Market Intelligence - 13.11.12
13/11/2012
The financial markets were quiet until the result of the US presidential election came in. Every 20 years the Chinese Communist Party changes leaders at the same time the US president is elected. These two events have dominated politics and the economy and everybody was waiting for the results and for the initial speeches of the new Chinese leaders.
While the change in China is much less spectacular than in the US because it is already known in advance who is going to take over and the public has got plenty of time to analyse and study the people they will have to deal with in the coming five years, the election in the United States was far more exciting. In the end it wasn’t as close as many people thought and Mr Obama got the chance for a second term to do the things he promised and was supposed to have done already.
The situation for him couldn’t be more complicated and the cheers of the financial markets were extremely short-lived this time. Most asset prices corrected sharply on day one after the election. The market players realised that after the public ballyhoo, reality is back and that doesn’t look too good for the near future. As a first step Mr Obama has got very little time left to avoid the ‘fiscal cliff’. If he and the opposition can’t agree quickly on the next budget, automatic tax increases and spending cuts will strangle the lagging US economy in early 2013. The market has realised pretty quickly that there is a lot to do and a lot of problems to be solved.
In China the new leaders (Xi Jinping and Li Keqiang) have started their new terms with great promises. They promised substantial improvements in private wealth and income, a rigid fight against corruption and a serious eye on environmental and social issues. Pretty stern challenges, but that’s what the public likes to hear and the belief in China in their government and leaders is still significantly higher than in the western world. The Communist Party knows very well how to run the country and knows too that political and social stability in the country is related to the economy and the hopes of poor people that the success of the country is going to reach their wallets too.
The European debt crisis has returned to the headlines and the unresolved budget problems in the southern part of the continent, strikes and rising local conflicts made people aware that we are still far from any solution or recovery. Unemployment is rising and the forecasts for the euro zone for 2013 are far from positive. As already mentioned, the situation in United States is not much better and if the budget deficit is not successfully handled pretty soon things could get quickly out of control; some are ready comparing the situation in the United States with the one in Greece.
Market intelligence
The past two weeks were pretty interesting, far more than we expected. Readers will remember that we thought that there was a bit more risk on the downside of prices than on the upside, but despite all concerns, the US market made it again and prices were able to gain another fraction instead of correcting on the downside.
The separation of trends we mentioned two weeks ago has intensified in the last fortnight. Higher kills in Europe, the significant slowdown of production and expectations in the automotive industry and the serious economic problems around the Mediterranean made European players far more pessimistic than those in the rest of the world. It was another good example that for the US, the glass is always half full, while for the majority of the Europeans it is half empty. As a matter of fact both can count themselves lucky if the glass is only half rather than totally empty. Anyway, life has to go on and it is useless to stick your head in the sand.
Being tightly related to the Asian markets, US hide suppliers continue to be pretty positive and rather stubborn against any idea of declining hide prices. They were again able to manage the markets almost perfectly. They played the supply card again and with the reasonable forward position on cured hides they continued to draw a picture of scarcity and were able to force their buyers to pay steady if not fractionally higher prices. However, what is possibly much more important for them is the protection of unsold wet blue inventories. Even with much better sales in past weeks, most pundits are still reporting pretty reasonable volumes of unsold wet blue hides and with Asian buyers stubbornly refusing to pay the adequate production cost, only higher raw material prices can actually close the gap between valuation and market price.
Managing supply is one side, but there has to be demand too. In the end it is all about China. This is the place where consumers are still positive about the future; they believe in the stability of the country and the success of their nation. People are willing to spend; they are not afraid to do so. They believe and trust in the continuing success of the country and the government is extremely successful at camouflaging all the underlying problems it is facing too. Consequently many manufacturers are enjoying solid domestic demand and there are hopes for further rises and improvements in 2013. Companies not producing for the domestic market are either in serious trouble or manufacturing for the large brands and retailers around the globe who may face headwinds, but never stop. The manufacturers of finished products need raw material and that keeps buyers pretty active.
This might be only part of the story and is not the case for everyone and every product. We have to make this comment, because it could otherwise be misleading. In our analysis the real physical demand is actually focused and covered by decent business for leather of the medium- and higher-end of the quality and price range. We have discussed this subject already in the past: the material cost of the substitutes for the majority of products is a restrictive parameter for (some) raw material prices. We will deal with the issue again later this year when we dare to take a look at trends for 2013.
