Market Intelligence - 01.07.08
01/07/2008
MARKET INTELLIGENCE—01.07.08
Macroeconomics
Inflation, inflation, inflation, stagflation, explosion of energy prices, rising food prices et cetera, et cetera. Any time we open a newspaper today, or switch the radio or TV on, we seem only to read and hear the same story.
The problem is that our experience of this situation is completely different depending on our individual position. And there are many positions these days.
Consumers see budget and spending ability shrinking fast because, almost every week, they have to spend more on the basics for living. That is what those people call inflation. Statistics around the globe are showing inflation of between 10% and 30% and this is hitting the poor more than anybody else.
Highly paid experts mainly from private banks still take still a scientific approach and attempt to prove whatever point of view they have with statistics. One very popular statement is the one that says present prices (mainly for commodities and energy) are nowhere near their peaks considering the actual inflation-adjusted prices of today. So, for them, there is nothing alarming (easy to say when you look at things from their income level).
Then we have the Central banks, in particular the European Central Bank (ECB) and the US Federal Reserve. While the ECB is completely independent and understands its job completely as a fight against inflation, we have on the other side of the Atlantic a Federal Reserve that is anything but independent and is becoming something of a little toy for the institutions with the big interests.
Consequently the fight against inflation is a thing of minor interest, and the general economy (politics) and big business interests are in the foreground.
Let’s see if the idea proposed by former chairman of the Federal Reserve Alan Greenspan—to flood the market with liquidity—will be successful one more time. If it is a solution at all, it looks a bit of a short-sighted way to save the economy from recession because inflation is also affecting the US. The end of lower prices from the China effect, and the weak dollar have already increased consumer prices by frightening levels.
This just proves the difference between theory and practice; everybody is (a little bit) right and we may take the chance to add another position. Consumers in the western markets have changed their spending attitudes. Falling food prices over the past 20 or so years in combination with the globalisation effect, and ever-declining prices for other basics such as garments and footwear have freed large amounts of cash for other use.
They have had money to spend predominantly on communication (mobile phones), holidays and multiple units of small-ticket items.
Beginning with the end of the 90s and lasting until the beginning of this year, more such units were sold in the old economies and this was added over the past years with the rising wealth and consumption of the new economies.
As long as low commodity, food and energy prices—in combination with low labour costs—kept product prices under control, it was almost a perfect world with only a few complaining about the export of jobs and industries from their countries.
There will be no further declines in production costs for the moment; few further savings on labour are available and China, for many reasons, is also becoming more expensive. With the rising cost for food, energy and transportation, global consumers who had ever larger proportions of their income available for the ‘non basics’ over the last decade will now have to revise budgets and to deal with the fact that more money must be spent for the basics.
Over the past two weeks we returned to the pattern of the fist four months of the year. The oil price finally broke the $140 mark and the dollar fell again and is now flirting again with the $1.60 to the euro mark.
The ECB has said another increase in interests rates is on the way, but the Federal Reserve is leaving interest rates low and still seems unwilling to tell the markets that there is also little alternative for the US but to raise interest rates there too eventually. Speculators were taking advantage of the short-term interest rate spread and sold dollars to buy euros. The renminbi also gained against the dollar and hit new record levels of around 6.86 renminbi to the dollar.
Market Intelligence
We have extended the section of the general economics this time because, in our view, the global situation has more impact on the leather pipeline at the moment than the situation in the pipeline itself.
After a long period of ignorance in which the threat of rising commodity and energy prices were completely underestimated, we have now entered a period in which the problems have come to the media’s attention and, even more importantly, have reached the wallets of consumers.
There is a clear reflection of this in the most problematic areas of the leather pipeline today, in particular the upholstery, garment, and bag leather segments, and now also automotive, which are suffering most. None of these items actually fall into the category of the basics of life. In some cases, it is not that consumers are reacting, but producers are realising for themselves that their businesses could be dramatically touched by people’s changing spending habits.
Footwear’s particular situation
Shoes, on the other hand, can in most cases still be considered as a basic. Since global incomes on average are still rising (for 2009 the global growth rate is expected to exceed 4%) this part of the business is by far less affected by the present situation.
So most of the present reporting is still rather more driven by the negatives than by the positives.
The raw material markets are reflecting the situation pretty well. Hides which are predominantly used for shoe production are still in healthy demand and, no matter what people are actually reporting, product flow is still completely intact.
The situation is completely different for all raw materials related to the above-mentioned problem segments. There might be even one addition and this could be the end of the popularity of women’s boots.
There is still some expectation that there will still be women’s boots in most shoeshop windows next winter, the fashion of seeing knee-high women’s boots on the streets for almost all of the 12 months of the year has definitely ended. And we must also not forget that most women now own one or more pairs of boots, so they may not be attracted to the idea of buying even more boots for next season.
