Despite economic worries the market remains active
MARKET INTELLIGENCE
Macroeconomics
The financial and business world was and is still looking at the consequences of the subprime crisis in the USA. Like all bubbles this one also had to burst one day, and now it has. It’s just that the consequences are a bit more complex and that is why many are finding it difficult to deal with the situation.
What we are seeing now is that greed in combination with unproductive investment has never (at least so far) generated added value or evenly-spread wealth. US banks were selling mortgages to families, knowing that in times of rising interest rates they were not going to be in a position to meet their obligations. Interest rates went up, incomes did not. Home-owners were unable to make their monthly mortgage payments, and banks—or investors who bought the risk—found that they had lost some of their money and gained a number of houses. Basically nothing unusual; it happens all the time.
No longer a regional problem
Except that business now is global so that what had been a regional problem in the past can now have global consequences, and this is what has happened in the US (subprime) market. Suddenly investors everywhere were reconsidering their risk exposure and—what a surprise—all of a sudden valuations changed. While a carry-trade was yesterday still the smartest and safest ‘perpetuum mobile’ for making money without risk, it had become suddenly (what it actually always has been) a high risk and speculative investment. Stocks that looked as though they could only go up suddenly went into meltdown. And the problem has spilled into emerging markets such as the property sector in China.
The good thing is that the markets always seem to sort themselves out eventually. We were worried about excessive liquidity around the globe, and at least a certain part has been absorbed now. Commodity prices have also declined and metals as well as oil have lost also some of their inflated values. As bad as they may look in the daily news, the recent developments have positive elements and we are entitled to hope that the general economic situation will benefit and move onto a more solid and realistic basis.
The US dollar gained substantially from the recent developments. It sounds ironic as the problems in the US should have weakened the currency, but since the problem was mainly in the US a lot of money came back into the country to reduce risk-exposure. The dollar was up to 1.34 against the euro and, even more impressive, was the trend of the yen against the euro, reaching levels of around 150 yen to the euro after being close to 170 not long ago.
On Friday afternoon (17 August) the US Federal Reserve decided to lower interest rates by 0.5%, which calmed the market down for a bit, but this measure will not solve the underlying problem; nobody knows what kind of risks are still hidden in the financial system.
Market intelligence — the hide market
As usual the hide market does not pay too much immediate attention to the global economy. Buyers and sellers of raw materials were obviously not too impressed by the developments in the financial markets.
Sales numbers from the United States to Asia remained high. It seems that most players were happy to anticipate any negotiation that might take place at the All China Leather Exhibition in Shanghai next month and to get orders sorted out prior to the meetings at the show. Also European suppliers have admitted that interest from Asia was significantly better they had expected at this time of the year, and in view of the upcoming event in China. Fundamental strength
We consider this as further confirmation of the general fundamental strength in leather demand. Knowing their raw stock position, the order book, their budgets and business plans, most manufacturers and retailers seem to have very few worries about sales for next season and are keen to replenish their stocks.
This is a little bit in contrast to the latest publications from the large retailers in the United States. Some of the big retail chains including the biggest, Wal-Mart, have already published concerns about business projections for the rest of 2007 and we have even seen some profit warnings.
Manufacturers should already know about any reductions or delays in orders, but their raw materials purchasing attitudes do not reflect any concerns for the next couple of months or so.
More activity than expected
As already mentioned we have seen more raw material trading activity over the past few weeks than we might have expected. In many cases prices were even able to regain some ground, but we can’t repeat often enough that focusing too much on quoted prices and taking them as a reference is not the best idea; it’s better to ride the trend and focus on supplies, which are reliable in quality and consistency. From what we have seen in the past six months, companies in China are on a fast learning curve for this, as for almost everything else.
Also in this part of the world, which is by far the largest consumer of leather raw materials today, the market has separated into the ‘smart and professional’ and more traditional players.
The traditional players—whether buyers or sellers—are still trying to beat the market. They try not only to buy more cheaply against the prices they hear or read on the day, but they also try to select the cheapest offer. The flaw in this economic strategy is that they do not take enough parameters into consideration for their decisions. This is leading to a second-level market where sellers as well as buyers are trying to profit from short-term differences in market conditions. These differences are not only related to price; second-level sellers will also use quality and weight as performance parameters in a firm market just as buyers will use contract reliability as their parameter in a falling market. It doesn’t actually help any of the parties, because there is never any determination and safety about the final result. At the end it is a little like trading options, you have a high leverage and risk, but with the small margins along the leather manufacturing pipeline, the size of gains is far smaller than the number of losses these days.
As a result, the first-level market, which is where most leather businesses play today, is growing quickly, while the second-level market is shrinking quickly.
First-level players take far less risk in their buying and selling decisions. They work with financially strong companies that do not depend on short-term, speculative gains and this is delivering more long-term security. This security means these first-level players are the ones that can make commitments in quantity and shipping times.
As regular readers know, we have always been of the opinion that the market has simply been going through a period of correction for standard grades, and the price quotations many were using to measure decline have not been an adequate reflection of the real market situation. Second-level players—the sellers and buyers who only focus on short-term gain—will have had quite a bit of trouble, especially sellers for whom the renegotiation of high-price contracts will have led to losses. Trading levels of the first-level players, the more traditional leather companies, are proving to be the more reliable partners.
Splits remain stable but changes expected
The split market hasn’t seen any changes recently, but we expect exciting developments after the summer holiday period in the northern hemisphere and, in particular, after the Shanghai exhibition. The main question centres on the possibility of the split finding its way back into volume leather production.
The skin market has also been in holiday mood. Despite the FMD outbreak in the UK and the shipping restrictions into the main markets, we haven’t heard that this has created a sudden shift of replacement demand in other supply markets. Buyers obviously took the situation calmly. The double-face market seems still to be in a state of uncertainty and in particular Turkish buyers are still waiting for clearer indications about orders from Russia. A number of players are talking about adequate stocks of semi-finished and finished leather, which are waiting for orders to be turned into garments. Before they see the cash for this, tanners are unwilling to take the risk for any further commitment on new materials.
The situation for the coming two weeks will be a bit uncertain. The large sales of the last month could be enough to cover buyers’ inventory, but will have certainly put sellers into a comfortable position. So, fundamentally, the market is on pretty safe and firm ground. If there are a number of ‘late-comers’ and demand stays high for the next few weeks, and even into the Shanghai fair, we will return to a situation of tension in the market. Sellers are in such a comfortable position at the moment that they would try to put their prices up again.
However, if most raw materials needs are covered, there could be a pretty relaxed period ahead. If forced to state our position, we would say we were 51% positive about the market. We can hardly believe that tanners would be willing to pay higher prices in September before knowing more about the way consumers are likely to react in the autumn.
