Market Intelligence - 25.06.13
25/06/2013
The general mood in the financial markets is no longer free of concern. The conflict in Syria, which could spread, is keeping oil prices high. The demonstrations in Turkey could develop into more confrontation and add to the instability in the region.
More people are also pointing to China and debating if the economy there could be facing a credit crunch pretty soon. Some analysts are repeatedly talking about financing problems for small and medium size companies and large numbers of bad debts among the big players and government companies. The banking system could consequently face a serious problem soon.
Many pundits are pointing to the small positive cash-flow many companies are generating and the question of what will happen to the profits, if any. In most cases they are not shown as dividends or reinvested, but just pulled out and distributed in the public sector to ‘supporters’ and in the private sector to add to the wealth of the owners, but not so solidly as to finance the business well and reduce debt. What works in times of strong growth and easy access to loans could eventually become a serious problem, as we have seen already in a number of cases in thriving emerging economies. Possibly the Chinese government has a better grip and control of the economy, but whether it is really sufficient and politicians are independent enough to take adequate action at the right time remains to be seen.
In the US the Federal Reserve has indicated an end to the ‘easy money’ policy and this is beginning to worry investors. The US dollar has lost value and investors are still not clear about what the end of the era could finally mean to them. For the moment the markets have decided pretty much for a ‘business as usual’ policy. Shares are still the best investment for many, while bonds are more risky with the expectation of rising interest rates. Precious metals are trapped between those who still believe that they will see a great recovery when inflation returns and interests rise, and others who consider them a useless and non-yielding investment.
Oil is presently only benefitting from the supply risks in the Middle East. Large inventories of oil, higher production and stable demand should have put prices under more pressure if market logic were just following supply and demand, but speculation remains the driving force and with a certain structure on the futures market you can still make pretty easy money without too much risk.
One cannot deny that the forecasts are still pretty positive and although global growth is expected to slow a little, it is still believed to be well above 2% in 2014. So far, so good. But the mood and the sentiment of business people around the globe is not longer as faithful as it has been for a long time (excluding the regions of crisis in Europe of course). No one is able or willing to specify the concerns, but privately the rise in risk potential for business is being mentioned far more frequently. The summer break is traditionally not the time for big action or changes, but may be a good time to analyse and prepare.
Market intelligence
The market games continue. The leather pipeline is tied up in a stagnant raw material price and market situation. Suppliers are trying to continue to control the market and are managing the situation pretty successfully at the moment. They are just waiting for the few tanners who still need material to fill their productions, paying the price asked. This is not really volume business and we cannot find anyone in the major leather producing markets who is talking about volumes of raw material purchases that would reflect a certain market confidence or proof that present raw material price levels can be converted into the equivalent leather prices.
While buyers argue, that they have no clear picture of leather demand and prices for the second half of the year, sellers are pointing in the direction of raw material increasingly being needed in the busy season after August. Tanneries will have to purchase and accept the price in the end, whatever it is.
We have been in this market situation for almost the whole second quarter of the year. Except for some minor corrections in some origins (US) the market has been trading in very narrow ranges with lower selling volumes not being followed by lower asking prices. In Europe tanners have had less inventory and the lower seasonal slaughter in this part of the world has allowed packers to hold abattoir prices higher than international price levels actually justify. Overseas, many origins tested the limits and found them. Not to cause too much damage, slight adjustments have been made in the second quarter, but generally we are still trading at or close to record price levels.
The poor profitability and uncertain outlook for the leather business for the rest of the year has taken quite a bit of the enthusiasm away and as the second quarter progressed, the more faith has faded. However, the raw material markets and the leather pipeline have not yet come to any clear conclusions.
The main problem from our perspective remains the fear of the consequences of a decline in leather demand and price reduction. Except for packers, almost everyone is longing for a market adjustment, but everyone knows it would be painful too. Less demand means less business and less production, more competition and more losses. We have not had the best of times so far in 2013 and another hit would not be what the leather pipeline is looking for. So everyone is waiting and hoping for a breakthrough and some positive news from retailers and manufacturers, indicating that next season will see a rebound in demand and the chance finally to adjust leather prices to the raw material price levels we have reached. All of this excludes the two thriving sectors: luxury and automotive, at least still for the moment.
How realistic is the hope for better times and business in the second half of 2013? Well, one can never be too optimistic. There is no real concern, but what we need is improvement versus what we have seen so far. For the last six months production has been for finished product that will be on sale to consumers in the coming six months, so what we have seen in the market is already past, only needing to be sold now in the shops. The biggest problem in business is not what happens, but how much expectations and plans have been fulfilled. Basically, we had the opinion that most people have been reasonably disappointed and that budgets in many cases have not been reached. While some big brands and corporations may have met their targets, it seems that the markets and retail businesses that are not individually monitored had have not performed the way their owners had been expecting.
Just looking at the constant information about cash flow issues and just noticing the delay of payments in domestic China is an explanation for most of the story. If retail sales take place, retailers would be able to pay suppliers as soon as they order products for the shelves, and then the suppliers would be able to pay manufacturers. It doesn’t seem that this is running a smoothly as many people were hoping and expecting. So either the retailers have taken their cash and used it for other investments or they have not reached the levels of turnover and sales they needed to pay on time for what they ordered. There are number of people talking about reasonable stocks of shoes and other consumer products that are still waiting for buyers.
