Market Intelligence - 12.11.13
12/11/2013
The past two weeks were not too exciting, at least until the European Central Bank came out with the decision to cut interest rates in the euro-zone by another 0.25%. This was not really expected by the markets, which thought the crisis in the EU zone was fading already. The ECB decision means that the central bank is not convinced and needed to bolster the economy by a further reduction of interest rates, possibly also to fight against another rise in the value of the euro, which could have reduced the competitiveness of the EU economies.
In the end it was obvious that it was a rather political decision. Interest rates for the real economy are possibly already low and would not have needed another reduction, but very low interest rates and the problematic budget situation of many of the southern European countries led to a large majority of the ECB board voting for another reduction. Bad news for the private saver and good news for the financial ministers and possibly also for the banks.
The US has produced more positive news in the past fortnight, especially regarding its gross national product and the labour market there. This gave the value of the US dollar at a time when many in the market were expecting exchange values against the euro to reach $1.40. Many investors were caught on the wrong foot and when the data was released a sudden drop in the value of the euro set in, falling in only a couple of days by as much as it had risen since August to end the period at levels of around $1.33. Investors are starting to wonder what will happen next. From our standpoint anything can happen, because the euro bulls are still around. However, the EU economy looks still pretty vulnerable and the final months of the year are always determined by moves to prepare a position for the end of the year.
It was interesting that the main commodities that normally benefit from a decline in the dollar were not able to rise. Gold and oil to name the most important ones are falling instead of rising in line with a firmer US dollar. Oil investors are impressed by the high supply; despite the fantastic growth in automotive sales there is still abundant supply despite all the media attempts to talk oil demand and prices up. It will be good news for consumers if energy bills fall and heating oil stocks can be replenished at reasonable prices before the heating season starts in the northern hemisphere.
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The cattle hide market is continuing to rise and performs strongly. The declining kill in the US and large sales done in August and September, in combination with long term programmes, have cleaned up the productions of the beef industry pretty well and offered them further opportunities to test the waters with higher asking prices every week, the US packers being the most ambitious in this respect.
Other markets were pretty much currency-driven and in particular in Europe suppliers became pretty scared by the rapid rise the of the value of the euro and were relieved by the sudden turnaround towards the end of last week.
Apart from this, very little happened that we have not already discussed, so we spent some time trying to work out how profitable the industry is at the moment. As mentioned for a while, tanneries suffer from the rising cost of raw materials might in many cases have been operating at a loss for most of 2013. To the extent that tanners were willing to share the truth with us, it was quite interesting.
We were not concentrating on automotive tanners or on those who serve the luxury sector. They operate in particular conditions and enjoy strong demand for their products from their particular customer base.
For more standard tanneries the situation is pretty interesting. Most European tanneries we spoke to complain about their situation. Hide prices for them are on average about 20% higher than at the beginning of the year. The rising cost of energy, chemicals and administration due to EU legislation are adding to the problem. Leather prices have only risen by between 5% and 10 %, but order volumes are down and clients have increased their quality demands.
Rising split credits were helping, but could not compensate, so we hardly found any upholstery tanner claiming to be operating at a profit at the moment. The biggest worry is the falling demand for upholstery leather in Europe in what is generally considered to be the strongest production season there. Only those that have a decent level of exports to Asia in their production said that their order book is at least allowing them to plan production for a couple of weeks.
Apart from problems with production and margins, the highest alert level is finance. With the crisis in the banking business and present and coming new regulations the financial side of business is getting very difficult and risky. Those operating with high levels of bank loans are afraid that with insufficient results in the fiscal year 2013 their finance facilities will be cut and not allow them to finance their business any more. If raw material prices remain at the levels of today any further reduction in financial resources would be pretty crucial. The situation in the upholstery sector is significantly worse than that of the lower number of remaining shoe upper tanners.
In a second review we spoke to a number of tanners in China. Due to size and the different structure of the market there it is not so easy to get a clear picture. It is certainly not easy to get clear feedback on the situation of a company. However, in general it was clear that the situation is a bit better than in Europe. Although also suffering from the high raw material prices, the split credit has had a much higher impact on calculations in China and local split credits are so high that most tanners who had a decent stock position and a lower average price than their European colleagues were reporting positive results due to the immediate cash returns for splits. Also financing is easier and cash-flow can be managed in China.
This is why many of the Chinese tanners we spoke to were far less concerned about the rise of raw material prices. Although it might be a bit short-sighted, Asian tanners have a longer lead time until the raw material arrives; the worst scenario for them is a sharp price decline in the production season between purchase and the arrival of goods. With leather production now in full swing and results still all right, they are not happy with the sharp increase in asking prices recently, but being reasonably well stocked they are trying to squeeze as much profit out of the present market as they can before bothering about the next round of business. Certainly they will try to minimise the risk by reducing raw material purchases, but they are pretty happy for the moment.
We did not enjoy hearing, however, from many shoe upper tanners in China that they have experienced a sudden decline in leather orders in recent weeks. They expressed concern, as this is a bit too early from their point of view. In the north of China the trend towards more wet blue production and a rise in the production of substitute materials. This coincides with ongoing declines in southern and coastal areas.
In general the situation in bovine tanning in Asia is better than in Europe and the financial worries much less. The risk is just that one day leather orders and consumption could decline and we all know that this is something that will be answered with a quick reduction in production and activity.
In the meantime tanners are trying to respond to the high raw material prices again by chasing cheaper alternatives to their preferred origins. This explains why steer prices have increased but not yet reached the records of spring, while cow prices have already surpassed the record levels of spring. Also the cheaper origins of South and Central America as well as Africa are popular again. A lot of Chinese importers and tanners are travelling and have been seen in many of these parts of the world.
The split market is a bit mixed. While in Europe lime split prices are seeing some pressure and gelatine products have even seen some declines in prices recently, leather-related prices are as firm as ever. Some prices quoted in China for splits are so high that one wonders why splits are used when the price for grains is not much more. A lot of this is the consequence of the strong demand for suede as a result of high hide prices earlier this year. It will be interesting to see if fashion continues to support splits in the coming seasons. For the moment full hide tanners are enjoying the situation and the returns from this by-product.
The skin market is still in a strange two-fold situation. The top end of the range for nappas or linings is still performing extremely well with prices stable and firm. But standard items are still facing problems. UK and other European lambs are struggling to maintain their price levels mainly due to slow demand from China. Orders for nappa garment are said to be pretty slow and stocks too high. This has come at the wrong time of the year, with not much time left for shipments until the holiday break for new year in China (January 31 2014). Stocks still available from the Muslim festival of Eid al-Adha (October 15 2013) and current production can hardly be absorbed. It is surprising that with the prices reached for splits and hides ordinary lambskins are not more attractive in the leather market at the moment.
The coming weeks will be the last ones for discussing shipments to Asia from various origins before new year. By the end of November there will be a number of weeks when shipments have to be put on hold and can only be resumed in the second half of December for arrival after the holiday.
Many suppliers report a strong uptick in letters of credit openings and requests for shipment for safe arrival before the holiday. This is certainly a consequence of the firm market. No tanner wants to risk a delay that might invite a supplier to cancel a contract.
This is laying the base for a stable and firm market. Suppliers who have cleaned up warehouses and are still finding interest for hides every week are hardly likely to consider lowering prices for the near future. Those who are covered sufficiently will be thinking already about the first quarter of 2014, while others who are not so lucky will hope for falling raw material prices but are likely to have a tough time covering their needs at prices that fit into their calculations.
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