As a consequence we still see steady prices for the standard hides for volume and standard shoe production. Other items, in particular those for medium- and lower-end upholstery leather production, are starting to pile up and since we are entering the summer season a lot of sellers are getting pretty nervous. Here it doesn’t help that in Brazil beef production has substantially declined in 2008 and that a considerable number of hides have not even come to market to add to the problem.
Cash-flow problems
To make things even worse, a lot of tanners are now missing orders are also entering a very serious cash-flow problem.
Apart from reduced turnover, they are faced with massive rises in costs and this problem can barely be managed by many of them. Pundits who have been in the trade for quite a long time have seen this kind of cash crunch a number of times before and they know that the summer months and early autumn are always the most critical times of the year.
With banks in most parts of the world in a similar problem, nobody expects them to be able to bale troubled companies out during this very problematic period. In fact, what we reported a while ago has become even more evident. Banks and credit insurers are rather restrictive and continue to cut credit lines or insurance covers rather than expending them.
Move away
As a result there are today two reactions to be seen.
A number of tanners that have, until now, been producing upholstery leather are now trying to shift their productions into shoe leather production. Certain growth in shoe leather consumption can still be expected—even it it’s only small growth—and there could be some market potential for this kind of shift.
Whether this can be technically managed and if growth is strong enough to allow newcomers to find market share remains to be seen. Of course this has also to do with fashion and with the price development of alternative materials.
What nobody must forget is that a lot of alternatives to leather are still oil based and are seeing a sharp increase in product prices, which may not have come to an end yet.
If this is true, leather could become a much more attractive material again in the next season of production. It would be quite interesting to know if larger shoe manufacturers are already taking precautions and instructing their designers to consider leather again as an attractive item.
Shoes aside
For other items, it remains unclear if the consumer will not stay away from upholstery due to his restricted spending budgets.
Another interesting market segment is going to be automotive leather. With the strong growth of the car markets in the emerging economies, the outlook for the production of automotive leather was still pretty good. However over the past months the situation has changed. Traditionally cars with leather interiors were mainly to be found in the medium and higher or luxury end. In the US and Europe the sales of gas-consuming cars has significantly dropped since April.
Declines of between 15% and 30% have been registered, and with the situation in the petrol market today it is pretty hard to believe that there is going to be a short-term change.
The growth of consumption of luxury cars in the emerging markets would definitely not compensate for the decline. This leaves only the question of people who are shifting now to the purchase of smaller and less energy-consuming vehicles perhaps spending more money on the interiors instead and probably considering leather to make their car look more prestigious.
Even if this were to happen and people are not just trying to save, most of the smaller models today are not offering medium and high-end leathers, which would allow less expensive hides to play a greater role in production.
Bleak outlook
Following the above, we can only come to the conclusion that there is a pretty bleak outlook for the coming summer for medium-priced upholstery hides, and, most likely, this part of the market is going through deep trouble.
The real situation will however only be seen in the last quarter of this year. We are in a period of transition where the consumer and the producer are still not fully clear about how they are going to react to the general change of the economical environment, which has hit us all pretty suddenly in the end.
We will probably only know if some of the changes companies have put into effect—such as energy-saving efforts and reducing stocks—will prove successful after the Olympics, at the start of the new season in September.
Split prices
Everywhere splits are said to be still under severe pressure and prices continue to fall. There is still a lot of hope that the extremely and historically cheap levels of prices will stimulate demand later this year and, at least, stop the continuing price reductions that hamper the calculations of tanners producing grain leather.
We are still a bit more optimistic about the situation for collagen and gelatine use and would not be surprised if the demand for lime splits might increase and then at the same time meet reduced production.
For skins the situation was pretty much unchanged. Here and there people were reporting increased interest from Turkey and also some of the larger Chinese tanners were reported to be sniffing around Europe for new season lambs.
Even with a large kill in the UK and Ireland the mood was not any less depressed than it had been some weeks before. There was not a big amount of trading reported, but seemingly there was enough to stop any further price descent.
There seems to be also a pretty good demand for lining skins and if we make the assumption that shoe leather production will at least stay the same, we feel that the skin market all over should be on pretty safe ground. For the coming weeks we have to watch if the interest from Turkey can be converted into any mentionable volumes of sales to have some more idea about the development of the market into the peak summer season.
Also for the next weeks we have no idea what could change the present scenario. Europe is going on holiday, energy and food prices will stay high, cash is going to remain tight in most parts of the leather business and in China the effect of the Olympics will still persist.
As we already said in one of our previous reports we expect the first and next significant possible timing point in the second half of July when Asian tanners have to take their decisions for their production in September and October when the new season of production starts all over the world.
Until then we still remain pretty cautious and believe that standard item shoe production will hold, while all upholstery related hides will still continue to struggle. This could have an effect on the general market tone and is definitely not to be ignored.
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