Macroeconomics
After the flood of good news and other positive economic indicators in the previous weeks, things went quiet again during the period under review (November 3-17). Some of the previous stock market gains were eroded as the dollar gained ground, reaching €1.14 before sliding back to less than €1.17.
After the massive increase seen in US GNP in the third quarter, fears that growth in the fourth would be sharply down gained strength. However, US consumer spending remained as strong a force as ever, as evidenced by the rise in the closely- watched Michigan consumer index on Friday, which climbed 3.9 points to reach an 18 month high of 93.5. Europe posted more mixed results with the Reuters Purchasing Manager Index also being up. But then retail sales in Germany were down by more than 3 % in September while unemployment remained as stubbornly high as it has been in recent years, at around 10 %, the same as in France. Auto sales in Germany dropped in October by 4 %, confirming worries that the September rise was just a blip.
Just as interesting were the stories carried in world’s press on the massive and increasing influence of China, which is fast becoming a major player in the world’s commodity markets. However, businesses and governments are also starting to worry about the dominance of the China Dragon. Though this is nothing new for the leather trade, commodities purchasers in South America are feeling particularly vulnerable, as are those in Australia, New Zealand and also some of the countries in Africa.
The situation in Iraq is clearly becoming more serious by the day, as is the inability of the US to manage the country effectively. There is now the danger that Iraq could become a never-ending conflict like that between Israeli and the Palestinians. The consequences for the US economy, both in terms of the national budget and the effect on consumer confidence, can only be guessed at.
Another confident move by the Chinese Dragon was the joining of forces between TCL (China’s largest TV maker) and France’s Thompson Group. Thompson has taken a majority 33% share in the joint venture while heading the marketing and distribution into the European market. In one of our early versions of the MI we explained how manufacturers in China develop, moving from the supply of basic commodities, to manufacturing, then finally distribution and the whole supply chain operation. The deal is a textbook example of this model.
Market Intelligence
The past two weeks were dominated by developments in Europe which were mostly negative, confirming our long held belief that the industry is undergoing a major restructuring. As far as price and trading developments were concerned, though our immediate forecast for the US market was bang on, it was too optimistic with regard to Europe. In the US, trading activity was subdued as sellers played the low slaughter card. Buyers meanwhile stuck to their story of having sufficient inventories, too many holidays and (as far as the larger operators were concerned) insufficient margins. So a standoff ensued, as each side waited for the other to make the first move. As it was, buyers teased sellers with bids of 3-5 % below market levels. For their part, sellers responded with disinterest, pointing to the low kill and pretending they had little need to sell.
Both positions were nothing more than feints. Sellers need to sell again and probably need to move even more shipments in view of the upcoming holiday season. Buyers for their part will have to make their decisions by the beginning of December at the latest, if their production is to be uninterrupted. Sellers in the meantime could fall into the trap of believing that the leather business is not as good as it looks. Nevertheless, tanners are likely carrying better inventories than is widely assumed. They also have time on their side as they can stretch their inventories due to the upcoming holiday season.
The holidays may indeed be the key factor to the whole situation. We remain convinced that the leather business and the outlook for 2004 is reasonably good while the latter part of 2003 has worked out better than expected. The shops are not overburdened with inventory and despite the downward pressure on them, prices are holding steady at retail. On top of this there is also a general willingness to replenish stocks for 2004 at both manufacturing and retail.
But then there is the problem of timing. Not so much in terms of the US where lead times and production cycles already chime with the established practices surrounding the import of consumer goods from Asia, but in Europe. Here, the tanning industry’s comprehension the dominant supply and demand cycles is now lagging way behind the reality of the here and now. With the continuing migration of production to the Far East, product variety, flexibility and lead times are all changing rapidly. Starting with the acquisition of the raw material, production cycles have been extended from 60/90 days associated with European/US consumption to the 120/180 day timeframe linked to Asian market requirements. At the same time, levels of volume and quality/product varieties have contracted sharply. As a result - and whether they like it or not - the position of European raw material suppliers in the supply chain is being redefined across a whole swathe of different hide types. Though many have yet to wake up to the fact, they are now on the threshold of a new era in pricing, logistics and timing. They need to ‘get with the programme’ or risk being left out altogether.
This scenario fits very well the latest consolidations that have taken place in the meat industry. Via its ‘Bestmeat’ subsidiary, The Netherlands-based beef and by-products company Sobel, has added Germany’s Nordfleisch to its portfolio, the result being the second largest beef producer in Europe. Together with the existing Sobel subsidiaries of Dumeco in the Netherlands and Moksel in Southern Germany, Nordfleisch in North Germany completes a nice triangle on the continent for the company. A company spokesman claimed that synergies will contribute massively to results, adding that he expected the European beef production to eventually become dominated by five or six major operators, the same as in the US, and a consolidation of the by-product distribution side of the business can expected.
