Market Intelligence - 05.02.13
06/02/2013
On the financial markets we have seen quite a lot of movement in the past weeks. Financial investors obviously took the first two weeks of the New Year to discuss and decide on their strategies before taking any clear positions into 2013.
However, in the last two weeks a couple of clear trends have emerged as to what speculators think is going to happen. The euro is popular again. After almost two years of concerns about the European debt crisis, the financial markets have obviously decided that it is not going to be as bad as many thought. Although nothing fundamentally has changed, countries like Spain, Italy and Portugal are in the position to borrow money again at a reasonable cost. The risk premium has fallen substantially and international investors are readily buying these bonds, which are still yielding much better than many other options. European banks are returning good portions of the liquidity they had taken from the ECB and this makes investors believe that the credit crisis in Europe might be over.
This optimism might be a bit premature if one is looking at the economic situation and the labour market in the euro zone. If the countries in difficulties cannot generate new jobs and growth quickly the situation could deteriorate again. All this did not make much impression on investors and they were readily buying euros, so the value of the euro rose to $1.37. The European currency has gained more than 10% from the lows seen in 2012. The opposite happened to the Japanese yen, which continues to be pretty weak and has lost more than 10% against the US dollar since mid-December. Investors are concerned about the debt situation in Japan and the policy of the government to stimulate the economy by spending even more. However, the weaker yen will help Japanese exports on the international markets. For imports however the opposite applies, but that might be what is intended after many years of deflation.
In the US, President Obama has started his second term and generally the US economy is delivering positive indications that it could gain strength again. In the past weeks we saw consumer confidence rising and manufacturing expanding. The real estate market seems to be gaining a bit of momentum.The Federal Reserve has indicated that it will continue its policy of low interest rates and support the market with whatever liquidity is needed. This is what the investors like, because it gives them money to play with, so we see commodities rising and stock markets performing extremely well. The stock market indices are at pretty high levels, in some cases not far away from their all-time highs.
In China economic growth is also back on track and analysts are expecting the economy to grow by more than 8% again this year. This is what China needs to keep the labour market intact. At the same time, we can all see that private consumption in China remains extremely strong and is further reducing the dependency of the economy on exports. This is actually what the government wanted and what international analysts have always recommended. One of the prices of massive growth has been the pictures we have seen on television of Beijing and other large cities in China with heavy smog in the past weeks, making breathing extremely difficult and air pollution at critical levels.
Market intelligence
Sometimes we think it would be better to skip a publication of Market Intelligence because within the fortnight we take between the various issues nothing really happens that is worth reporting or thinking about.
Such is the situation again at the beginning of 2013. January has passed by and nothing has changed in the last two weeks from what we knew a fortnight ago. The tanning industry continues to purchase raw material and even higher asking prices have not scared any of the buyers away. Supply of raw material is barely steady and the volume of production after the Christmas break demanded more raw material than was available.
This situation applied mainly to Europe, which is still driven by fresh hide supplies in most cases. We mentioned this situation two weeks ago, saying that tanneries are not carrying adequate raw material stock for reasons of finance. But we also suggested many of them were unable to imagine that raw material supply would ever become such an important issue. In saying this, we should not forget that many tanneries prefer fresh material for technical and effluent reasons and are not considering a return to salted material ever again. Consequently, we are just fluctuating between the soaking volumes and the killing numbers, which are more than ever before dictating the market conditions in Europe.
Also in the market in general very little has changed. The luxury section is still dominates and top-quality raw materials are desperately sought after and cannot be found in the volume required. With the massive margins available in the production and supply of luxury products it is no surprise that also absolute premium prices are paid for premium materials too.
Independent of how far off the market conditions may be and how easy most suppliers find it to sell their products, and also accepting that we might be boring, we still need to point out that conditions are not as brilliant as the general market may look. You can talk to every tanner you want in every country you can think of and the situation described everywhere is exactly the same. If you have either the production set-up and image for top-quality materials and connections and a customer-base in the premium market, or a low-cost and low-price strategy, then demand and business are still satisfying. This is definitely much more the case for the high end, but business, with the right conditions, is not totally dreadful at the low end either. The problem that nobody can handle at the moment is the mid-quality segment. The material is either too expensive or not good enough to find a real home. The unanswered question that we have asked a number of times is how this situation is going to be resolved. We would not be surprised if a lot of inventories will have to be corrected to realistic market levels; a lot of people would find the results pretty shocking.
For those who have had no chance to liquidate these inventories already there is only one option left. The supply problem will persist and prices will have to go significantly higher if tanners are to have a serious chance of getting rid of the material at adequate price levels. This applies to inventories from cheaper raw material price levels and we do not even want to think about what the valuations would need to be at the raw material levels we have reached in the past weeks. We know that nobody is really happy about discussing this issue and that many prefer to pretend that the problem doesn’t exist, but we feel pretty sure that there are still more hides around than many people have tried to make us believe, just not the right hides.
