Market Intelligence - 09.09.08
10/09/2008
MARKET INTELLIGENCE—09.09.08
Macroeconomics
With August and the vacation period of the Western world finally ended, and the Beijing Olympics closed, many have expressed hope that normal market activity is going to return.
At least for the financial markets this is mainly true. The story of the past two weeks has definitely been the further sharp price correction of oil, the recovery of the US dollar and the dramatic meltdown of the stock markets (notwithstanding their rally after the US government’s decision to take control of the country’s main mortgage providers).
The situation in the Caucasus has calmed down, at least superficially. More headlines were made during these two weeks by the presidential campaign in the US and the tropical storms hitting the Caribbean and the coast of America. The tropical storms had a short impact on oil prices but they could not prevent the further decline of ‘black gold’, which settled at around $105 per barrel. Consequently, our anticipated turnaround of the speculative positions on oil and dollars continued apace.
The US dollar continued to climb on expectations that the European economy would continue to slow down into 2009, while the US economy might already be through the worst. As a consequence, European interest rates could decline, while, in the US, interest rates—in the attempt to fight inflation—might have seen the lowest point of the cycle.
As usual we do not tend to agree with this position; it’s more a case, in our view, that the speculators were just looking for a new place to gamble their money. There is little evidence for believing that the US economy is already through the worst, and it might just be expectation of what might happen as a result of a possible political change in the US after Mr Bush has left the Oval Office.
For the time being, the dollar has gained more than 10% versus the euro, and oil prices have fallen by more than $40 a barrel from their peak. Whatever the reason, this is good news for most of the world and certainly better for general economical development than any questionable political action.
Stock markets globally came close to meltdown in the past week, before that late rally, and while stock markets fell in the western world for the simple reason of economic worries, we saw also the stock market in Moscow losing a lot of its value because of investors’ reaction to Russian policy in the Caucasus conflict. Most international investors consider it to be appropriate at the moment to withdraw their investments from Russia and bring them to more safe locations.
This has definitely weakened the rouble, resulting in a blow for the Russian government; it has had to understand that building confidence is a very difficult and long process, while destroying confidence can be done much more quickly.
Due to the tight economic links between Russia and western Europe—and in particular because of the high percentage of energy supplies that come from Russia— European politicians are trying almost everything to calm the situation down and not stir up further conflict.
Market Intelligence
Over the past two weeks there was hardly anything in the air other than expectation for the All China Leather Exhibition in Shanghai. People were so desperate to meet clients, colleagues and partners from around the globe in the hope of understanding more about the current situation and what we might expect for the rest of the year.
As a result, the attendance at the fair, at least on the first two days, was much better than many had expected. True, a number of people decided not to go to the show, but on the other hand, many people who would probably not have travelled in normal circumstances turned up.
Decline in demand
In the end, there is not really much to analyse from the event itself as it just confirmed what we all knew already. The situation in the upholstery business is down to a pretty dramatic lack of demand. And while many thought that the Olympic Games and the production shut-downs ordered by the Chinese government were the main reason for the decline of production and demand out of China, it is now definitely clear that production levels could have remained at the same level if demand for the leather had been there. Knowing Chinese business people, they would have found a way of making it possible—in their own way, of course.
The simple fact is that there was no leather demand and, consequently, it was pretty easy to shut production down and to follow the government’s orders.
Furniture upholstery tanners in China are presently using somewhere between 30% and 60% of their capacity, and even at that, it’s open to question if these productions are covered by orders. Those manufacturers that are mainly producing for export are being hit much more by the economic slowdown and the reluctance of their customers to declare themselves for next season. This is probably the key question to the real situation in furniture upholstery market.
Demand never falls to zero and, most likely, it doesn’t even fall by 50%. However looking at the situation over the past four months, we had congestion in the pipeline with raw material supplies coming in on the basis of the volume of business seen until April. Not even half of this was met by the actual orders that had been placed for the slow season.
Inventories are too big and too dear
Consequently many tanners have now an inventory of raw material that is not only too big, but also far too expensive to meet the present market situation.
Tanners are facing not only high uncertainty about the future, but also significant delays and a lack of commitment from their customers about articles, volumes and prices for upholstery leather production in the season to come. There will definitely be more clarification on this in the next four to six weeks. A number of tradeshows are taking place, and retailers—in all their caution—need to decide what they are going to offer to their customers. Consequently decisions, right or wrong, are going to be made over the next two months at most.
The biggest problem for tanners today is that they know that present raw material prices and market levels mean they will lose a lot of money on stocks that they are still holding from the previous season. So, with everything they are trying now, this could push the raw materials market so far down that any new purchases will allow them to make cost averaging without losing too much money right away.
