ACLE—the most important points
26/09/2007
18.09.07
Macroeconomics
The financial market is still dealing mostly with the economic outlook in the US. Weaker than expected data from the job market supported opinions that the next move of the Federal Reserve will be to lower interest rates. The only question pundits are asking is by how much and when.
This has accelerated the fall of the US dollar and it marked a new all-time record low against the euro.
Central banks are still injecting large amounts of liquidity into the banking system to avoid what is called a ‘credit crunch’. Some say this shows that there is a lack of liquidity in the market; we tend to disagree and call it a lack of confidence between banks.
Players are so uncertain about the risks of their lending partners (the banks), that the normal flow of liquidity is significantly affected, but there is no sign globally that there is a lack of liquid money. Stock markets are bouncing up and down, but a sell-off of assets to raise cash hasn’t been seen so far — or may have been avoided by the actions of central banks.
So, for the normal player things may look pretty stable and politicians and bankers continue to publish calming statements, but it may still be wise to stay on high alert and to keep money safe.
The oil price rose too and reached levels of more than $80 a barrel, and this before the cold season starts in the northern hemisphere. Nobody knows how cold the winter is going to be, but there is the possibility of energy bills going up for private households and enterprises. Also food prices continue to climb, which is not good news for family budgets in many countries of the world.
Although 9/11 has passed once more without any major violence, there are continuing news reports of the preparation of terrorist attacks, confirming again how unsettled the situation still remains.
Market intelligence
The world of leather has been focused pretty much on the All China Leather Exhibition in Shanghai and most reports from the show have been written and read already. However, it might not be a bad idea, having had the chance to digest the emotional impressions from last week, to try to summarise the most important points.
Something that was certainly apparent at the show was the surprisingly positive mood displayed by tanners, in particular those from China. This was a bit of a contrast with the concerns we might have expected after the turmoil and uncertainties of the financial markets before the event. It may also have been because the next piece of bad news from the US came on the Friday afternoon when the show had already closed.
In any case during the show hardly any of the Chinese tanners seemed to accept the possibility of a global economical downturn. This might also have been justified by the strong domestic demand many reported and also by some of the international leather buyers, some of whom certainly left no indication that they expect any deterioration of their business for the next season.
So far, so good, but it still left observers wondering if things could really be as good as they looked. Our regular readers know that we have been rather on the positive side, so it would be easy to feel that our impressions were confirmed by the current situation. But will the global economy continue to remain on track and will the consumer continue to spend when, in some countries, the situation is starting to become more cloudy?
For the moment at least things for the leather pipeline in general still look pretty stable, not to say good for many. However, the leather show in Shanghai also delivered the impression that the situation is still not equal for all. The ‘fashion’ leather producers, in particular for handbags, are still the most favoured ones. Upholstery is still probably the sector with least fun. The largest part of leather production, which is for shoe uppers, is really neither here nor there, but is not facing any difficulties as far as the volume of orders is concerned.
Imbalanced view
The imbalance of demand was something we hadn’t expected to be so pronounced as it appears to be from our conversations with a number of suppliers, tanners and manufacturers. Low-price and cheap raw material is in short supply, and prices have increased much more than what we thought.
Prices have reached levels that can hardly be justified, but this extra incentive is still not producing more hides. Some have even gone as far as to claim that tanning areas—particularly in Africa and the Middle East—that had been depending on this kind of material have had to cut production owing to a lack of supply.
There are obviously a number of reasons for the lack of cheap raw material. The main one is definitely the fact that most of the global growth in the consumption of leather products is coming from emerging markets where average incomes are still low. We all focus on the well known brands and on sales statistics from public companies and mature markets, but we frequently overlook that it is producers and retailers who show up in no global statistic that carry out the largest share of the production and sales of leather.
Most suppliers reported demand exceeding supply and enough buyer interest to cover long-term contracts. Suppliers of dairy cows and similar material were also looking on the bright side of business life and were meeting strong interest and sales.
Quite the reverse situation was seen for the upper end of the raw material price band. The biggest worries and complaints came from the suppliers of average and upper average raw material selections. This applied in particular to the suppliers of US packer steers and European male hides.
Here one could see mostly concerned faces; they were seeing little interest in this material in the market in Asia at this stage. It seemed also, that the product flow wasn’t as good as it should have been over the summer and a number of suppliers were hoping for some sales to get relief from their inventories.
A lot of factors were mentioned: Foot and Mouth Disease in the UK has interrupted movements, so have the summer holidays, the split market—which is accounting for quite a part of revenue in heavy hides—and poor selections as a result of the warm weather in Europe last winter.
The unexpected and higher summer kills and the significant problems in the calculations of medium- to higher-quality upholstery tanners in Europe have also been factors.
A great deal of leather production is still for furniture and automotive and, for different reasons, their consumption of the material is below average at the moment.
