Market Intelligence - 09.07.13
09/07/2013
The world is entering the holiday season, but has not become quieter yet. Although the situation in Turkey has calmed down, new riots in Egypt have led to another takeover of power in the country. Now it is the military again and it is not totally clear yet what the new balance of power is going to be. Considering that Turkey hasn’t made the headlines recently, but having been one of the strongest supporters of Egypt’s ousted President Mursi, and remembering the conflict in Syria, it is pretty obvious that the region is still in a state of turmoil.
This has led to another strong recovery in oil prices; it seems that apart from any physical shortage, speculators and investors are happy to take any piece of news to push up the price of this, the central energy resource.
In Europe the euro crisis has made the headlines again after one of the key ministers in Portugal stepped down. Bad news about the labour markets added to the concerns and have forced the European Central Bank to make a statement that interest rates will stay low and the money supply will continue to be sufficient. This has weakened the euro considerably; it has lost almost 2% against the US dollar in just a week. At the time of writing we have been back to levels of $1.28, the level the currency was at before bouncing back significantly. Many pundits are now expecting the euro to enter a new phase of weakness and would not be surprised to see a slide in the third quarter.
In China the government is trying to play credit problems down. The authorities seem not to tire of explaining that the financial system is in order and media have been asked to report and speak more positively about the present situation. This is not good news and many people familiar with the situation are pretty concerned about a credit bubble and the problems of bad debt around the country. Apart from enterprises, many are talking also about local communities that have overspent by investing far too much credit during the recent boom years. One must not forget that the central government in Beijing asked the provinces to invest in infrastructure and to create jobs and growth. Hardly anyone can really know what the real situation is, but we tend to believe that the situation is more critical than many want to admit today.
In Brazil – also one of the strong performers in the past – people have taken to the street to demonstrate for better education and infrastructure and by looking into the issue one had to realise that Brazil’s recent rise had been more on the basis of the export of raw material resources and the rise of asset prices rather than the result of a growing industrial base and production. This makes the situation as fragile as it had been in other regions before.
The summer is traditionally the period for little to happen on the financial markets and for politics to be the main focus of the news instead. We tend to believe that 2013 is going to be no exception.
It’s also worth mentioning the widespread espionage on global communication. What has been published by former Central Intelligence Agency employee Edward Snowden was already known, but has been brought to global public attention and has made up a lot of people’s minds about privacy and civil rights. It is pretty obvious that in the time of the internet individual privacy and civil rights have pretty low values and governments do not tend to respect them any more. This includes the Western democracies. It is another clear example that whatever is possible to do will be done eventually. You just have to look for a justification.
Market intelligence
The issues of market intelligence tend to be a bit shorter in the months of July and August. Although Asia is not on holiday it is also influenced by the general summer slowdown in activity in the northern hemisphere. This is affecting manufacturers in this part of the world with many export customers not being available for any discussions or supplies. In many countries the temperatures are also pretty hot, which is weighing on production activity too.
While in previous years less activity during the summer was the main reason for shorter versions of market intelligence, this year is a bit different. For some time already everybody dealing with the leather pipeline has been suffering seriously from the lack of real activity and news. We have dealt with this subject a number of times already and don’t need to repeat it again. There is still the supply chain, there is still the leather pipeline, there is still the raw materials market, but all has become extremely static these days. One of our colleagues mentioned that recently in one of his weekly reports.
Consequently there is very little to think about and to report. The leather pipeline starts with the raw material, which is still accounting for anywhere between 35% and 60% of the final leather price. With a steady growth of private consumption in the emerging markets even the massive crisis in Europe and the US were compensated for. After a sharp decline due to the financial crisis in 2008 prices of raw materials have recovered and demand for leather products has steadily grown. The massive contraction in the protein industry is aimed not only at controlling their core business, but also to focus much more on the by-products. This has changed the structure of suppliers in most of the dominating supply origins significantly. Many packers have become producers of semi-finished or finished leather and gained so much control of supply, in combination with an intense analysis of the added value chain, that they feel entitled to set price levels for the raw material.