As was recently reported in the news section of leatherbiz.com, Shanghai Richina (side leather) and Garden State Tanning (automotive) have formed a joint venture to expand productions in China. Apart from the fact that it means a further concentration of production and purchasing power, it is further proof for the restructuring process taking place in the trade.
This process has been at work for some time in Europe as was seen earlier in the year when a large and reputable vegetable tanner in Spain filed for bankruptcy protection. There was also the loss of Ireland’s last wet blue plant with the closure of the Michell plant. In Italy meanwhile, rumours of voluntary closures in production in the coming months continue to do the rounds. And so the process continues.
As stated, we were a bit too optimistic in our assessment of the European picture, believing from our discussions with tanners at Bologna that the market would settle and find a solid base. And while we still believe nothing has changed as far as the fundamentals are concerned, it was evident that Europe’s busiest tanners were not sufficiently moved to improve the market sentiment. Buyers have yet to take advantage of the attractive raw materials prices being offered by European sellers who continue to be burdened by the high kill all over the continent.
As it was, the first week after Bologna was widely seen as the week to take stock of what had been learned at the fair and receive international customers and friends who remained in Europe. In the following week, the mood became more depressed as the bad news began to dominate. The companies with good and profitable order books saw their chance and started contesting the large number of offers being put their way, citing the reduced production over the Christmas holidays. A two week shut-down is looking likely this year and many are even talking of a three week holiday. In that it can be safely assumed that the slaughterhouses will also slaughter less as the holidays are set in the calendar - and that slaughter levels are likely to remain low afterwards because of the carnival season- our advice would be to lock in as much profit as possible by trawling the market in a sensible way over the coming weeks, and buying as many hides as possible.
But we are fully aware that this position is not likely to be very popular in today’s business climate, especially in the Western world. In the good old days producers were willing and able to build stock in this way when they considered it profitable. Many also built hidden reserves at the end of the fiscal year by buying inventory which they could then write off against tax. In today’s just in-time dominated world, however, and under the new banking rules, almost every company is being forced to keep inventories to a minimum. In a raw material environment where storage and interest charges can double or even triple of the annual cost of the raw material itself, this not a particular smart policy but an excellent opportunity for those unburdened by the rules of company controllers or bankers.
The logic outcome of all the foregoing is that, towards the end of the year - instead of seeing an increasing level of demand and deliveries in Europe when market prices are low – the opposite is now true. Sellers are trying desperately to lower their inventory while buyers are in the main not willing to buy or take product before the end of the year. That this is not very good for the market price is obvious, but at least it offers opportunities for those who do not follow modern management methods such as just- in-time.
In most parts of Europe there is still one more round of major price negotiations with the abattoirs and tanners to go, in the first half of December and undoubtedly, many European tanners will see this as an opportunity under the present conditions to give the market another beating. It follows that for the moment at least, the buyers are the ones holding all the cards, especially those with sales locked in for the coming months. They have the added opportunity of widening their margins further, allowing them to lay a very good base for the first quarter of 2004.
Another thing preventing market consolidation in the previous weeks were the strong rumours doing the rounds concerning tax and Customs authority investigations in Southern China. Tanners being imprisoned, companies no longer answering the phone, even Customs and forwarding offices being visited by armed heavies, the rumour mill had them all! Then there was the less sensational but no less serious news of containers being stuck in port, goods becoming available for re-sale and delayed shipments. From what we are able to gather, the investigations are every bit as serious as they have been made out to be, even if they are only a re-run of those seen in the Shanghai area earlier in the year. They show that either Beijing is serious in its intent to clamp down on uncontrolled currency movements or it’s simply a case of local officers reacting to not receiving their usual ‘commissions’. Most likely, it’s a bit of both.
Whether this is a major issue for the trade is a different matter. While is likely to impact on split prices, many of which are destined for Hong Kong, this is likely not to be the case in terms of hides. This is because the big volumes go to joint-venture operations. In any case, the percentage of hides entering China via Hong Kong is simply not that great. As ever, the psychological effect was greater than the reality, so it weighed on the market mood.
As it was, the split market lost a bit of momentum. Not that prices were immediately affected, but quite a bit of confidence was eroded nonetheless. In Europe the split market remains reasonably well cushioned by the strong demand for collagen products, even if producers are beginning to worry that, with the move of leather production to Asia, local supplies of lime splits will dry up. The collagen industry also has to worry about EU regulations regarding the transparency and origin of collagen for human consumption. In theory, these allow hardly any splits to be used for collagen production. Fortunately, the authorities in most cases have chosen to take a pragmatic view to the enforcement of these rules, as otherwise another valuable raw material would be denied to European producers. For the time being at least, demand for bovine collagen seems buoyant as producers try to secure supply
