Market Intelligence - 08.01.13
08/01/2013
The financial markets started to clean up for the end of 2012 in the week between Christmas and new year. With almost the entire previous week of the year being closed for holidays around the globe, investors and commercial players started to close their books and walk away from any risk and investment until January.
The main drivers and attraction were the conflict to prevent the US from falling over the fiscal cliff, the elections in Japan, the conflict in Egypt and the never-ending story of the EU debt crisis.
Statistical data demonstrates a moderate rebound of the US economy. The housing market shows a very good performance and the low interest rates and prices seem to be boosting the market again. Industrial production data from China let the market believe that the locomotive of the global economy is slowly expanding again.
In Japan the new government has announced that it is going to implement new stimulus programmes. This might please consumers and the markets but it will expand government debt even further, making Japan’s difficult budget situation even worse.
In the US the one debate as 2013 began was if the Democrats and Republicans would find a compromise over taxes and social spending. President Obama has time until early January to find a solution to avoid the fiscal cliff everybody is talking about these days. Automatically raising taxes and spending cuts can only be avoided if the Republicans accept higher taxes for the rich while the Democrats have to accept less social spending in exchange. The markets assumed that the two parties would find a solution in time. Investors took a few positions and stock markets moderately rose as they year ended and oil also saw a positive performance on the back of low interest rates and hope for more economic expansion.
Good news for the economy remained bad news for the US dollar, which fell against the euro to levels not seen for some months. It ended the last full trading week of 2012 with levels around $1.32 against the euro.
Market intelligence
In this issue we will try to review 2012 and try to give an outlook into what lies ahead for 2013.
As 2012 wound down and the western world all but closed for the Christmas holiday, economic activity slowed down all over as a consequence of globalisation. Also 2012 was at the end a challenging year and will be evaluated by different players in totally different ways. Normally the leather industry as a whole has either good or bad times, but this doesn’t apply for 2012.
Let’s have a look at the highlights of 2012 first:
Prices of various origins and raw materials reached high or even record levels
The demand of wealthy consumers in particular in emerging markets remained high in support of the luxury sector
This included the premium auto industry, which suffered a serious set-back in the last quarter with the effects of the EU debt crisis.
Sales of leather products in general were taking full benefit from the purchasing power in many countries, but leather as a material faced increasing headwinds due to tough price competition in traditional consumer markets. Leather consumption in production was either reduced or substituted for price reasons. This trend was only cushioned by the strong performance of some consumer markets, in particular in China.
Sheep and lambskins had a roller-coaster ride. After a boom in the first quarter of 2012 with players speculating on the next rally of prices due to fashion, they had to realise in spring, that speculation can go wrong too. The expected orders from various brands did not materialise and many grades fell by 40%-60 % within a week.
Cattle slaughter dropped in some countries. Ireland and the UK and the US were examples and reduced slaughter was the strongest argument for the supply side to insist on higher raw material price levels.
How volatile the market can become was demonstrated by the immediate correction of heavy male hide in Europe after the publication of the production cuts in the auto industry.
Producers and suppliers are increasingly using wet blue production to manage supply and to control the raw material flow to the tanneries. With large beamhouse capacities in Asia and their lower production cost, this has developed into an important conflict. Missing cured volumes and large wet blue stocks are in competition and make a balanced market condition even more complicated.
Moreover we have to admit, that we are surprised, that so many players in the leather industry have so far managed to finance their businesses. Low interest rates certainly helped, but cash resources have been pretty stressed. Rising raw material prices, energy cost, chemicals and in many places labour charges required more finance, which was not always easy to get. We thought it would cause more victims in the industry than we actually saw.
While Chinese exporters are complaining about the revaluation of the RMB, the rising value of the Chinese currency provided relief for calculations. It started the year at 6.35 to the US dollar and fell in the late summer to 6.40. By the end of the year it was trading at 6.23. On average, imports became cheaper, exports more expensive and sales on the domestic market more attractive. Tanneries looking for raw material, manufacturers importing more leather and retailers more finished leather products … everybody was taking advantage of the Chinese market.
Drought in the US has and will influence beef production. Kills have been temporarily higher because farmers were de-stocking their herds due to the lack of pasture. Animal feed has become far more expensive while consumers continue to watch their wallets and either look for cheaper imported beef or for cheaper alternatives, such as chicken and pork.
