Market Intelligence - 20.05.08
20/05/2008
MARKET INTELLIGENCE—20.05.08
Macroeconomics
The situation of the global economy is becoming more difficult and the main reason is inflation.
Rising prices are a concern in the old economies because many people feel the pain of a shrinking budget after having covered their basic needs. In poor nations the situation is different and the recent price increases have already created riots, sending starving people into the streets.
The are many questions regarding the pre-set price levels, focusing on whether they are just the result of a gap between supply and demand or if speculators are investing money in the attempt to generate higher yields. While energy is already a sensitive item, the situation surrounding food is explosive.
Rising food prices and starving people are an extremely sensitive sensor and emotions can be quickly triggered as we have seen already over the past weeks and can actually destabilise global relations more quickly than many would admit today. Although everybody claims that nothing can be done about the markets, it might be wise to keep a close eye on the development.
Within the last two weeks the markets were pretty much in a buoyant mood. Oil jumped to new records and analysts are now trying to beat each other’s estimates on how high the price of a barrel of oil might go. At the moment, the most conservative estimate is $160, but some people’s estimates are as high as $500 for the end of the year. Let us hope they are not right.
The currency market did not believe the dollar would extend its gains against the euro. After a short visit below $1.53, the euro rebounded sharply and jumped back to levels of almost $1.56. There are still strong hands who are not yet convinced that the worst is over for the greenback and continue happily to buy euros or sell dollars when the market offers attractive levels. With movements of almost two cents per day being pretty common at the moment, one can see that speculation is presently still pretty much divided about the next trend the greenback is going to set.
Falling interest rates may have had a stabilising effect on the credit market in the US, they may also have supported exports because of the weaker dollar, but at the same time they have also caused import prices in the US to soar and this is pushing inflation up again. Import prices are up 15.4 % year on year and higher oil prices cannot be the only excuse.
Market intelligence
The market situation remains pretty mysterious—at least to us. The US hide market continues to shine with record export sales week after week. Although there is the usual debate if the numbers are reliable and correct we think it is not really important how accurate the weekly figures in details are, but much more that they have to be accepted as a reliable indicator.
The big question is again what to do with the information, to find an adequate interpretation and finally to convert the results into a a basis for the decisions we have to take for our own purposes.
We think it is pretty useless to debate the reliability of the numbers. They will be close to the truth and variations will be within the normal and acceptable frame. If there can be any question raised, than it might be a timing issue.
It seems to be most likely that the big suppliers from the US are playing a very smart game in 2008. We had dealt with this issue already in the past and although we can get no official confirmation, we believe to be heading pretty much into the right direction.
Someone who is not much of a trader might, in a speculative mood, have analysed the market situation and might also have had a look into the history books and formed a clear understanding that the volume (shoe) leather market is today almost dominated by a type of a cartel of global-playing brands with little competition from others.
In the recent past the US market ran frequently into trouble by not taking leather prices into consideration. So industry players in the US seemed to take every single market chance to inflate hide prices even when they were not covered by obtainable leather prices. In the 2007–2008 season the situation was even more difficult, because production costs of leather were rising sharply and left even less room for price experiments.
On these occasions, when prices in the US were pushed too high, the US lost its grip on the market and opened the door of the main export markets to other supplies.
Hides from other origins entering the market brought two consequences. There was a break in the flow of shipments and high price contracts quickly turned sour when other markets happily substituted the supplies from the US with cheaper raw material.
It was almost set in the genetic code of raw material suppliers to try to squeeze the last drop out of the market, but an understanding is needed of the ignorance of the calculations of the tanning industry and of the fact that leather is not a product.
The dominance of the US supplies in standard production is still pretty strong and volume manufacturers—in particular for shoes—still favour the uniform and reliable volume supplies from the US. So it is legitimate to assume that the larger hide producers have learned from the past and have prepared better for this year.
In view of a pretty unstable economy for the rest of 2008, the seasonal high kill starting from April and the weak dollar, the often repeated wish of the leather industry to hedge their raw material needs at a profitable level on a long-term basis has seemed possible at last and it seems that the extremely large export sales from the US are covering the needs of some of the large producers for an extended period of time.
Consequently, the market potential for other supplying origins will be restricted for the same period. The only option could be to bet on a sharp reduction in prices in competing origins to threaten the existing contracts and to tempt tanners to delay or ignore their commitments as has happened in the past.
