Market Intelligence - 03.06.08
03/06/2008
Macroeconomics
In the world of economics, there is very little new happening and the media and expert commentators are going over the same old problems—without arriving at any conclusions. This leaves us wondering if they are not able to come to any meaningful conclusions, or if they simply don’t want to.
As a consequence, there is some most interesting ‘data sidestepping’—or as the financial world describes it, ‘range trading’—going on.
Oil was climbing from record to record before falling back to levels below $130 per barrel. The dollar was again closely correlated to the price of oil and it fell as well to levels of $1.58 against the euro before the link to falling oil prices dragged it even lower to levels in the $1.54 region. However, the rate is bouncing rather than following a clear trend.
Fundamentally, however, one can sense that investors are now starting to buy the dollar in expectation of only a mild and short-lived recession in the US and a slowdown of growth in Europe. The mood is changing at the moment with critical news from the US being ignored in the currency market and a possible rate increase in the States—owing to inflationary pressure— dominating investor decisions at present.
This would narrow the gap between the interest-rate level across the Atlantic and make dollar investments more attractive. However, it is only speculation that the worst is already over for the greenback is— at least for the moment—since many of the fundamental problems which have weighed on the USD are still unresolved.
Recent statistical data has been pretty disappointing for the consumer products industry and must have been a strong warning for retailers and manufacturers operating in the old economies. Consumer confidence and retail sales fell in Germany and in the USA and consumers are responding strongly now to rising energy and food prices by displaying a great deal of uncertainty about the future.
New horror scenarios about the future of energy and food prices are circulated almost daily and the prices for services and healthcare are rising sharply too. In some countries property prices are falling and so it’s really no surprise that consumers are seeing more and more money being absorbed by basics, leaving less and less money to spend on luxuries and pleasure.
We have been dealing with these circumstances for a while already and manufacturers can count themselves lucky to have had, and still have, strong growth in the emerging markets to compensate. We can only hope that the consequences of the earthquake in China and the end of the Olympics will not cause the Chinese economy to fall into a hole after September. Looking at the share prices in Shanghai in 2008 and after the earthquake this situation is at least worth watching.
Before the end of the Olympic Games, Beijing will not allow any negative publicity about pollution or labour conditions, but who knows what is going to come later. Meantime Beijing has reported its highest air pollution levels ever and even staying outside the city has been officially designated ‘hazardous’. It will be interesting to see how this is handled when the athletes of the world compete in the region.
Market intelligence
The raw material market continues to deliver more question marks than answers and the fundamentals and facts haven’t really changed over the past two weeks.
In most published reports we are reading concerns. The general economic fundamentals are not making anyone happy and despite the volumes of sales reported from the US and even moderately rising prices in Brazil most suppliers have not much faith in the future of the market and display little courage in raising asking prices.
European producers in particular are still complaining about business, except those whose production covers either the top quality end or extra heavy male material. The standard salted material, and cows in particular, are not finding the demand they would need to clear productions. In addition, there are whispers about delays with letters of credit, leading to a certain increase in physical stocks.
It might be time again for a rough analysis of what has led us to the present situation and what this could mean for the future. Looking at the market today we see the following:
* A strong performance of automotive leather with the exception of the USA
* A weak performance of standard upholstery leather
* Strong demand for shoe leather
* Strong performance of the luxury markets
* Rising costs mainly for energy and chemicals
* Massive pressure on leather prices from retailers and manufacturers
* Rising need for cash-flow to compensate for energy and chemical costs
* A weak dollar and a rising renminbi
* Decisions from the Chinese government on tanning areas (in Hebei province for example), which could influence the pollution situation close to Beijing during the Olympics.
As a result of the above we have had strong demand for shoe-related standard raw materials from US origins, better than average performance of hides for the upper end of the quality range of automotive production (despite the influence of the dollar), and poor results and price development for average quality hides for upholstery production, in particular those of non-US origins.
Cash-flow crisis
Due to rising energy and chemical costs and the increasing difficulty in keeping sufficient cash-flow, many tanners have had to find ways of generating liquidity. Where banks have been unwilling to assist, the only option has been, and still is, to lower raw material inventories to free cash. This has applied in particular to Southern European, but also some Asian tanneries.