This has been pretty successful when we look at a timeframe of the last 12 to 24 months. We have to admit that it took us quite a long time to believe how serious the suppliers were. With the growing demand for leather, in particular in the emerging markets, this strategy has turned out to be completely successful. As long as the demand for leather was growing they were, and possibly are still, in the driving seat when it comes to pricing. One is reminded of the OPEC cartel and the oil market, with the only difference that there are no futures markets and hedging is not really possible for hides and skins. What we have had until now is producers who can turn the supply tap off and on as they think is advisable not to endanger the price of the product.
What market players are discussing now is if prices have been so overvalued as to negatively influence the demand for leather, so that the production of leather in the next seasons is set to decline. Looking at sales and shipments, one tends to believe that the demand for leather is already shrinking because the positive mood and the strong demand for raw material in the first quarter has ended already. We now have a slowdown in purchasing and far longer-lasting inventory positions in most tanneries around the globe. The supply side believes that the traditional recovery of demand and production in the winter semester will sort that out and raw material demand will be high enough to absorb the stocks they had to build up to obtain the target prices they wanted.
It’s a very difficult subject to deal with and you can find arguments to support every position. However, one way or another it will become a risky game for either side. We are still trading at or close to record levels. Rising prices will quickly exhaust the remaining financial resources of the tanning industry whereas falling prices could mean depreciation of the value of inventories, not to mention the usual problems connected to falling markets. This might be one of the reasons why the markets are so stable and trading has been in such narrow ranges for such a long time.
All will depend on the position the supply side can and will take. No matter what suppliers say, the flow of product hasn’t been sufficient for some time. This means nothing as long as the supply side can still hold the material and just move what is needed. This game can be played for a long time and if it lasts long enough the day will definitely come when buyers have exhausted their stocks and have to return to the market to replenish their inventory. However, all this does not answer the fundamental question about leather demand. If the declining trend continues and the consumption does not recover enough it could become nasty.
So far any bad news has been ignored, but we read in the latest news that the once market leader for leather furniture Natuzzi has had to lay off 1,700 people due to ongoing losses. Is this a company problem or a synonym for a fundamental problem for leather furniture that is hitting others equally hard? What are we to think of the never-ending stories from China that shoe sales are short of targets, that wholesalers and retailers are paying late and sales are behind budget? What are we to think of the serious complaints about production costs rising all over and the material cost of leather not being absorbed into the pipeline at the moment?
We can leave these issues at this this stage because the fundamentals seem to be reasonably clear and we might have to wait until after the summer holidays to see how the raw material market reacts.
The split market remains strong on the back of the demand for more economic raw materials. Wet blue drop splits are still finding ready takers. However the situation in the collagen market is that prices are no longer as firm as they were because some of the alternatives to lime splits are showing the first signs of weakness. If prices adjust further into the fall, the market for bovine lime splits will face more headwinds.
The skin market is still difficult. European sheep and lamb have settled down after the sharp spring correction. Demand for new season lambs in the north of Europe has fallen well behind expectations this year although there are fewer skins available because of the long, cold winter. Nor is China showing great demand for nappa skins owing to the large stocks built up in the first quarter of the year. So, like in the bovine section, most interest remains in isolated and privileged segments like shoe lining, high-quality and light double-face and nappa. Prices haven’t moved by much recently.
Over the coming weeks business will continue to slow down. Only Asia can deliver surprises because they are not going on holiday. From our perspective we do not share the hopes for a large round of sales. Most tanners seem better stocked than suppliers would like to see it. Yes, they will have to replenish one day, but if we look at the total raw material demand this year in comparison to the previous ones, you see the declines. Either the leather industry was overstocked already and is winding down the inventory it built up or the demand for leather has been shrinking as a consequence of price.
If one looks at many casual summer shoes, mainly from the big brands, there is a clear trend for more colour and design, but far less for leather as a material. Youngsters as consumers care about design, brand and price and less about quality material. Looking at the weak performance in leather upholstery and garment too, one has to have concerns that any seasonal rebound in demand might be less pronounced because of price and margin problems for the majority of companies in the leather industry.
Well, we must wait and see how the situation continues to develop over the summer. The next strong trend-setter might be the All China Leather Exhibition in Shanghai at the beginning of September when the trade gathers and market discussions become more intense again after the summer break.
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