Market Intelligence - 17.09.13
17/09/2013
The Syrian crisis remains a major concern. However, concerns about a military strike and its consequences have eased a bit with the option emerging of the destruction of all chemical weapons under international control instead. The news of this was more important than how realistic a proposal it is. Politicians favouring an air strike have found very little support in their own countries and most of the world was happy to see reduced the risk of another war in the region without having any serious solution to the human drama which has developed since the civil war began.
Like all previous Middle Eastern interventions this one has little chance of being an easy, short and effective one.
The financial markets reacted predictably. Oil prices fell and stock markets advanced.
Of the remaining sectors we saw gold falling again. The markets believe in a modest recovery in Europe (although anyone who thinks the crisis is over must be naïve), with some recovery in the US also, Japan posting good growth and China showing steady and on-track growth of around 7.5 %, with no indication of a slowdown for the rest of the year.
It’s worth mentioning the decline of currency values in the emerging markets. Already an issue for some weeks, the lower values are having an impact on the leather pipeline too. Exports from these countries are becoming cheaper and more competitive.
The US dollar is still trading in a narrow band between $1.31 and $1.33 against the euro. It seems that the end of the tapering in the US may be in sight and this, with the elections in Germany, are the factors holding the market in tight control.
Market Intelligence
The long-awaited show in Shanghai is already a week behind us and most people are back from their trips and have had time to digest their visits and impressions.
Although most things about the show have already been said in various reports, we would like to share our main impressions and information with our regular readers.
Basically the weeks around the show had delivered pretty much what experienced long-term analysts of the raw material markets had expected, with the situation in the US being the main centre of interest. With more than 30 million hides a year, the US is one of the three largest supply origins for the Asian leather industry.
After the US market had, for the vast majority of the leather articles, catapulted itself out of the price range of many (if they wanted to produce profitably), suppliers tried to hold positions and keep prices steady throughout the spring and summer. By the beginning of the summer it was already obvious that this was proving unsuccessful. Prices began to ease and suppliers had to take the decision either to correct the market before the All China Leather Exhibition or to hope for a sharp rebound in demand after the show.
Already some weeks before the show it was clear that suppliers were not willing to take the risk of attending with large numbers of unsold hides, which, by the way, were well known about among buyers. So, many sellers travelled early to visit buyers, trying discreetly to convince them to buy larger volumes prior to the show, and to a certain extent they were able to do so (if they were willing to discount prices significantly). How far these discounts had to go remains a secret, and the prices published were only half of the story anyway. Buyers claim that they got a number of hides cheaper and sellers claimed to have obtained what they announced and published.
At least US sellers were in a position to stimulate demand and the published number for the week before the fair saw a total of 700,000 hides sold. Since this exceeded the weekly slaughter figure, it was taken as a great success and sellers immediately returned to their claims that they had sufficient contracts to justify higher asking prices at the fair and to challenge those who had not made a final purchase decision yet. At least it took a decent amount of pressure off the market, which was a good starting base for the fair.
Sellers were hoping for another round of active sales during the show from buyers who might have been scared to miss the boat. On the first day of the fair it even looked as though this would work. The owners of many small and medium-size tanneries from Hebei province came to visit the show. With a lot of beamhouse business being relocated in the past months to that part of China for cost reasons, they were pretty optimistic and willing to buy smaller packages, with the sheer amount of buyers adding to reasonable sales. However, it turned out as the show progressed that the large buyers were not at all enthusiastic and did not really follow their colleges (and definitely not at higher prices). That made it one of those weeks in which sellers were asking higher prices and were not willing to go lower while buyers said they were not willing to buy unless prices were in their favour.
This leads us to a far more interesting question about leather demand. No matter what raw material suppliers think, in the end everything is determined by the volume and the price levels of the finished leather market and the products companies make from the material. From this perspective the trips to Asia were far less positive. In China at least it was hard if not impossible to find any tanner who was expecting leather demand to be higher in the coming season; quite the reverse, the majority thought it would be lower on a year-on-year basis. Certainly price pressure will persist and this forces producers towards cheaper leathers and raw materials. The extent to which this has already affected the market can be seen in the rise of exports from Brazil and the difficulties the US market has had in the same period. Anyone travelling in the Chinese centres of leather production in recent weeks will have seen cheaper hides in the warehouses as higher-grade hides are being substituted by lower ones. This can easily be seen in the rather stable markets for cows in Europe and the US. Cows have replaced steers and bulls in the raw material product mix for many shoe and bag leather producers.
This is not good news for the raw material market in the longer term. If price continues to matter, we will see demand fading and greater levels of substitution and replacement. This is generally not depressing the market in one hit, but is a slow process that puts pressure on prices in steps. We have to admit that we are seeing a lot of this already.
With production costs rising in China and the RMB steady or even slightly firmer, those emerging markets that were being hit by falling currency values have felt the benefit, in particular those that have a local raw material base. Speaking to tanners in Vietnam, India, Indonesia and Pakistan, we heard far more positive statements about the situation, in particular from tanners directly connected to local manufacturing of shoes and other products, and even more so from those involved in an integrated manufacturing set-up.