In the US and Europe retailers were much more cautious in view of the uncertain times in the general economy. However, this was already reflected in the decline of export orders for the main manufacturing countries around the globe. Again, talking about China you hardly found any manufacturers who were not complaining about export business, and saying that only domestic demand was generating the margins and the sales they needed to continue and maintain their productions. If China is now slowing down because of insufficient retail sales or the risk of a credit crunch, it would hit production pretty hard, because it is unlikely that other markets around the globe would be able to compensate with an increase in sales and orders.
The leather pipeline, like many others is actually operating like a harmonium. You pull and the instrument sucks air in, just as the leather pipeline sucks in material. When it is completely stretched it comes to a stop before turning around. Just as the instrument then pushes air out, the pipeline pushes material back.
We might already have been in such a situation for some time, but if we have it has been camouflaged by the positive edges in the business and the willingness of many suppliers to balance a decline in demand by building inventories.
A clear picture is also given by sales structures, as far as one can obtain realistic official data. To make it simple, we can just focus on the exports of raw material from the United States and from Brazil. The sales and shipments of hides from United States have never reached the levels to justify the firm prices we have seen. As a result, many manufacturers decided to look for more economical alternatives and this can easily be seen in the double-digit rise of Brazilian exports this spring. So a lot was taken out of the expensive markets and shifted to more economical raw material sources. It proves also that the leather orders were there and needed to be covered. It was just a question of price.
As we have already mentioned numerous times, it all depends on the price for finished leather. Since nobody has seen sufficient increases for commodity leather, the raw material market in the volume segments had to hit a ceiling, and with the change of the seasons we are in now, people have had the chance to reconsider the material used. We cannot find anyone who is not checking and discussing cheaper raw material alternatives to keep business running and to meet what the market expects as far as prices are concerned. It was just too much to expect that leather could be seen as a premium, exclusive material and could achieve premiums in retail products. What worked in the premium end with high added value did not work in the commodity market. It might still in the long-term, but it is naïve to think that you can expect the consumer to pay a premium right away. This might have worked up to a certain point in the emerging markets where consumers had more wealth and were ready to buy products that portrayed the right image. But it can take a long time to achieve this.
Demand and prices might have been thriving for quite some time on the back of increasing consumer consumption in the emerging markets, and a lot of the raw material price increases were compensated by currency effects, average higher retail prices in China, much better returns for splits and by the cost-averaging effects of inventory management. However, this was last season and now everybody has to think about the next seasons. The price levels we reached in the last cycle seem to be too high; manufacturers expect that they can achieve the equivalent selling prices on a global scale in the seasons to come.
Nobody knows if this will prove true yet, but the confidence is there and consequently everyone has become pretty cautious and the demand for raw material and leather has been shrinking accordingly in the past months. So far this has not been converted into cheaper raw material prices but it has definitely already converted into a shift from higher-priced materials to more economical alternatives. The coming six to eight weeks will be pretty decisive because the manufacturing pipeline will have to decide on how to act for the coming season. It seems people are not overly excited and more cautious than optimistic.
The split market continues to be pretty firm. Not that prices are significantly rising, but the levels they have reached are impressive enough. The combination of the demand from the leather industry for more economical items and the rising use of bovine collagen in pharmaceuticals and food is keeping demand pretty high and the added-value potential, in particular in foodstuffs, is supporting the price levels we see. Without a clear indication about fashion and materials for the next season in leather production, it is difficult to say what will happen to splits, but in our view they are looking presently a bit overvalued in comparison to the price of some full hides.
The skin market is basically running to the same pattern as we saw a year ago. After a steep rise in the first quarter, there has been a decline in the second and presently it seems that prices are beginning to settle down. However the demand is a bit of a mixed bag. China is still very quiet and people are still reporting large raw material stocks sitting around and waiting for customers. The Turkish market is recovering a little and the demand for new-season double-face skins is beginning to improve without having any direct impact yet on prices. Lamb and sheepskins, in particular in Europe, look pretty attractive from a price standpoint and if bovine raw material in many cases is too expensive, ovine raw material is, in our opinion, attractively priced at this moment.
As we have already said, we believe that July and August will become quite important. The stalemate between buyers and sellers has to come to an end and decisions have to be taken. The beef industry, under the lead of the slaughter industries in the Americas, will do everything to defend the prices of their byproduct. They are counting on large industrial producers of leather to replenish their inventories and this should give them the opportunity to defend against any major correction in prices. However, the big boys are just one part of the market and they can’t make it on their own. Private deals in volume with undisclosed price levels will have to secure product flow and volume sales while the rest of the market and the reference prices in the official reports will tell another story. This has worked pretty well so far, but it will only work in the future if enough sales and product flow can be generated to lift the pressure to sell. This would require a major improvement in leather orders for the next three months and at this stage that doesn’t seem likely.
For the short term, that dice are not yet thrown. Only serious disturbances from the financial markets and economies in general could trigger something serious in the short term. The public continues to see a reasonably steady market, even if the reality behind the curtains is different.
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