Market Intelligence - 19.03.13
19/03/2013
Europe continues to be trapped in the debt crisis. This week the EU agreed on a EUR 10 billion bailout programme for Cyprus. Economic news out of other countries, particularly in the south of the continent, is not getting any better. National debt in Spain has climbed to record levels and is likely to continue along that path in the coming year. Italy remains constrained by political paralysis and it seems unlikely the necessary decisions to release the impasse will be taken any time soon. France is not showing any improvement. The new government is losing popularity and does not seem to be qualified enough to take the necessary action to resolve fundamental problems. Smaller countries such as Hungary, Bulgaria and Slovenia are also facing internal political issues. The stronger performance in the northern part of the continent does not seem to be enough to safeguard against the general malaise. All in all it is surprising the euro remains pretty stable and the financial markets relatively unscathed.
In the US, signs are growing that the economy could return to a positive track. It is beginning slowly to grow again, the labour market is improving and consumers are returning to spending. The housing market looks like it is beginning to turn and if these trends persist, the situation has a chance to improve. However, the budget deficit remains a burden and as long as the two political blocks in the country are not reaching agreement it could remain tricky for the economy for some time.
Consequently, the performance of emerging markets – in terms of consumer spending, investments and rising wealth – is the main driver for the global economy. However, one should not be blind to the problems that might become a challenge in these countries, too. In China, for example, market observers are talking about large amounts of uncontrolled money invested short-term in businesses. If these businesses fail, this could become a threat to overall stability. The growing tensions in the Middle East and the unclear position of North Korea are also worrying.
Russia, while claiming to be a supporter of free trade, is closing its borders, trying to copy the success of its neighbour, China. It is far from a safe place for foreign investors, hindering imports by bureaucracy and restrictions and controlling a great deal of energy supply, but it is an important pillar of the global economic community.
Investors remain cautiously optimistic about the global economy. Growth is forecast for 2013 and stock markets and commodities are holding at least steady or growing moderately. Some commodities, such as cotton and wool, have performed well. The euro was able to defend the level of 1.30 against the US dollar and oil was able to stem against further weakness.
Market intelligence
The past two weeks have been not very exciting for the market in general. There are a number of isolated niches that deliver excitement but, in general, one has the feeling that most people are waiting to understand more about market conditions in the weeks to come.
This is fairly normal at the end of the first quarter. The industry is waiting for the results and reports from the leather shows in Hong Kong (Asia Pacific Leather Fair, March 25-27) and Bologna, Italy (Lineapelle, April 3-5). Around the time of the Hong Kong show, most of the raw material suppliers take the chance to travel to tanning centres in Asia, to visit their clients and to discuss market conditions into the summer and beyond. This also applies to leather buyers and leather product manufacturers.
While, for many years, the main subject of discussion has been how leather demand and consumer activity is going to develop, it seems most of the discussion will be about prices of raw material and the security of supplies. The prices of standard raw materials of bovine origin have gone up over the past few seasons and leather producers have not been fully compensated for the higher price they have to pay. In the past weeks, the groundwork has been laid for serious face-to-face discussions during factory visits and at the fairs about raising the price of leather.
The strong performance of the luxury markets and the positive outlook of many of the high street brands make most people believe the end of the price spiral for high-quality materials has not been reached. The results of premium car manufacturers confirm this. Since those in the automotive industry have a clear picture about their margins, it might be a difficult fight. However, it is definitely true that this market segment has potential and the ability to pay more for high-quality and exclusive leather articles.
As we have said a number of times, for the rest of the leather business, the situation is very different. There is no question that the Chinese consumer is ready, willing and in a position to spend. Average retail prices for quality consumer products in China are higher than in the rest of the world and allow many manufacturers in the mainland to obtain better prices for materials.
The opposite applies for most of the traditional Western consumer markets, where competition remains high and with many of European countries battered by financial crises, retail price levels remain under serious pressure. Since all the leather in the world will not be absorbed by the wealthy, the majority of the products have to be bought by the man in the street. Higher food and energy prices, coupled with people’s preference to spend on electronic gadgets, keep budgets for leather products tight.
On a global scale, an oft-touted theory says that increasing population, increasing wealth and the restricted supply of cattle hides will cause raw material prices to continue to rise and to stay within a substantially higher trading range than at any time in history. This argument has been used many times in the past decades and as logical as sounds, it has never materialised, and raw material prices have always corrected sooner rather than later.