Apart from the valuation in many cases these inventories are also binding up a lot of cash and the record price levels of today demand more and more financial resources to keep the ball rolling and the invoices paid. Nobody wants to talk openly about this subject either because everybody is afraid that bad news could trigger what everybody fears: rising payment delays, unopened letters of credit or even failures when people have no resources left to pay their invoices.
We know that we have raised this problem too a number of times in 2012 and many may accuse us of being too negative and prudent. We tend to believe that we might be early, but not wrong. Eventually we have to get this market back into balance between supply and demand. A moderate ease of demand slowly adjusting to supply, fading speculation and fear at all this will combine to stop the market gently and correct prices back to profitable levels for all market segments. Nothing of that is on the horizon and that means that eventually the tsunami wave will just hit the wall suddenly. This might still be a bit away, but preparing the life-vests in time has never been wrong.
After the recent rise in leather prices in China and the excellent returns for splits, we have seen a firming market again in the past weeks. Some ‘need to buy’ and some ‘hot money’ were pushing prices higher again in most markets. The increased leather price and the optimistic outlook for the Chinese economy and consumer markets are the driving forces. Among EU tanners only the absolute top-end producers can still compete in the battle for quality raw material.
Even calfskins found a lot of interest again in China and have been selling at prices that just leave Europe in wonderment. The ambition and optimism of Chinese tanners and brands that they will find enough buyers even for expensive, locally made products remain unbroken and Chinese brands are making their way into the higher end market.
Continuing positive consumer sentiment in China safeguards the market for the time being. Although almost everyone would love to see a raw material price correction hardly anyone is really expecting it for the months to come. However, this is all based on the general sentiment that there will not be enough hides available and packers around the globe are still successfully selling the impression that hide supply will be insufficient for the rest of the year, a far too generalised statement. Let’s remember: physical demand and supply eventually always get into balance, for whatever reason.
So, the market barometer for the majority still fair-to-sunny and many have started to get used to it, which means buying, because tomorrow it is going to be more expensive. A classic description of a market bubble is when the purchasing decisions are made without alternatives. The feeling of missing out is stronger than caution over the potential consequences.
We will have a serious look at the leather pipeline to make sure that we don’t miss the last exit. This could be a few centimetres or many kilometres away, but missing it would mean falling over the cliff.
In the meantime managing production capacities and inventories will be more challenging than ever before. If one looks at the international price table it is hard to find any serious alternative. Hardly any origin justifies its price level and no seller is waiting for a new buyer to walk around the corner. That is not an attraction any more but rather a burden and it confirms even more that it is better to hold onto the material than to sell.
This is possibly another fundamental mistake. In market conditions like these it might be the one and only long-term chance to improve customer quality. Now might be the time to select customers and to upgrade when a better client (with more money and better prospects) knocks on the door. When supply and demand are back in balance there will be far less ambition to change and sellers may look back with regret at the moment when it was possible to start to deal with better buyers. No matter what the market does, survival of the fittest still applies in today’s business world and so it might be wise to think twice when new options knock on the door. When one day the market performance of leather turns south it will be the best and most successful who handle the conditions.
The split market has remained steady at the high levels reached. Only in China one hears that split credits have come down a bit, which sounds a bit strange looking at the hide markets. The increased split credits of the last quarter supported hide prices and improved calculations by quite a bit. With the present situation in the hide market splits should continue to enjoy reasonable support. Only fashion and leather trends could weigh on demand in the near future.
The skin market continues to be on solid footing too. It does not have the same dynamic as the hide market but enough to perform well. Skins in general have gone up in price. The Leather Fair in Istanbul delivered mainly positive comments. However, similar to the situation with bovine, the skins market is mainly driven by exclusive and luxury items. Lightweight, elegant skins are keenly sought and prices for the specials have reached frightening levels. However, the big spenders of this world and the cold winter have boosted sales of finished products. For the rest the situation is not so bright. Interior design is a small niche, but has had a pretty stable season so far. Nappa is in decent demand, but the prices for lamb nappa are not yet rising sharply. What is promising is the better return for wool and the still large price-gap between ovine and bovine leathers. Wherever possible a substitution would not be a surprise. Many people remember that last year we saw also boom in the first quarter and bust in the second.
After the very strong performance of the market in the first month of the new year we are quite sure, that things will now slow down a bit. This is not only for the reason that most Asian customers will be on holiday in the coming weeks, but also because the market needs to digest the recent price increases. The higher leather prices many tanneries in Asia were obtaining at the end of last year have already been equalled by the raw material price rises we have seen in January. Without a further jump in leather prices tanneries can hardly work profitably with the present raw material costs. In Europe the situation might be a bit different because there are still a number of drums that need to be filled but the upcoming Carnival season will not support beef consumption and slaughter.
So, short-term sellers are well cleaned out and they will definitely try to get some more profit from the short-term situation. In general however, we think that the market is now ready for a break and we would be surprised to see prices moving very much in February. Everyone not located in the US dollar region has to watch the currency market too. It seems that the financial markets after a quiet start are ready again for speculation on roller-coaster movements on the markets.
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