Consequently we had all kinds of final assessments about the show. From moderately positive and excited, to concerned or even depressed.
With the different market conditions described above, it is perhaps no surprise that there were different interpretations of what this would mean for the development of future prices. Nor is it a surprise that the community was quickly divided into optimists and pessimists.
Wishful thinking
One doesn’t need to be a psychology graduate to understand that most opinions were not the result of careful analysis, but a mixture of individual commercial interest and wishful thinking. While those who are either neutral or have an understandable interest in lower prices are focusing on the problems of leather prices and the general economical outlook, the rising cost of energy, effluent treatment and labour are other reasons for the shortage of cheaper raw material. Perhaps with rising prices buyers will be forced into the more expensive grades of leather, which are not the ‘buyers’ darlings’ at the moment.
We find, that both sides have strong arguments at the moment, and we are not willing to favour either side at this stage at least not before more information about the development of the financial markets and more results from the consumer fairs can be obtained in the next six–eight weeks.
Until then we believe that everyone is well advised to analyse risk positions and to take appropriate action to balance them.
Gossip column
Filtering the gossip and the facts obtained during the show, and a tour throughout Asia, there are a few other things which we consider worth mentioning.
First of all the situation in China. The new tax policy for imported hides has made it less interesting for smaller operators to import hides and skins. It adds a 15%–20% surcharge to the total cost of imports. Consequently Chinese domestic prices have surged and seem extremely expensive to the external observer.
Secondly, we have to mention the government policy on effluent issues. Although many in China are still playing it down and stress the fact that there are always ‘Chinese solutions’ to the problem, one cannot avoid forming the impression that things are seriously changing and that the government is not just going to let things go for the sake of jobs and production.
Nevertheless, if you expect a strict countrywide control tomorrow, with all tanneries not complying to the law being closed, you will be disappointed. But as far as we are concerned, there is more to this now than only talk and expectations. A serious ‘wind of change’ is blowing and things will change now—and more quickly than some who are touched by the situation would like. Eventually a move of cheap (beamhouse) production to other locations in Asia or the Middle East would come as no surprise.
Another issue is the ongoing problem with splits. There is simply not enough demand for split leather and, assuming leather production in general is not declining to a large degree, the rise of split inventories seems inevitable for months to come. As this business always runs in cycles, maybe some have the courage not to invest in stock markets, property or other commodities, but to invest in splits instead waiting for better times.
It’s either this or wait until split leather comes into the picture for manufacturers again. Maybe we are too pessimistic, but we have been unable so far to find any indication of improvement in the short term. For the medium or longer term we have to wait to see if the automotive industry develops an interest in using split leather for interiors. Steering wheels, door panels and so on are nothing new, and if quality specifications are met it might create a new boost for the product. This would not surprise us.
The woes of the dollar
Lastly, those who are touched by the loss in value of the US dollar will also have to wonder how they are going to deal with the problem. Not only has the greenback lost significant value against the euro, it has also reached historical lows against most currencies.
This is either leading to rising prices in dollar terms or in a net reduction of the value of commodities, in our case hides and skins. Most are just looking at the exchange between their local currency and the dollar, but this might not be enough. Exports are burdened by a weaker dollar, imports of finished products can also get cheaper and add to the problems of the leather industry in non US dollar countries.
Another factor is the exchange rate between the Chinese yuan and the US dollar, which has, so far, been only very slowly adjusted by the Chinese authorities. If, one day, a sharper revaluation of the yuan against the dollar takes place, it could push hide prices in dollars higher because import prices for raw material and finished products into China would drop, and with the increasing domestic demand for consumer products in China, buyers could be attracted by cheaper prices.
The skin market has shown clear signs of improvement. In particular nappa skins are attracting increasing interest in the main markets. Domestic skins prices in China have risen over the past months, making imported skins more attractive.
Foot and Mouth Disease in the UK is also causing some buyers to look for alternatives. Double face skins do not see much support yet as the last winter was too warm and stocks from last season still need to be absorbed. Weather conditions have not yet invited buyers to take new positions and consequently this market has not moved so far.
For the coming weeks we have mixed emotions. The demand for hides and leather remains pretty good. Just on this basis it would be easy to remain optimistic and to predict steady or even firmer price levels. The problem is however, that the demand is segmented and most of the positive tone is focused on the lower price segment.
The international uncertainties in the financial markets are also not settled and could still build into a serious global problem. The holiday in China at the beginning of October will also slow activities down.
We don’t expect any negative swing in the market; we remain positive, even though the correction in the second quarter remains intact. Despite the positive fundamentals, one should remember that it is not only the financial markets that could quickly have a negative effect. Some markets have other individual problems, such as with currency exchange rates. More expensive raw materials, in particular from Europe, could also face greater resistance, because demand for leather makes calculations above a certain price level pretty difficult.
So, we remain cautiously optimistic, but on a higher alert level in general, and less enthusiastic for the medium and higher range of products.