Certainly, the present cycle is longer and higher than ever, but this cannot be used as a confirmation for the theory – there are a lot of new factors to be considered. For example, more producers now control supply, and trading is on the decline. The main players have become much larger and less flexible. A lot of the raw material producers – beef companies – have become leather producers or at least semi-finished material producers. Interest rates are low and make it easier for many to hold on to inventories which are temporarily not required. Technical innovation has allowed them to use more raw materials and increase the yield of available hides and skins.
We should not make the mistake of generalising from the few well-performing segments. The strong performance of the premium car segment and the growth of luxury interiors in emerging markets keep demand for premium-quality upholstery hides in Europe high. The same applies to the luxury leathergoods, accessory and footwear segments, which create demand for quality calfskins. All other hides see a decent demand, but the gap between premium and the rest is widening. Reports from the US are trying to write the market up, but prices have been steady for a while and if one looks at the medium to lower end of the quality range, like Brazil or Africa, prices have not shown the same performance.
This raises the question again as to whether we are seeing a general bullish raw material market or if we are just dealing with segmented trends which are supporting the high end and are not reflected on the commodity levels.
This is the key question that needs to be answered in the coming weeks when we are going to get more information about the decisions of consumer product manufacturers regarding the materials for the coming seasons. We believe strong consumer demand, particularly in China, is the major factor for the uncontrolled rise of raw material prices. The endless optimism about the willingness of the Chinese shopper to spend increasing amounts of money on leather products makes people believe raw material prices have potential to rise further. So far, everyone betting on this has been correct and whatever has been stuffed into the pipeline has found a buyer. The logic remains what has been right in the past has to be right in the future.
Decisions for the second and third quarter and the next season of leather production have to be taken pretty soon. Tanneries and manufacturers have to decide whether they are going to invest their cash in stocking up on raw material to make sure they can meet possible demand in the months to come. Margins in the commodity sector remain squeezed and cash resources are dwindling quickly. There might be finance available for Asian tanneries but in Europe banks are reluctant to increase credit facilities on questionable margin outlooks. It is no secret that a number of payments in Europe are coming later and later and credit covers are not sufficient to cover the increased amounts of invoices sent down.
Since raw material demand and supply has eventually to come back into balance, demand could easily shrink because of financial constraints and for suppliers, it is difficult to manage the customer base. The risk level is rising and the manufacturing pipeline requires clear indication whether brands and retailers are willing to increase retail prices to cover the higher raw material and production costs we have reached.
The split market continues to perform well and there is no change in the general market so far. As long as collagen raw material supply remains tight, hide prices remain high in splits and are still the preferred alternative to grain leather as price levels have very little chance to decline. Splits have always been a reasonable indicator for fashion as well as the general market and so should be watched carefully. It is also worth mentioning that a number of cheap wet blue hides around the world are a reasonable investment considering what can be achieved for split credit these days. We, at least, believe there is an imbalance in the valuations.
The skin market is taking a certain profit from the strong performance of the wool business. Skins which offer a good size and good returns for wool are still performing pretty well and this applies mainly to the late-season sheepskins from Europe. As far as lambs are concerned, we are finishing now in Europe; the winter season and the Easter kill is about to start. Prices for premium material remains high and with the price cycles we have seen in the past years, with prices falling rapidly into the summer, many manufacturers are prudent to take purchasing decisions on the levels we have reached. However, for the moment, the skin market is steady and the industry is waiting for the results of the shows in the coming weeks and the indications offered by customers for the next season. The late and intense winter in the Northern hemisphere was certainly a help.
For the leather pipeline in general, the price levels we have reached have to be digested by the manufacturer and consumer. Without higher finished product prices the present levels cannot be justified and only a shift of consumption to the emerging markets could keep the price levels where we are. If growing wealth allows the consumer to spend more on leather products, we will see an increase in leather consumption with serious consequences for the industry and the leather production pipeline in the years to come.
A taste of this can already be seen the automotive industry, where manufacturers are closing production in Europe and opening new factories in Asia and South America. Although this is neither new nor surprising it is having a strong impact on the market. This kind of restructuring never takes place without strong influences on the supply chains and the markets.
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