Independent of the general firmer trend in many markets and predominantly in the US one should not ignore the complaints of those who are selling lower quality hides and skins; we have to listen and think about everyone and not just the ‘happy few’. The process of substitution is still accelerating: linings made of polyurethane (PU) and microfibres, splits substituting grains, upholstery shifting more into textiles and artificial fibres, shoes made of canvas, the auto industry combining more PU with leather or just reducing the amount of leather consumed in production, to name a selection. Leather is less than ever before seen as ‘the sole material’.
The rise of prices and the constant discussion and rumour about less production of raw material has already for a number of seasons triggered discussions and acceptance of alternative materials. This was compensated by rising demand in emerging markets.
The crisis in many parts of the world, the fashion of spending limited income on electronic gadgets rather than standard leather products and leather losing a lot of its shine as a material for ordinary people is weighing on prices and consumption. Higher energy and food prices are also absorbing purchasing power from the target consumer for these average price standard products. This is only compensated in part from the rising spending power in Asia and the bread-and-butter business at workable prices is being desperately missed by a large group of tanneries and manufacturers around the globe.
How sensitive the market can be can be seen in Europe. It seemed it would be a never-ending story of premium car sales. Despite all the overcapacity and problems in the medium and low end of car production, the premium car makers were pointing to excellent sales and a never-ending growth That was until the end of September. Suddenly a few warnings appeared, the kill was a little higher and the pipeline had to be emptied just a little (in part also for the sake of balance-sheet ratios at the end of fiscal year 2012, and not because of lower demand) and suddenly the market developed cracks.
This is not the end of the world, and nor do we believe that there is any fundamental problem in demand, but values had been too high; prices were related more to stories and fear than to the real equation in the market and it needed very little to make happen what should have happened a long time before.
It will be interesting to see how the automotive tanners react. Hides have reached a fair value level, but tanners are trying to depress the market further in an attempt to widen margins and to balance some of the losses that occurred over the summer with inflated margins in winter. Watch out. With the present price levels in other markets the premium hides will look inviting very soon to overseas buyers again and the price for higher-quality leather has more room on the upside than the cruel battlefield in the medium and lower end. One thing is for sure. Chinese tanners are constantly upgrading their quality and production because domestic demand and rising cost are forcing them into the higher market segments to survive.
The split market is still strong and demand seems to outpace supply for the majority of products. Prices for wet blue are still high. Also no news as far as the lime split and collagen products are concerned. High prices and in Europe a reduced soak of hides in the automotive tanning industry has reduced the supply in this part of the world and manufacturers of collagen of all kinds are struggling to get enough supply.
The skin market has stabilised. The extra slaughter due to the Muslim festival of Eid al-Adha at the end of October has to be digested and has offered more supply to the market. Many net importing Muslim countries are now absorbing their local supply first. The early cold weather was very good news for the sales of double-face jackets and shoe linings. It was just a few days, but retail reports suggest that this has triggered winter shopping early this year in western and eastern Europe. That was a great relief to the main tanning centres supplying these markets. Consequently we see steady prices and a pretty relaxed environment on both sides, supply and demand. Wool prices have nicely recovered in the past months and this has also come as a relief to those who have to sell fellmongered wool. However, we see good prospects for premium qualities in this market too, but a bumpy road for the more standard items.
We are now approaching the end of the year. In Europe there are just four weeks to go and for Asia the shipping frame is getting tighter too. The present market environment allows hardly anyone to believe that prices will change much in the remaining weeks of the year, at least for medium and higher standard operations. The kill in Europe is going to peak shortly and the US is predicting lower kills to come and Australia is expecting its summer break. This makes suppliers pretty confident that they will not have to make any major price concessions in the near future. Tanners seem to be fed up with higher prices and what they need to buy they buy, but it is interesting that most suppliers have no programmes for the first quarter 2013. Buyers are buying hand to mouth and are looking for quick shipment of the product.
With the lead times in Asia tanners will not have much time left to plan their first quarter productions and to think about how, when and where to cover raw material needs. European tanners have still a bit more time to take decisions and to collect more information about their orders for the start of 2013. From the today’s perspective we fail to see any reason for either side to move in the coming weeks. We may be able to expect more movement in December when decisions have to be taken.
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