In China we saw a great discrepancy between the shoe pipeline and the upholstery segment. Also bag leathers, one of the strongest performers in 2007, was facing a slowdown. Owing to the problems of the US economy and a stagnant consumption in Europe many of the large upholstery tanneries in China had to cut production and this process accelerated in the second quarter because of the rising governmental restrictions, in particular in Hebei province.
In addition, the constantly rising value of the renminbi inspired many tanners in China to open their letters of credit as late as possible and to try to persuade their suppliers to extend credit terms. The idea is pretty clear as governmental policy in China is to let the value of the renminbi appreciate constantly, particularly against the dollar.
With the steady (almost daily) rise in China’s currency, it is pretty obvious that delaying the day of payment as much as possible will be more than tempting, especially for producers who are selling their finished product in domestic China.
Empty pipeline
So, even with a fundamentally strong leather demand globally, the pipeline was emptied for various reasons during the first quarter of 2008. Top of the list was the conflict between rising production costs and the clear indication that clients were not willing to compensate tanners for all of it.
Most of the burden was shouldered by the European hide market where suppliers are mostly only add-ons to basic production in Asia. They realised late, if at all, that the currency market and the general market trend were either not favouring their raw materials (upholstery), or the wind of the currency market was blowing straight into their faces. It got even worse when their home markets in Europe were also struggling and facing similar problems for finished products.
The raw material demand shifted and origins such as the US and Brazil, Australia and some African countries had currency and price-structure on their side; as a result, these countries began to absorb more and more of the global raw material demand.
Upholstery upheaval
Industry observers could see how deep the structural problems of the upholstery industry are by reading in the Italian press last week about one of the big and very well known Italian leather upholstery manufacturers, Natuzzi. Its results and outlook are poor and, even if some of the problems are of its own making, its situation is a decent reflection of that of the industry.
It is easy to believe that other manufacturers in Europe and consequently also their leather suppliers could face similar problems and this explains why the mood in northern Italy was, and remains, pretty depressed. Considering in addition that the traditional slow period for upholstery, and the summer holidays, are still in front of us, it makes sense to be really a bit prudent about this part of the world.
So for the short term the fundamentals are still difficult and various effects are are causing this. However, as explained above, and it is normal to hear more about those who are suffering than from those who are doing better. The high uncertainty of the overall economy in many countries is also weighing on emotions.
A brighter road ahead
Looking a bit further down the road things may not be as negative as the structural problems are making us believe. The latest forecasts for global beef consumption are expected to rise only a fraction, perhaps by 0.8 % for the world. So only a moderate rise in slaughter weights would mean that it will be impossible for a larger volume of cattle hides to be available. Despite the stagnant consumer markets in the old economies, most of the same will be compensated by the growth in other regions.
If this proves to be the correct scenario we will most likely see a similar situation to the one we have seen for the past year. Total volume will be satisfactory, but the average product price may decline further or remain stable. In other words, there may be a reduced average net revenue or reduced profits because of rising production costs.
In the end, such a scenario would favour low-cost producers and would increase the pain for manufacturers in the old world.
Split market stays the same
The split market (does it still exist?) remains in the doldrums so we have very little to add to the pretty poor statements we have been making for several months now. We are simply not hearing of any movements and improvements, and most producers continue to struggle to dispose of the splits they are producing.
The lamb and sheepskin market has also slowed down. Even though the whole Hebei area is almost shut down, the situation in Turkey and Poland is still very quiet. This means a decent proportion of the potential market is not active, but although there are not too many stocks pressing on the market at the moment, this could quickly change. Chinese buyers are desperately waiting for the end of the Olympics and are convinced, that they will be able to carry on as before afterwards. Well, we are not fully convinced about that.
For the period leading up to the summer we think that the market will be more driven by the overall economic picture than by the supply and demand issue. Currency, oil, football and the Olympics might play more important roles than anything else. It sounds strange, but emotions seem to be dominating more than facts again.
Everything points in the direction of going into the summer with little real variation on prices and we might continue to trade in a pretty narrow range. The next breaking point could be towards the second half of June and after that second half of July, by when Chinese buyers will finally have to decide on their ‘post-Olympics’ future.
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