We are not too optimistic regarding this possibility because, in contrast to the past, prices for the existing long-term contracts are not at loss-making levels. The temptation to renege on such contracts and to spoil reputations and relationships cannot really be too high; tanners would most likely need more reasons to consider such an option.
Comfortable situation
For those who have covered their needs the situation is pretty comfortable now. They have fair coverage in hand at reasonable price levels. Others have much fewer options at the moment. For there to be lower raw material prices leather business has to be poor, which cannot be in tanners’ interest. At the same time, better leather business for the second half of 2008 would sharply increase the risk of rising raw material prices.
Despite the sharp gains in production and transportation costs, the potential for sharp gains of raw material prices are certainly limited. However, even noting the problems of the global economy we are still on a moderate growth track, which plays against any further and substantial pressure on raw hides.
What we have seen and still see today is an adjustment and a structural change. This can still weigh on the market for a while. In particular, there are issues surrounding the situation in China and fundamental problems in the furniture upholstery segment. However, one has to be optimistic about growth in the shoe and car upholstery sectors.
With the rising price of fuel people are tending to buy smaller vehicles with lower fuel consumption, but with more extras and interior options including leather. Price is an issue here, but demand over all car price segments remains decent and presently there is little sign that total global demand is going into decline.
Olympic effect
Consequently we could see a seasonal bumpy market road ahead. We can only repeat ourselves in the market assessment we have been following for a while, except that the period of market restructuring is actually taking longer and looks like being much deeper than we thought. It is clear that the impact of the Olympics on business in China, which we considered a number of months ago only as a potential factor, has become a severe factor for several regions of the country.
The most important subject for market development is certainly the validity of the large outstanding export sales contract position in the US. For the reasons stated above we are not too concerned about it owing to the still existing fundamental growth in the global market. However, the situation in China means that any changes or problems in this part of the world could have a significant short-term effect. Already shipping delays in view of the Olympics or financial problems would quickly accumulate physical stocks and weigh on the market in the short term.
Seller shortage
The other side of the coin would, however, mean that large volumes of product are already absorbed by the market and any additional demand for raw material would not find any ready sellers in the US. Buyers would have to move into alternatives.
The size of unsold inventory has certainly decreased over the last six months and cheaper hides are probably still in short supply. In any case, we consider the likelihood of a sharp rise of prices—even higher demand does materialise—pretty low. The seasonal decline of production in Europe and the massive pressure from the cost side should, and will, limit any significant rise in prices within a time frame of four-to-six weeks.
For the summer we might see some flurries of business, because Asian tanners traditionally need to replenish their inventories for arrivals in early autumn. This applies in particular to upholstery and leathergoods production. In Europe we don’t expect any upswing in demand until the end of September, except perhaps for some gap-filling. The fundamental market trend over the coming months will depend more on shipments and in particular Europeans will watch their movements with great care as they are reaching the low season now.
Rumours of a better split situation
The split market is driven by rumours. Some people are reporting some bargain-hunting from traders who are taking the chance to grasp cheap existing lots here and there. Some are interpreting this as the turn for the better but we are still doubtful and believe that the next fundamental chance for a change could be after the summer at the earliest.
The skin market is also in a kind of a transmission period. The impact of the problems in the Hebei province can also now be felt with the shipments into China where many are reporting a slowdown of production due to government controls. There are reports of some stocks in the hands of traders in the port cities, for which they seem unable to find a home.
In Europe the Turkish tanners are still sitting on the fence and so far we have not noticed much new-season lamb buying. So, it seems that the skin market is treading water at the moment and there are very few signs that this might change in the near future.
As one can read from the above, there is very little that can be expected for the near future. Those in the leather pipeline who have business to do have taken advantage of lower raw material prices and covered most of their needs. Local and seasonal influences like the lower kill of heavy material in Europe may force some tanners to consider moderate price increases for the period until the holidays for limited supply reasons. With the recent rise in car sales from the European premium producers it should not harm them too much for the moment. However, this will not change things much. For the remaining European tanners the situation doesn’t look too good for the rest of the summer.
From Asia we expect no more activity before the middle or end of June when decisions have to be made for the second half of the year. Until then it seems that inventories will last and the upcoming Olympics will still not favour increases in production or encourage buyers in China to increase inventories.
We might see some fluctuation in the European market. Currency is a strong factor there. For the rest we still think that the market remains in decent balance. So, those who still have to plan their raw material needs are well advised to analyse their needs and risks. Not that we anticipate much price rise potential, but sometimes it is better to secure what you know and get it in hand while you can.
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