern management and investor information. But just a few weeks after everything was presented as being still in the pink, premium producers have also had to admit that business is no longer running at the same speed as before.
Some brands and models still enjoy strong order books, keeping productions intact for the coming months, but there are also quite a number of brands and models that are doing far less well and so all in all even the premium manufacturers have had to announce production cuts and the volume of manufactured cars will substantially decline in the next three to six months. Most people close to the industry do not see any improvement before the second quarter of 2013, but it remains to be seen if the slowdown will have passed by then.
The consequence for the leather industry is a serious downturn in leather requirements, because it’s not only a reduction in production, it is also the reduction of inventory and we know from past experience that the industry is now fighting hard for low inventories at the end of the fiscal year 2012. That means that shipments of leather to the industry, which is running quite a long supply pipeline, have been suddenly revised, creating the now the traditional jam in the supply chain. We understand present leather production is being cut by 20% to 30% to reduce the product flow in the pipeline and to achieve targets are set for the end of the year. Most manufacturers are advising, that the level of production will continue to be reduced until the end of the year and many have already advised that their production year will end with soakings in week 49 or, at latest, week 50. Most likely, production will only resume in the second week of 2013, already indicating a pretty long Christmas break of two and possibly in some cases even four weeks. Although the kill will be reduced in Christmas week, beef production will continue and a lot of the fresh, chilled hide supplies will be interrupted for quite some time
With the strong recovery and even strong performance of many European car manufacturers, the product flow of premium hides used in car leather production has been constant and fluent in recent years. The traditional infrastructure for sorting and warehousing hides had been reduced, with most of the male hides and a good number of the heavy female hides going week by week into the drums of automotive tanners in Europe. Only the medium- and lower-quality end in Europe and the lighter-weight female hides were being salted and prepared for the overseas export. Although a few more hides in 2012 were prepared and considered for markets in Asia because prices were better than the ones to be obtained in Europe, the increase of salting capacity is not enough to meet this sudden requirement of additional infrastructure.
The consequence was, as we saw begin already at Lineapelle in Bologna at the start of October, that processors and slaughterhouses have had to look quickly and seriously at their sorting facilities and whatever they consider cannot be handled or stored in the coming two or three months has to be moved quickly and customers have to be found, in most cases at the cost of lowering the price, in conflict with the general market trend all over. While US and Australian suppliers are still claiming to have strong order books and strong demand from Asian customers, European suppliers have been suddenly confronted with the above situation.
Apart from the problems of capacity and infrastructure in continental Europe, the shift of sales and production of many European hides is not as easy as it seems. Continental European bull hides require totally different technology in tanning and a number of eastern European supply markets have no direct axis to customers in China due to documentation problems. Consequently hides that have become available on the market now are not in immediate and direct competition to the high-priced raw material used by the Asian tanning industry.
This applies not for the regular dairy cows or for standard items from, for example, the UK and Ireland and this is why most of the problem is actually focused on Germany, although obviously spreading from there into other markets too. One may not forget that in the periods of strong demand other origins were able to benefit and to market their product either directly or as a blending material to the automotive tanners in the EU.
Apart from this problem we are hearing also off more and more issues in regard to finance. There is no major bankruptcy, but a lot of tanneries are obviously counting their money to make sure that they can meet their obligations. The long period of high-priced hides and very slim margins is now clearly leaving its mark on the wallets of the tanning industry. Problematic also is that the seasonal rise in demand and turnover is missing in a lot of companies.
While the situation in Europe is pretty grim and far worse than one would expect for this time of the year, the leather business seems to be still reasonably good in Asia. A lot of tanneries are complaining about their export business, but domestic demand is compensating for much of the decline. In addition some of those who are producing for brands cannot just reduce their production and have to run no matter what the raw material cost is at the moment. The small and medium-size tanneries are facing much more serious problems and many of them have finally decided to cut production instead of losing even more money. However, the production in total is still reasonably busy and this can also be seen in the volume of raw material sales from the traditional supply markets.
All the above has actually created two markets, which are presently not really interacting or at least not for a certain part of their production. While prices, under the lead of automotive-related raw materials, are descending in Europe, prices in the US are still pretty firm. The main buyers for the product are complaining about the price and claim not to be able to adjust leather prices on the upside. Who would buy at almost record high prices if they didn’t have to do so?
