Market Intelligence - 20.11.12
27/11/2012
The world was shocked by the outbreak of new violence in the Middle East and the war between Hamas and Israel. Although by the end of last week a ceasefire was achieved the situation remains unresolved and new war activities can be expected.
Many are asking how it could get that far and the real question is: cui bono? The civil war in Syria still continues, Turkey has asked NATO partners to assist at the border with Syria and suddenly this confrontation has added to the explosive situation in the region. It is pretty obvious that some people took the opportunity at this sensitive moment to increase instability and to pour more oil onto the fire. One can have many theories about who could have a vested interest. For the world it is certainly the wrong issue at the wrong moment as it is still dealing in many areas with serious economic problems; the case of war and attention for stability in another region is the last thing Europe and the US are looking for at the moment. Maybe this could be one of the most accurate explanations too. Considering, that we are now dealing with, the instability in Afghanistan, the war in Syria, the dispute with Iran about the nuclear weapon programme and again with the Palestinian conflict one can see how dangerous the situation in the region is and how quickly it could change from some smaller fires into one big one.
The financial markets were pretty unimpressed by the political problems that made the headlines. There were a few days of retreat before the markets recovered nicely. The oil price was able to gain on the conflict in the Middle East and added a few dollars to the price per barrel, but it did not show any big jumps, as one might have expected with the situation in the Middle East. However, oil supply remains high and it is rather a surprise how strong oil is performing. The present price levels can hardly be explained by the physical market situation, but seem to represent more a playground for financial investors rather than a true reflection of supply and demand.
The EU debt crisis and the fiscal cliff in the US made it onto the front pages, but caught only limited attention. Further financial aid for Greece is still on the cards, Portugal is still fighting hard and might have a light at the end of the (very long) tunnel with the austerity programmes showing some results here and there. In the US, hopes for a budget agreement are rising. The EU commission was not able to find agreement for a new budget, another demonstration that the levels of harmony in the organisation are not at their best.
Moderate signs of improvement were seen in the US economy with the labour market and the housing market showing a few sparks of hope for the better. The great shipping season started last week with Black Friday, the day after Thanksgiving and retailers hope that shoppers will spend more money this year than last. More days (32 days until Christmas) and longer opening hours do not, however, necessarily mean more money to spend.
China also delivered a few positive signs with the purchasing manager index rising and industrial production too. However, many say this is a political presentation of the data, aimed at giving the new leaders a good start.
Despite the uncertainties in Europe the euro gained value and recovered from some of the losses seen until November. The level of $1.30 against the euro was in sight at the end of last week.
Market intelligence
We are now slowly heading towards the end of the year 2012. The leather pipeline thinks in seasons and not in calendar years and consequently the end of December is an important date for fiscal and accounting purposes, but not really a breaking point for the valuation of the business situation. However, the Christmas season in the Christian world and in the main Western markets is always a time to review and to draw a bottom line under past twelve months.
We will review the year 2012 in the next issue of Market Intelligence, but we can feel that many of the players along the pipeline are already preparing for the year-end and many of them have already finished or are in the process of closing activities for the current year. It is a bit like the Christmas shopping. Many are early, a few are on time and some run out just five minutes before the shops close. The problem in the leather pipeline is just that you never know how people decide when to do it.
Activity in the past two weeks has been predominantly from Asia. Everybody agrees that Chinese interest in purchasing has been pretty brisk. In other parts of the world, in particular in Europe, the leather industry has been much quieter and orders and business activity are still reasonably depressed with many people claiming that they do not have enough orders to run their factories in full.
Even those factories that are still pretty busy in Europe are admitting that most of their business is based on exports to Asia and other emerging markets, either for finished products or for leather as a material. Without the strong performance of private consumption in many of the emerging markets the situation would be pretty dull all over. Also tanneries in China are mainly busy because of domestic demand. It is interesting to see a constant upscaling of quality and price in China for the domestic market, but also the fight against the rising cost of production on the mainland.
While on the export side price is still the major factor, consumers in China are demanding better quality material. Rising income and wealth and the willingness to spend is supporting the medium and high-price sector. It is a surprise to find while shopping in the typical Chinese department store that many local products have reached price levels that would have been almost unbelievable even a few years ago. This is also touching the raw material side. The medium- and high-end raw material origins are finding more interest and potential customers in China every day. At the same time, European tanners are struggling in the middle price section and only those tanneries that are operating in the top luxury sector can still achieve the selling prices and amount of orders they require to maintain production.
