Market Intelligence - 21.04.08
20/04/2008
MARKET INTELLIGENCE—21.04.08
Macroeconomics
The world, including normal people, is starting to watch the financial markets with much more attention. In normal times most people think that their personal life is not much touched by the big boys and their games, but slowly but surely people are starting to realise that the consequences are pretty much influencing their situation and at least in the western World the markets are dominating the news and headlines.
One of the biggest pieces of headline news is inflation. It is actually pretty funny to see that this term is today used and accepted by the so-called experts. Going back about a year or so the same people were trying to tell us that there was no inflation and would not be any.
They were talking about core rates, insisting that the rise of raw material resources—including food prices—would be of no influence and everybody should be pretty relaxed, that inflation was and would be under control.
The experts have changed their minds and with rising food and energy prices, not to speak about other raw materials, the effects cannot be neglected anymore and even the official statistics show that inflation in western countries is well above the desired ranges. The euro zone has said publicly that it has an inflation rate of 3.6%, which is far above the levels the European Central Bank likes to see.
As a consequence, any hopes for a cut in interest rates in Europe were slashed, which immediately made the dollar fall again against the European currency. It reached new lows and came very close to the next magic mark of $1.60 to the euro.
Oil shot up again and hit new records as well, $115 a barrel. The game of selling the dollar and buying essential commodities continues and the spiral hasn’t been stopped in the past fortnight and took a break only last Friday.
Concerns in China
The Chinese government is getting more concerned about the development of the economy there. The problems are coming from a different angle and the authorities need to take measures to make sure that the economy does not overheat.
As a consequence interest rates in China were increased by 0.5% for deposits in private banks. The renminbi continued its appreciation against the dollar and broke for the first time the level of seven per dollar. Chinese industrial output continues to be high and rose by more than 8% in the first quarter 2008.
For the UK many are afraid that the problems in the US could spill into the country with house prices falling and set for a steeper decline during the rest of 2008. This is also weighing on sterling which has lost quite a bit of its value against the euro, falling to levels above 0.80 against the continental currency.
Market intelligence
We have to admit, that we would call the present market situation rather foggy, mysterious or even better said rather obscure.
The reason why we have to say this is the big conflict between market reports and the facts that are delivered for example from the export statistic from the US. With record sales week after week it is pretty hard to understand why there still is such a pessimistic undertone in the reports one is getting.
We continue to believe rather more in facts than in gut feelings and it might be better to analyse the situation rationally rather than be carried away by emotions.
Profit warning
For quite a long time there has been a massive discrepancy between the volume of business in leather and the profitability of the same. In particular in the tanning sector a lot of enterprises around the globe are struggling and fighting against rising costs and insufficient potential to increase their selling prices. This is nothing new, and nor does it come as a big surprise, but the problem has intensified because production and energy costs have increased at an accelerated pace.
The total consumption of leather has definitely not declined but many tanneries around the globe have seen their profitability shrinking or even completely disappearing.
Those who are producing with insufficient margins or even at a loss have definitely become much more prudent as far as their raw material purchases are concerned, while others who, for whatever reason, are still operating in the black are taking their chances to grow and to increase production and gain market share. The total consumption of raw material and leather has definitely not declined and this explains why the demand for raw material is still reasonably strong and persistent.
In view of the structural changes in the trade that we have talked about so many times, the rising cost of production—which is not equally spread around all production locations—and the movements in the currency markets have altered conditions and this is reflected in the leather pipeline today.
European production is probably suffering most because for producers there the currency problem comes top. China today is no longer the one and only place for production and we are seeing shutdowns and a shift in production to other Asian countries.
Raw materials in focus
What does all this mean now for the unclear presentation of the raw material market? Let’s start with the situation in the US. For almost two months USDA has been publishing large numbers of export sales and the outstanding shipments cover almost two months of production.
Although many are questioning the truth of the numbers published we would not be surprised if they were correct. Even if some of the sales are based on letters of intent rather than real physical business, we believe that the vast majority of the sales are definitely a reflection of the demand and purchasing activity of tanners, particularly in Asia.
The dramatic fall of the US dollar has not only made US hides more competitive, it has also increased caution over the volatility of supply markets, in particular from the euro zone.
We have said already a number of times that we admire the discipline of the US packers for not falling back into normal attitudes and raising prices. Instead they are taking their chance to secure a regular flow of material instead of losing market due to hectic actions on the price front.
Brazilian restrictions
Something that may have added to the attraction of US material is the reducing availability of adequately priced raw material (or better said wet blue) from Brazil.
Also analysing the price-quality ratio in the first quarter of 2008, it is clear that US material has certainly been one of the most attractive raw materials available around the globe.
When we add all these arguments up, it comes as no surprise that a lot of the global raw material demand has shifted to North America and is reflected in the large numbers which are reported week by week.
However, we are willing to admit that all these contracts will only be valid if the production budgets and the orders for finished product avoid being hit hard by international financial prices. If finished product consumption goes into decline a lot of these sales will become questionable, but this is nothing new along the leather pipeline and the flow of material can quickly become jammed again.
European headaches for spring and summer
In Europe the situation is not that easy. Abattoirs are fighting hard to prevent further declines in the value of the by-product they handle. Unlike in the US, in Europe the kill of cattle and the weight of hides decline quickly in spring and summer.
With the fundamental and steady demand for fresh hides of a certain quality and weight, the supply of adequate material in May and June can be difficult; sometimes there is not sufficient supply to meet production demand. Although this is only the case for a small part of the European industry it is part of the driving force behind the rising courage of slaughterhouses to ask more for their product.
Inventories falling
It seems also that some of the excessive stocks that had been sitting around the continent have been absorbed and a number of high processors and traders have been able to reduce their excessive inventory. With the expectation of a lower kill for the next four-to-six months some of the pessimism should start to fade and those in the leather sector should have the courage to believe that the market might turn for the better.
This might be a bit premature. As long as the euro stays as strong as it is and European hides look as expensive as they are now it would require a strong increase in demand and prices in US dollar terms to open further market potential for them. The temporary shortage of some specific grades will not change the fundamental problems of prices for the industry in Europe.
Split misery continues
The split market remains in misery. There are some rumours that splits might see some return here and there, but for the time being that will definitely not be enough to change the mood and the situation in the split market. Output is still bigger than demand and the market remains in significant trouble. We fail to see and expect any change for the better. We will have an open eye in Bologna next week to see if the Italian tanneries might have some fashion ideas which could stimulate the demand for the second half of the year.
The skin market has lost a bit of its steam for the moment. Prices had gone up due to strong demand for wool and cheap nappa leather as well as a shortage of adequate skins. With the rise in prices, demand is fading for nappa material and what can be expected for the next season of double-face nobody knows these days. It seems that the market needs to take a breather before deciding which way to go.
We are interested to see how things are going to develop over the next weeks. The Lineapelle fair in Bologna next week could offer some fashion indications and from China we will start to learn if the upcoming Olympics will have an effect on production over the summer.
The financial markets continue to be ready for any kind of surprise. If there is not going to be any major surprise from either side there is a fair chance that the markets will continue to consolidate and prices will stay steady. For the European markets a recovery of the US dollar would be the best chance to protect the sector against further negative influences from the currency market.
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