Ailing automotive
If the situation in furniture upholstery were not already difficult enough, we are now faced with a similar situation in automotive leather. Although everyone following the automotive market closely already knew the performance of sales of new cars in spring and, in combination with high petrol prices, nobody could actually be surprised about the production cuts that are taking place now after the summer holidays.
We would estimate the average the production cuts in budgets are down by between 20% and 30% versus the levels of the first quarter of 2008. Consequently, the vast majority of automotive leather manufacturers are facing the same problem as furniture upholstery tanners, although they have more security about production for the months to come.
The result of the above is a pretty depressed market for upholstery related hides and this was just the confirmation of what we all knew already and had been expecting. There was simply nothing coming around the corner to solve the problem of the leather pipeline in this sector.
Better news in footwear
Side leather for footwear is, fortunately, showing a significantly better performance. Although Europeans in particular were pretty pessimistic, because of some problems among shoe tanners in Italy or Spain for example, one has to accept that total production is not declining. Most big manufacturers we have spoken have told us that, even if they are not meeting their growth targets for 2008, they are still producing more leather than in 2007. This will not compensate for the decline in upholstery, but at least producers and this pipeline are having a much better time of it, which was also reflected in business conducted and talks taking place in and around the show in China.
Hides which are usually used in this field are still able to find a home and many suppliers were quite content with their levels of business. It was also interesting to notice that there is more demand now out of China for calf and kips. Worries in many quarters that difficulties in traditional markets for this material would put additional pressure on raw material prices were quickly destroyed at the show.
We have to admit that the individual situation of companies is varying more than ever before. We have seen many times in the past such a wide discrepancy in the situation and opinion of different people in the same business. Readers should bear this in mind as we try to offer a general market analysis; variations either side of the average are pretty big.
Cash in hand
Another big concern at the show was the economic and cash-flow situation of many tanners. Not only the usual suspects in southern Europe, but also companies in northern Europe and the US have made headlines with announcements of restructuring, closures, work shortages and so on. Hearing this has made everybody ask if this could be an indication of serious financial problems to come.
We don’t want to join the theories and just hope that those who are pessimistic will be proved wrong in the end. The fact is, however, that a number of producers almost everywhere around the globe have already announced that they are going to shut down production units. Since the trade is almost always dealing with overcapacity, it is probably time again for some restructuring and it is much better if this is done on a voluntary basis rather than forced by bankruptcies.
However, there are also more and more complaints in Asia, and in particular China, about tighter cash-flow positions and problems among tanners to get payment from their domestic customers. This means that domestic demand in China might be still good, but not good enough to absorb and turn around production levels quickly.
Split nightmare continues
The split market continues to be a nightmare for many. Wet blue drop splits are still difficult to sell and if you can get rid of them you still have to deal with other problems such as getting payment, letter of credits, shipments, and claims from clients that you would never get in normal times.
Only gelatine splits in Europe are doing better because, with all the production cuts among larger tanners, gelatine producers are facing reduced availability for at least the next two or three months. Consequently, prices for buying splits, which had been close to nothing before the summer holidays, have already moderately increased.
The skins market has performed much better. Not that there is a rally in the market, but most productions are absorbed and we were surprised to see how much interest there was for reasonably priced goat and sheep. Adequate business was done already for double-face selections as well. Prices are not going up, but at least material can be placed and demand is, in most cases, sufficient.
What does all this mean for the market in the near future? Well, actually nothing new.
The congestion in the supply chain of upholstery material will take some time to resolve. On the other hand we can see that a number of tanners have realised that prices for many raw materials have or will very soon reach levels that, in the long-term price-cycles can be considered to be low.
It has always been better to own raw materials and secure adequate price levels rather than hope for further reductions. The big problem is that this is only the case in the upholstery segment. And cheap raw materials don’t help you much when you have no orders for which to put the material to use. So it needs not only a lot of courage but also a deep pockets take the advantage of the situation we see for the foreseeable future.
For those who do have the opportunity to take advantage of the situation, it could actually be a very solid base of a company’s future success. The problem is just we don’t know how many are willing to act in anticipation of the future. So for the weeks to come we still expect a lot of troubled water for many. The Italians have just come back from holiday and it is still not clear if everyone is going to be able to pay the bills which have built up over the summer.
In Europe the situation might become a little bit easier because of the fall of the euro. If the Euro is not gaining against the US dollar, some of the price pressure might fade just for currency reasons.
That doesn’t resolve the question of where all the dairy cows are going to be placed, but at least they are not completely out of the market any more, as they have been for the last four months.
All in all, we believe that in the weeks to come, and until the real situation on the demand side is clear, the raw materials market will continue to face headwinds. However, as we already said many times, this applies much more to upholstery than to to shoe leathers. It will be interesting to see if the price gap between upholstery hides and shoe hides becomes wide enough to make more tanneries switch.
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