The situation is reflected also in the raw material market. European luxury brands are still enjoying strong demand from China and the other ‘new rich’ markets, and their exclusive production in Europe is still running strong order books including for their sub-suppliers. Successful brands in China are adding to the demand of high-quality products. Consequently the top end of the quality range is still not facing any headwinds. High-quality leather is part of the success story and not in question as a material. The rest of the product range is in a different state and the price of leather is the critical factor. Demand for product might be good in numbers, but the price is still ‘the factor’ and in particular in the US and European markets the consumer is more price-conscious than ever with less money to spend.
The price levels reached for many raw materials is putting leather under more and more pressure. So far growing consumer demand has kept material demand steady too, but season by season more and more manufacturers are walking away from leather. This is reflected in leather prices that are hardly rising. Over-capacity at tannery level and the prices for alternatives are making the life of many tanneries extremely hard.
Many may remember the massive drop of lamb and sheepskin prices in spring. Some big players bet on another strong season for sheepskin leather in decoration and shoe linings but saw the red card from their customers and suddenly the demand they had created and the inventories they had built to keep potential competitors away due to lack of raw material supply became obsolete. Demand disappeared and prices dropped by 40%-60 % just in a few weeks.
It was also a good example what can happen even for strong brands. The famous boots of a famous company become quickly copied and manufactured with the same or a similar look and made from synthetic materials. Discount retailers began offering the alternative product at less than half of the previous season’s average price and within a moment the volume of demand for the material disappeared. The shoe style was still in the shops, but the material changed.
The drop in prices hides in Europe for premium car makers was not a result of substitution, but just the consequence of a fall in demand and a cut in production which suppliers had totally discounted as a possibility. Just believing in the published success stories and the great expectations management teams were selling to the markets and analysts was enough to wipe any concerns and warnings away. When the reality hit the public it took just a few weeks for raw material prices drop by 10%-15 %.
We will know in the coming season if the demand and the upscaling of quality in China is successful among consumers. It could work, but there are also pretty strong arguments for saying that the price will kill the trend. See above what happened to sheepskin boots.
At the moment we still see production capacity expansion (not only by leather producers, but also at slaughter level) meeting forecasts of reduced bovine slaughter in the future. This mixed with cheap money and a certain attraction from speculators results in well supported raw material prices.
We have always been of the opinion that sustained higher raw material prices have to go along with higher inflation and since we do not see inflation (yet) in most countries we fail to see the justification of higher raw material price ranges. Many expect inflation in the coming years as a consequence of the massive injection of liquidity in the markets, but if the money hasn’t and isn’t reaching consumers’ wallets the normal guy in the street may just cut spending to the same extendt as prices go up because he hasn’t the money to spend. Higher energy and food prices or governments increasing taxes could also be the factor to prevent people from spending.
The middle class is in retreat and the number of wealthy and poor is rising, not in the same proportion, but as a trend. Perhaps leather is going to be increasingly attractive to the ‘big spenders’ and the premium market is going to absorb more leather at higher prices and leather will expand its status as a premium material. We think that we are now at price levels for many standard raw material types where the fundamental decisions of the consumer and manufacturers will be taken in 2013.
The supply side will also offer great challenges in the year to come. On the supply side a lot of problems are developing and we will deal with this problem in our review of 2012 and outlook for 2013 in December.
The split market is benefiting from the shift to cheaper materials and the use of splits as a cheaper alternative in many products. Collagen demand continues to run at high levels too, so a seller of splits has very little to worry about. Generally it is more difficult to get the right product rather than to sell it. Prices are stable, steady or firm and it seems this will continue for some time.
After the short rebound seen some weeks ago, the skin market has lost a bit of its shine. Prices are hardly moving. Maybe this is also the consequence of a pretty warm start to the winter in the northern hemisphere. The was a short moment of cold weather at the end of October, but that was too short and since then it has been rather warm and wet. The forecast is for some colder temperatures in December, which could still be early enough for retail, but if it doesn’t come until the last week before Christmas a lot of sales potential will already be gone.
We cannot predict what is going to happen in the coming weeks. The two scenarios are either a slowdown now, because Asians have covered what they need until the Chinese New Year holidays in February, or they will continue to absorb available raw material in preparation of a battle for raw material in 2013. EU tanners will most likely not be very active. The end of the year, management of stocks, cash-flow problems and a general insufficient order position will keep them on the sidelines.
Sellers will not take any big positions either. So one has to believe there will be stability with limited market activity.
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