Despite all the above, we learned in the crisis after 2008 that if prices are low enough tanneries are very willing to shift raw material supply from their preferred items to more attractive ones. Many will remember that the very low prices for extra heavy bulls out of Europe attracted many buyers in Asia to test the raw material and to use it as long as it was cheap enough. Looking at the prices today the gap might not yet really be wide enough to make all the technological effort to use European bulls instead of their American counterparts (yet).
However, something has definitely changed. The market, which has been globally in such narrow price ranges for an extraordinarily long period, has now started to move. The declines in continental Europe in the past three weeks have been greater in their extent than any of the price movements we have seen since April. Global tanners will notice this, and many players will now sit at their desks trying to work out if it is just temporary and a local incident or if it is a real new trend indicator that will lead all cattle hide markets to lower levels.
The more demand-oriented players continue to point at the price of leather manufacturing. Despite all the shortages and high raw material prices, hardly any price concessions have been made triggering higher prices for leather; there has been more consumption of alternative materials instead. They are of the opinion that raw material prices are due to supply shortages, but that this is only temporary and will always be balanced by falling demand for the material and manufacturing capacity, with tanneries closing down to reduce production capacity, bringing raw material demand back into balance.
Their opponents are convinced that supply will be the driving factor and determine the price for the material, because shortage and scarcity leads to exclusivity and will raise the value of the by-product. The forecast for slaughter in many countries due to rising beef prices is pretty grim. A lot of feedlot operations are not replenishing their herds and the kill of beef cattle is predicted to fall in Europe and the US. This is going to reduce medium- and high-quality raw material supply and this is encouraging the slaughterhouses to believe that there is no need for a fall in prices, but quite reverse, in the years to come the average price level is going to increase.
To us there is a bit of truth in both positions and it might only be a question of quality, which we have discussed a number of times already. Where leather is a part of the story and quality of the finished product, price levels and customer attraction remain high and there would be room enough for higher prices. For the segment in which leather is just a preferred material, the situation will be different and the price for the raw material determined by the price for finished leather, which is determined by the substitutes.
One must also not forget that these are all long-term theories and they cannot assist with short-term problems of the raw material trade. In particular sellers must be ready to manage short-term over-supply situations. This means for example that European suppliers have to decide if they are willing and in the position to store raw material as long as needed to wait for short-term adjustments. Financial resources and storage facilities will be definitely part of the management decision. In any case we are entering into a very interesting time in the raw material market.
The split market is still taking full benefit of the high raw material prices that we have seen over the summer and the strong demand from the collagen sector. Split prices have been pretty firm and most suppliers are pretending to be sold out already for the coming months. If raw material prices drop, split prices will soon look expensive, but we are caught in the long lead-times between production and consumption, so that short-term switches between products are hardly possible. So, prices rose in the last two weeks and there is hardly any change to be expected in the near future.
The skin market remains pretty stable. Wool prices have sharply increased in the past weeks and this is offering further support to skin prices. Customers have now taken a break because the Eid al-Adha festival in Muslim communities is taking care of a short-term flood of raw material in the coming weeks. Tanners hope for excessive supply and suppliers being forced to lower prices to move product. This might be true for some of the local material in the region, but will certainly not affect the supply of the premium-quality lambs that are dominating the demand pattern at the moment. So, we might see a similar market situation as for cattle hides. Supply and prices for high-quality material will not be affected too much while the average- and lower-quality products could face more problems. Since prices corrected sharply in the spring, the downward potential for even standard items is not so large.
For the coming weeks we expect tanners to go more into a wait-and-see mode. The recent decline of prices in Europe has shown that raw material costs can definitely go down, although suppliers have given the impression that there will never be a correction in raw material prices again. Tanneries are not making a lot of money at the moment and so they will look for every opportunity to improve their margins. Since most efforts to increase leather prices have been in vain they will most likely now test if they have a serious chance to save on raw material cost. Nobody has got any interest in sharp declines, because this could endanger leather prices and then having a double damaging effect on existing contracts and outstanding price negotiations.
A sharp correction on the downside would definitely endanger a lot of existing contracts and make negotiations increasingly difficult. We are worried about the long break of production around Christmas in Europe and we must not forget that more or less at the same time shipments to Asia will be interrupted because of the Chinese New Year holiday, which next year falls on February 10. More raw material could build up than people have forecast and could become a challenge to warehouses and bank accounts eventually. We expect further headwinds for raw material prices, but do not see any reason for a major correction at the moment.
Share this story:
