Market Intelligence - 30.04.13
30/04/2013
The financial world was pretty quiet again. There are rumours swirling around that the European Central Bank may lower interest rates again but it’s hard to be too sure about this. The interest rates do not seem to be the fundamental problem of the financial situation in Europe. The real problem is the rising unemployment in many countries, with Spain and France reporting new record levels last week. In Spain we have passed the level of six million unemployed. This is the real frightening news, because people without jobs are the real problem for any society.
The problem is also that governments and politicians are just debating about austerity programmes; the whole public discussion is just about politics and the past instead of dealing with options for the future. For almost five years since the crisis began there has not been a single programme or discussion on how to bring jobs back to the suffering economies of Europe. Politicians are too busy fighting for power and we are still seeing ideology everywhere instead of ideas, rigid positions rather than flexibility and not a sign of any masterplan to get the majority of Europe back on track.
We are totally missing any discussion about bringing industrial clusters back and to re-establish a manufacturing base. Nobody is seriously analysing the requirements and conditions needed for a return of production and jobs and it seems that, again, most are waiting for the next miracle to happen which could bail the nations and economies out of the doldrums. It’s unlikely that this will happen without effort, ideas and the willingness to consider that we are operating in a global competition and the analysis of the total cost of supply chains.
The markets have not been much affected by the news and there was very little movement. More interest was gained by the appointment of Italy’s new prime minister and the progress in finding a new government. Italy was able to place new bonds at record low interest rates.
Generally is the outlook for the global economy becoming a bit more cloudy. Stock markets are retreating and gold and oil prices were recovering moderately after a sharp correction.
The world was shocked again by the terrorist attack at the Boston marathon, as well as news about further attacks planed with suspects caught in Canada and Spain. The threat remains widespread.
The euro-US dollar exchange rate has remained in very narrow bands, sticking almost like glue to the $1.30 level.
Market intelligence
The past weeks have confirmed what we discussed in our last issue of market intelligence. Raw material prices have not changed, but for the first time in months prices are not climbing any more and there are various indications that in some markets prices could already be starting to correct.
In particular in the US, where prices are quoted publicly on a daily basis, the indications were pretty clear: the asking levels of many grades could not be defended and sellers, if they wanted to move material, had to consider counter-bids against the prices they were looking for. The story remains the same. Sellers are trying to tell the world that the present situation is only a break and tanners are still in such a desperate need to buy raw materials that they will have to return to the market pretty soon.
From our perspective we still see it two-level market. The luxury market and the premium automotive segment are still running their way. Exclusive selection of raw materials has to feed a very exclusive and high-price finished product market. This particular segment is still not showing any kind of slowdown and suitable raw material prices remain high; they have even had the possibility to increase in the past weeks (these products are expensive due to their scarcity and exclusivity in quality). However, this is a different world and suppliers and manufacturers that are not part of this exclusive society have to deal with a different kind of reality.
This story we have been told for a long time now is that there is a shortage of raw material. The discussion we want to have is about whether there ever has been a real shortage, that is a situation in which the physical availability of raw material has been smaller than the physical demand for leather. Or is it rather that we have had a virtual shortage that was more related to speculation and expectation than to the physical facts of available supply and existing demand? This is always particularly difficult in the supply chain, where you are dealing with production and retailers’ seasons and the lack of transparency on raw material production and stocks. This applies even more with the return of trading operations for raw and semi-finished products.
As long as there was a strong belief that the limits for raw material prices had not been reached we saw people who were happy to own more material than they really needed, particularly at producer in trader level. Tanneries, in their majority traditionally short of finance and also watching daily the equation between raw material prices and finished leather revenues, were far less ready to hold extended raw material stocks and became pretty easy victims of the situation.
It is difficult to change within the production season, even more so in the winter half when the majority of the leather industry is working at full capacity. Since there has not been a serious problem as far as leather demand is concerned, most players saw very limited risk in taking positions. Tanners had very little option but to follow the market because they never held sufficient raw material inventories to cover a long period of absence from the raw material markets.
With the end of the season now looming and the leather industry entering the low production period over the summer, the situation is changing for two main reasons. Firstly, tanners need less raw material and secondly they have to take decisions for next season. With stiff resistance from their main buyers to accept significant price increases for leather, tanners have no option but to manage the situation, and this means either to reduce production, to close completely or to take a risk for another season to produce leather at negative margins. A number of tanneries have clearly indicated that they are going to adjust their production capacity to the leather articles that they believe they can still produce profitably. In Europe, at least, we hear about smaller tanneries announcing that they have already, or they will close voluntarily in the course of 2013.
In the big production country, China, the situation is similar, with (possibly) another aspect. The intention of the Chinese government to control effluent much better is making it increasingly difficult for many medium and small operators to keep production afloat. Either they have to shift their production to less controlled and more remote places or they run the risk of being closed down overnight by the authorities. With a great number of such tanning operations in China, it is pretty difficult to make a judgement over how this might influence tanning capacity, but it is pretty obvious that it will not be by a negligible amount.
Additionally we also see the problem of profitability in China. Leather production was for a long time a pretty profitable investment and in the past this applied not just to the big boys producing for global retailers, but also to local domestic operators selling into the booming Chinese consumer market. However, everything has a limit and with the price levels reached, the rising cost of production and the threat from the environmental controls, it has become a much less attractive business to be in. Consequently a number of players are thinking of leaving the business, or at least of taking a break in the hope that things will improve.
In our view, this is all changing the total equation of the market. At the end of April, it is definitely still a bit too early to come to final conclusions, but we read the market as saying that the long-term cycle of a bull market has come to an end and there are serious reasons why we could now start to enter a long period of correction with a final settlement of prices, lower than the ones we have reached so far.
We know we have been discussing this already for quite some time and we have to admit that we underestimated the situation of the tanneries in the raw material markets. They had to buy because they did not have enough inventory. In that respect, the suppliers were totally right in playing it week by week. This has lifted raw material prices to the levels we have reached. With the inventories sitting in traders’ and producers’ hands there is no interest in any price correction or adjustment.
Looking at the situation in the past two to four weeks, one has the impression that the balance of power is starting to shift. Not that the industry has actually built up much more inventory; tanners simply need less because the season of lower production is approaching. Slowly but surely, the trade is also realising that there are still raw materials to buy because they are in the hands of people who are not producing, just holding them as an investment. This does not apply to everyone. However, eventually everybody who owns material has to turn it into cash and sell it. At least this is the ambition of the majority of the people in business.
It is pretty much a question of psychology. The market will change when an increasing number of players lose their optimism and their faith that the market will continue to rise. Looking at the general global mood, the winds of changes have begun to blow. The outlook for the global economy is no longer entirely positive; the crisis in Europe is far from being over and it might be totally premature to believe that leather as a general material is already exclusive enough to be sold at such a premium to justify the raw material price levels that we have reached. So, it needs very little in the coming months to change the mood of those selling hides and skins, from being patient enough to wait for better prices to taking a decision to make sure that the product flows. It is not going to lose its value, although sellers also have to make sure that the customer who buys is in the position to pay the invoice sent.
The good news is that at least at this stage it doesn’t seem that we are facing a serious problem and a market collapse. The leather pipeline is still flowing and isnnot yet seriously congested. Our main concern remains not so much the demand, but much more the question of profitability and finance. This part of the business is sometimes far more dangerous than the simple question of supply and demand within the supply chain.
The split market remains intact. We haven’t heard of any fundamental changes or any significant variation in supply and demand. However, all that applies to the hide market applies in the end to the split market too. Sometimes, it affects splits later because the seasonality is different and in today’s world the rising demand for collagen is influencing split prices.
The skin business, at least in Europe, is also dominated by the change of the seasons. The demand for nappa skins from China is definitely down, people are talking about huge stocks of raw skins in Hebei province in this market has already seen a pretty decent correction in prices since the APLF fair in Hong Kong at the end of March.
At this moment, considering we are entering the summer season and higher temperatures, the demand for skins for fellmongering in China has significantly reduced. With the change of the season in Europe away from big, long wool skins to new season lambs, the market hasn’t suffered yet. However there are still fellmongering lambs and sheep produced and they will find it pretty difficult to find customers in the near future. New-season lambs in Europe are still not really available in volume. The long, cold winter means lambs are not yet ready for slaughter and so a number of Turkish and Polish buyers are cruising around trying to figure out what the offers and what the prices should be. In the coming weeks we will have the Orthodox Easter (May 5) and this is traditionally a time of good volume of skins of young lambs in celebrating countries. The big question is how big they are and how the market will react when they are offered. For the time being, the privileged origins such as Spain and Italy have falling prices with levels declining by between five and six euros, which is not making negotiations in the market any easier.
For the next two weeks our level of alert is much higher. We are expecting a new direction in the market, either adjustment and correction or just a time of pause. This coming week the Chinese are taking a few days off for Labour Day and in most parts of the world the working week will be cut by a day with most countries celebrating May Day. Sellers will wait and see how much interest there is from buyers and the prices they bid, which will most likely be down. The seasonal kill in the US is now gradually picking up while the production season begins to phase out. Consequently, our expectations are rather for falling prices more than anything else. Traders and importers in China may see more risk in their positions and could become the trigger for price reductions.
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