The trip to China also provided confirmation that, besides the cost problem and the uncertainty of demand and finance, increasing environmental controls on the part of the government there is also an issue. So far, problems are still isolated, but several bankruptcies have been mentioned and a number of hide arrivals in the summer had to be resold because the initial buyer was not able to pay or clear the goods in time. So far, this is nothing really serious, but it can be taken as a general statement of the industry that companies with high leverage are finding it difficult to run their business.
There is a vast discrepancy between the Chinese companies operating businesses with a domestic focus and those that still focus on production for the large export brands and retailers. While the smaller units producing for local consumption are still finding business acceptable, the export-oriented companies are complaining about the profitability. Buyers are unwilling to raise prices sufficiently to compensate for rising cost and wherever possible many are reducing orders in China and expanding into other south-east Asian countries. Even large Chinese manufacturers and brands are taking advantage of cheaper production conditions outside the mainland. One operator has confirmed to us that he had shifted a whopping 25% of next season’s production from China to Vietnam and Indonesia. Nobody knows yet where the next tiger will rise (Myanmar?), but there is always an option to find cheaper labour, even if it means getting more of China’s West involved.
Certain trends can be considered influential for the next developments in the leather pipeline. First, the gap between luxury and commodity will widen further. Second, demand trails well behind that of previous seasons and if automotive were not having such a strong performance it would even be worse. Consequently, price is still the determining factor and cheaper alternatives are winning against better quality. We have seen record prices for splits and strong demand for cheaper origins.
At the same time the Chinese consumer market is no longer an endless growth story, and looking at several stocks along the pipeline in the wholesale and retail markets, the optimism of the past year might have been too high; inventories of unsold consumer goods have built up, and need to be cleared. However, travelling in China still shows consumers there are shopping-friendly, so the problem of unsold goods should be temporary.
Leather as a product is still vulnerable, it can still be substituted and the consumption from season to season can swing more in quality and quantity than many in the raw material supply section tend to accept. The usual logic, that a stable supply of hides and skins while demand for consumer products grows grows will constantly allow higher prices, is not working.
The USDA export sales reports for the weeks around the All China Leather Exhibition were somewhat better and some of the inventory could be moderately reduced. However, we are not impressed. Looking at the market performance of the past quarter, thinking about the massive wet blue stocks, and knowing that we are at the beginning of the high production season these numbers might provide some consolation for a week or so, but nothing more. We would like to see a few more weeks of the same to gain the necessary confidence that the tanning business is strong enough to support the market for some time.
The new season has now begun and over the next six or eight weeks, at least for the western markets, order decisions will be taken. When they are locked in, we will know more about the volume of leather required for the next season. At present it seems to be pretty stable on a consolidated level. And this is not the worst news. Packers should not complain about prices for their valuable by-product. In most markets it is still at a very high, sometimes even record level and certainly higher than a year ago.
The split market has shown a very strong performance again and the prices quoted are now jumping from one record to the next. Demand is strong and the little break we recognised in recent weeks has turned again into a very strong performance. Prices rose again and everyone with splits to sell was more than happy about the situation and the returns. This has definitely been a great help for tanners’ calculations and another confirmation that leather demand is shifting towards the cheaper products as a consequence of strong headwinds in consumer markets.
The skin market had also seen a decent recovery, having been sluggish for the standard qualities and strong for the luxury items over the summer, we have traced a decent recovery with prices for European lambs and sheep climbing silently by by between $1 and $2. The better the material, the more pronounced the rise. The recent and sharp advances in the wool auctions in the UK, Australia and New Zealand have certainly added and supported this confidence, in combination with the fact that average skins are hardly expensive after their drop in spring and early summer. This makes it far easier for the tanners to replenish their inventories even when leather orders are not yet in.
For the near future we don’t expect much of a change. We will presumably see a similar market pattern as we did over the summer. Top quality will remain in short supply. Automotive will outperform. Raw material suppliers will try to hold prices up, tanners seem to have bought what they need in the coming weeks and so it could become a decent stalemate for some weeks now. The next leather fairs in Bologna (October 8-10) and Paris (September 17-19) are already upon us or looming on the horizon and they will tell us more about the high-end market. It will be interesting to see if the rumours are true that high street brands are beginning to think about reducing leather consumption to avoid seeing raw material costs going even higher and impacting their results.
For cheaper origins like Central and South America and Africa, we can be positive. Some in the emerging markets with a raw material base might receive a boost in orders, because they are becoming more competitive with their declining currency values. For the expensive, standard raw material origins we continue to be cautious, because we are of the opinion that they are still overvalued, based on the actual leather prices and the trend in leather types. However, packers will not surrender easily and a number continue to tell their customers that they would rather hold onto their material than offer discount prices. Well, that was what they said in spring and prices have fallen by between 10% and 15% since then. If other markets follow, things will be interesting over the coming weeks.
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