MARKET INTELLIGENCE – 09.07.07

Macroeconomics

The main focus of interest over the past few weeks has been the futile terrorist attacks in the UK. After a fairly long period of tranquillity in the Western world, the terror threat raised its ugly head once again and reminded us all of the latent risk we are facing, wherever we may be. However, the financial world seems to be quite used to it now and the global markets didn’t really react too much. They quickly returned to normal business and soon busied themselves once again creating virtual wealth through mergers, acquisitions, take-overs, etc. The stock markets are continuing  to yo-yo and the markets in China, in particular, are highly volatile at present with movements of 3-5% in a day being nothing unusual.

Oil prices have increased again and global interest rates continue to slowly rise. This time it was the turn of the UK central bank to raise the price for money by another 0.25 %. And, with the financial markets pretty aware of the effects of inflation and rising interest rates on their asset values, they continue to assert that inflation is under control. For the USA this is essential as the economy doesn’t look too robust at present and the housing market, or to put it better the ‘sub-prime’ mortgage market, still seems to be quite vulnerable. This will continue to make things pretty difficult for the Fed in the future if, on the one hand, the economy is stimulated by lower interest rates whilst on the other rising inflation pushes interest rates higher. We believe that this conflicting situation could be one of the fundamental problems facing the global economy later this year and into 2008.

The euro and the GBP are looking pretty strong again versus the USD, and the greenback is once again not too far off the record euro level close of 1.37. On the other hand the yen remains weak, which is benefiting export industries in Japan. The conflict over the currency policy in the EU is also growing and while most of the EU countries respect the independence of the ECB and acknowledge that it is only trying to maintain monetary stability, the new president of France has already indicated that he feels the value of the euro is too high, and that this is hurting export business. He has also stated that the ECB should take ‘appropriate’ action to reduce the value of the euro in order to support Europe’s export industries. It will be interesting to see whether this was a controversial remark made to get him noticed as a newcomer in the political and financial community or if he is serious about this matter and if so whether this will go on to create massive tension in the EU and between politicians and bosses at the ECB.

Market intelligence

The last two weeks followed the path we forecast in our last Market Intelligence report. Psychological factors dominated and all of the traditional effects associated with a troubled market were very evident.

Most, if not all, suppliers were confronted with (market) claims, attempts to renegotiate contracts, shipping delays, cancellations, etc., and this kept most people busy and absorbed a large proportion of their working day in the past two weeks. If they were really unlucky they even had to travel to take the beating in person from their customer. It is always disturbing that these habits have not changed over the years and that the ‘usual suspects’, i.e. many of the Italian and Chinese buyers, were said to have justified the stereotypical prejudices again. The situation was topped off with new reports of cheaper prices, unsold stocks and many other price depressing rumours that surfaced on a daily basis.

In this kind of situation most players are deeply affected by the market conditions and it weighed quite heavily on the mood of many. However, once again it is not appropriate to generalise too much, but when your day produces more losses and negative results than successes it is easy to understand why the mood in the trade, or rather amongst raw material suppliers, was not at its best in June.

And, at this stage, the key question has to be raised once again…market correction or collapse?

It won’t come as any surprise to our regular readers that we are still fairly convinced that we are only witnessing a period of price correction. We don't think we need to repeat ourselves with an in-depth explanation for this as we have already presented these arguments in previous reports. So, we will only repeat the fundamental statements.

• The price structure between many markets and grades has been stretched too far.

• The prices levels quoted from some markets during the hype in the first quarter did not correctly reflect the real trading levels.

• Inventory position information was misleading.

• Excessive raw material volumes had been ‘placed’ in a semi-processed state in a number of locations around the globe.

• Due to the price pressure on leather, there has been a shift towards more economical origins from medium- to higher-priced hides.

• Global leather demand is still at healthy levels.

• Currency issues apply more than ever.

• We are currently going through the normal seasonal break in leather production.

• There may be a change in fashion.

As a consequence of this, we have seen larger price corrections in a number of markets around the globe and the most severely hit was undoubtedly the United States. Many players in the US market will most definitely call what has happened over the past eight weeks a collapse with prices on paper falling around 15%.  However, those that were hit the hardest were the same people that were denying an over-valuation of the product prior to the last eight weeks.  At the end of the day, whether we like it or not, it is not so essentially difficult to determine a realistic value of a specific raw hide these days. If this valuation becomes imbalanced and the balance is not redressed by rising prices in other markets, then you must be aware of what could happen to your selling prices— even when the information on sales and inventories as well as the quality of the main clients can be called ‘questionable’ at best.

But, these ‘individual’ problems are not really our concern in this bi-weekly report of the leather pipeline.

Pressure eases

After the price movements that have been seen since Hong Kong we believe that most of the excessive pressure has eased and that prices and quantities now provide a more realistic reflection of the market realities. As with a major earthquake, there is always a high possibility of some smaller aftershocks, but the high tension has passed for a certain time. The chances of some smaller aftershocks are certainly still high, because with new price levels reached in the USA and Europe, the South American origins, for example, still seem to hold the potential for certain adjustments.

In Europe the vulnerable markets such as UK/Irish hides, which are much more focused on the European customer base which is now going on holiday, could still offer some surprises, but with their limited volumes there is no chance that they could really shake the market.

A more positive mood

Well, let’s have a brief look at what has actually happened in the past two weeks. The reports and e-mails sent to us made pretty depressing reading as it seemed that there was nothing other than claims or reports of trouble over existing contracts; hardly anyone spoke of anything near normal trading along the leather pipeline. We are always suspicious when there is only one story dominating the market or the rumours and, seeing nothing but depressing headlines, we began to wonder if this was a true reflection of the situation.