How delicate prices can become was something sheepskin producers had to learn the hard way in 2012. Sheepskin lining became too expensive and the UGG fashion craze ran its course. The style was copied with artificial linings and cheaper shoes were made for the discount stores. Despite the fashion, the product was not prestigious enough to make it into the luxury bracket and suffered badly. If leather is not in a premium line, it will always have a weak defence against substitutes when it comes to price.
Many manufacturers are trying to turn this into a promotion campaign for alternative materials and use many strategies trying justify the use of man-made materials.
Despite all this, premium raw materials have reached record high levels and the average raw material price level is not far away. However, one can see a serious separation in price trends for high-quality or uniform products vesus medium or lower origins with less uniformity.
For us the two main headlines for 2012 were:
‘Leading brands have finally made premium leather a real luxury material’ and
‘The beef industry has controlled the markets by managing the supply’.
Looking into 2013 we think that we start the year with the following assumptions. The global economy shows signs of stabilising, mainly thanks to a recovery in the US and China. Geo-political issues, in particular in the Middle East but also between China and Japan, remain highly sensitive. Europe will continue to struggle with the debt crisis with high risk of rising social tensions.
Other assumptions are that there will be extended movements in asset, currency and other financial markets. In particular the currency movements could rock the leather pipeline. Since hardly any of the serious problems in many of the regional economies has been resolved the recent calm is deceptive.
Global cattle slaughter looks likely to fall moderately with some preferred origins (such as the US) more affected than others.
Retail sales will continue to be stable and without any political problems. Luxury should outperform once again. Supply will lose its shine in the leather pipeline. Price and finance will take over as the decisive factors. Overcapacity in leather production has to be reduced again. There are many ways to do this.
Overall, one has to expect for the coming year, once again, a major shake-out in the tanning industry. At this stage there are not enough hides to fill the drums that are waiting for business. Either they are being taken out of production voluntarily (unlikely) or by forced circumstances, but the saying that ‘more money (higher price) doesn’t produce more hides’ is still absolutely true and so either demand has to fall or supply has to rise. The latter is hardly likely to happen, so demand has to decline to return to a physical balance.
The wild card remains the stocks along the supply chain. There is common agreement that raw material stocks are low for suppliers as well as at tannery level. However, there is still no mutual agreement regarding stocks in semi- and finished material around the globe. Many people report that a lot of wet blue is parked in many places. With the recent market strength and the outlook for reduced slaughter, the owners feel comfortable with their positions. Independent of the quantity, we think that the quality of this material could be decisive. While demand for high quality remains still reasonably intact the medium and lower end is still the unknown factor. Will high prices and demand clear the stocks with a quality compromise, or will substitutes put a cap on prices and force suppliers finally to surrender and to take what the market is dictating?
The start of every new year leaves a lot of room for plans, guesses and opinions and we just tried to collect a few facts and expectations as the basis for the evaluation of everyone who has to make plans and budget for the coming year. Some may not apply to everyone, some might meet disagreement, but there should be a selection which could assist in making individual decisions to cope with the challenges.
The split market was a bit mixed. From China we received more reports about a decline in prices for drop splits and falling demand. In Europe we still deal with strong demand from the gelatine producers and prices at high and steady levels.
The skin market is in the typical Chinese winter mode. In Europe when skins get bigger and carry more wool the interest from China supports prices and demand remains good. Nappa business is still doing well and we are convinced that the high prices for cattle hides and the improving conditions in the wool market are supporting the lamb and sheepskin market.
So we have closed the curtain on 2012. We hope, that all our readers had a good and successful year. Times are challenging and in particular the ‘old economies’ struggle to defend their wealth and global position. Individual citizens are now feeling the full effect of globalisation and how qualified and cheaper competitors for labour and wealth are making it increasingly difficult to maintain previous standards of living. Governments are being asked to compensate and many politicians are trying to make people believe that a re-distribution of private wealth will solve all the problems.
Well, that may be a tranquiliser in the short term, but in the long term it would be a killer. Only education, mobility, flexibility, new inventions and clear analysis of the total cost chain can save the future of the old world. Many countries are not only in an economic, but also a psychological depression. Many other parts of the world are still in the process of dynamic growth and optimism. All this will be reflected in the leather pipeline. However, where there is risk there is also a chance for those who are willing and in a position to deal with it and take it as a challenge. There is still plenty of room for good ideas and products.
We wish all our readers a happy, healthy, peaceful and prosperous new year with a lucky hand for all the decisions which have to be taken for the leather business in 2013.
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