The only way to find out was to try to speak to as many people around the globe who we considered to be cool-headed enough not to get carried away by the market emotions without any true reason. And, after we had finished our conversations, we felt even more comfortable in our opinion that there is little risk, and that this could be little or no more than a normal market shake out.

A number of premium suppliers from around the globe confirmed that their days are not much fun as far as their discussions with customers are concerned but, at the same time, they were not overly-stressed. Most said that the past weeks had given them another chance to filter their customer base, but the extent of these problems was much less pronounced than the impression being given from the news and rumours that are circulating.

In addition to this, a lot more buying/selling activity was confirmed than we expected. Almost all of the suppliers said that their regular buyers had clear ideas about the price levels they were willing to pay, but most of them were not unreasonable and, looking at the prices mentioned, the overvalued hides have made their corrections, and a number of grades and origins were either able to hold pretty stable or incremental declines were enough to meet buyers expectations.

As far as buyers (tanners) were concerned we expected a much more negative mood. However, a large number of people we spoke to were pretty realistic about the situation. One put it very well when he said that he wasn't at all uncomfortable with the present situation because he was able to reduce his average purchasing price level for the next two to three months by 5% to 10% thus widening his margin and easing the massive problems in profitability he had endured in the first and second quarter of 2007. In addition, he commented that the time after September is much more important than the chaos of the low season during summer. At the end of the day, what he was trying to explain was that the reasonable price level at the start of the high season of production in September this year and a steady market with low volatility until the end of the first quarter 2008 will suit his business much more than an ongoing and uncontrolled decline now.

Furthermore, nobody we spoke to was actually complaining about the potential to sell leather. It was the same old story we’ve heard for the last few months—the trouble is not the demand for leather but just the price. But, the price corrections for raw material we have seen have not resolved all of the tanners’ troubles as the decline in raw material prices is certainly not yet fully compensating for the rising costs, taxes and fees that leather producers have seen in the last year or so.

Demand remains constant

Consequently, looking at the comments we have received from leather manufacturers and producers, there is still no short-term decline in leather demand expected. Speaking to raw material suppliers many of them, well the reliable producers at least, are not giving the impression that they are still overly stocked with raw material and they are particularly concerned about whether they can move their production in the next two to three months or not. However, quite a few were convincing when they said that the vast majority of their production of raw material is already sold into September. A number of suppliers also mentioned that it might have been difficult to find enough buyers for material in July or August, but most of their customers would freely discuss volume business for shipment and/or for arrival in or after September.

At the end of the day, it still remains a difficult time of the year. It is only the beginning of July, and activity is slowly winding down for the holiday season and one will certainly continue to hear more from those who are having trouble than those who are departing for their vacation in a reasonably relaxed mood. So, the public will continue to be affected by the negative stories, rather than by the more reassuring ones.

We can only recommend that our regular readers remain reasonably cool-headed and rational about the situation. The market will continue to go up and down and, at the moment, buyers who believe that they will also have regular production indices in 2007/2008 can now buy raw material and most probably at cheaper levels than they had budgeted for at the beginning of the year. This can't be bad and should not really cause too much of a headache for anyone who has steady and consistent business. If prices continue to slide in the next round of raw material purchasing it will be even more pleasant than the current one, but trying to hit the bottom of the market and depart from a regular schedule of purchasing would be a mistake as it has always been. Following the rational analysis of the market, it can't be a bad idea to enter tough negotiations with regular suppliers with the intention of finding agreement and securing raw material cover for the next two to three months by lowering the average cost. If the market allows another reduction when everybody is home, even better, and it would make the prospects for the leather business positive for the future, even now.

Whatever has happened in the last three months, the next three months will certainly lead towards another round of consolidation along the leather pipeline.  But anyone who gets it wrong this time or is not well-prepared could run into serious trouble later this year.

Splits remain unpopular

The split market was unable to deliver any positive news in the past two weeks, but how could it with all the problems in the hide market and the holiday season also affecting split manufacturers? We have to admit that it remains a mystery as to why splits aren’t attracting more interest, even if it were only for the sake of speculation, as the product is cheap and is suitable for many purposes. The question, and one we are unable to answer, is just when leather goods manufacturers will discover the material again and whether there will be enough demand to get a reasonable product flow in this segment again.

As far as skins are concerned, the Chinese market is still buying whatever will bring a good wool return and whatever is reasonably price to produce fine-grain shoe upper leather. Skins that perform are being readily bought and there are very few complaints at the moment. The situation is a little different in the double-face sector. After a flurry of activity from the Turkish market in May and the beginning of June things have slowed down quite a bit and most suppliers are reporting  far less interest at the moment. It is still a bit early but in general most tanners try to already be covered for this product in June/July. If interest doesn’t increase in August there could be another difficult time for double-face skins ahead of us.

In the coming two to four weeks we would not be surprised if we saw more activity in the bovine hide market. European tanners should still need another negotiating round to fill the final gaps before their holidays and to cover their re-opening period. In Asia decisions have to be made and the big players seem to have already placed their bets. The others are the ones who always try to hit the bottom of the market and only a sign that the market bottom could soon be reached will trigger a round of buying. It is going be very interesting to see how many of these bids are received positively. After the experiences sellers had in the last quarter, one can only hope that they will not make the same mistakes again. As far as prices are concerned, we believe that many of the imbalances have been settled and only minor adjustments are still necessary. The price levels reached should be comfortable for everyone to pass throughout the summer and to wait and see how the next season starts to figure out the next move.

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