Market Intelligence—23.09.08
22/09/2008
MARKET INTELLIGENCE—23.09.08
Macroeconomics
We were honestly thinking of skipping our traditional opening macroeconomic section this time. So much has happened in the last two weeks and we assume that readers have been following the news every day.
However, we should stick to the traditions in difficult times too, and so we will try just to summarise and to go through what has happened in the last fortnight.
Like all bubbles, this one too had to burst; we have expressed concern that this was going to happen, pointing out that speculation had taken over and greed was commanding decisions. Unfortunately this has become reality.
Over the summer things still looked pretty quiet and it seemed that all the warnings were completely in vain and useless. However, eventually it had to happen and it happened much more forcefully than anybody expected: Wall Street just imploded. Banks went bankrupt, others had to be rescued by governments or central banks, the biggest insurance company in the world joined the party and in all financial centres of the world fear was seen on all faces.
All those smart cookies who thought that making money was just a question of increasing the risk and leverage got a beating and had to learn that there are still no miracles in this world and ‘perpetuum mobile’ is still to be invented. The massive excess liquidity in the markets, which had been used to speculate, was all of a sudden absorbed by huge losses and turned very quickly into a shortage of the same.
There is no need to recapitulate all that has happened, but what remains frustrating is that all those responsible have walked away in the last years with huge salaries and bonuses, leaving all the trouble behind for, in most cases, the taxpayer again. Unfortunately it is not possible, but it would have been just and fair if those people repaid what they got but never deserved. Anyway this is now in the past, another page in the history books.
In the meantime central banks and governments are trying to restore confidence and inject enormous amounts of money into the markets to protect them from collapse. Most international stock markets took a big nose dive and only after the announcement of the US government to install a huge rescue plan were markets able to recover. However, the massive rebound of the stock markets on Friday, September 19 showed again that this financial world is basically run by speculators rather than investors.
Some stocks rebounded by more than 20%, although there is absolutely no guarantee that the problem is already resolved and that markets are safe again. People are still willing to pour money into markets, but on short-term basis rather than after fair analysis of risk and chance. The same happened to currencies, commodities (especially oil) and interest rates. The moment the rescue plan was published, risky trades and speculation resumed. The lesson has not been learned and it might need another crash to teach people finally that there’s a big difference between investing and speculating.
Market Intelligence
For the leather pipeline the situation has been less turbulent than on the financial markets, but certainly no less exciting. Everything we had been seeing on the horizon came to pass, in particular everything related to upholstery production; this sector of the leather industry has had to accept all the problems that were developing over the summer.
As a consequence, a lot of the Brazilian suppliers have had to travel to Europe, in particular to Italy, trying to sort out the non-payment of documents and outstanding shipments. How successful they were in the end we can’t really say. Most of them have said that they were able to settle all the problems, but we have our doubts. If we can trust the rumours and gossip, selling prices had to be renegotiated, spot re-sales had to be made in the end, and it seems that it was no exaggeration to say that selling prices have dropped by as much as almost 40% compared to the spring. It remains questionable to say the least if this is the end; we would not be surprised if the price for good quality Brazilian wet blue is soon well below a dollar per square foot again.
Prices for this kind of material have certainly been far overvalued, but a collapse of this kind in such a short period of time doesn’t happen frequently in our markets.
European prices had already adjusted, and with the help of the sharp gain of the US dollar in the past weeks, some of the market pressure was well cushioned. However, this market could not walk away from the massive pressure in the upholstery section either and most hides related to this industry were still facing enormous headwinds and production is no longer able find enough buyers.
Consequently, the prices for European dairy cows and some ox and heifer selections still needed further corrections to find the few buyers with courage who were willing to take a position at present levels. A lot of European hides were falling below the magic one euro per kilo mark, and we have to assume that lot of slaughterhouses and processors have had to bite the bullet and take losses. If nothing extraordinary happens they will face significant write-downs on inventory that they have had to carry over the summer.
The situation for male hides was a bit better as these are still protected by the reasonably steady situation in the US steer market. With the help of the firmer US dollar a reasonable amount of European steers and ox found their way into the Asian markets, where tanners were quite happy to have an alternative to the reasonably expensive US standard materials.
Ambitious budgets
It is quite amazing that the shoe business remains still pretty much untouched by general global problems. Many familiar with the trade including those who were visiting the GDS shoe fair in Düsseldorf in mid-September are reporting something of a slowdown because retailers have become less confident about the future. This might be the case, but it seems that, rather than facing a substantial decline in sales, it’s more that they cannot meet their very ambitious budgets for the year.
There is certainly no question that the global financial crisis as well as record energy prices in the second quarter will also have an effect on general consumption, but it would be no surprise if the basics of life were to suffer much less, while the luxury sector—which has been an over-perfomer in recent years—will be hit much harder. The massive meltdown in the Russian stock market and the huge losses and lay-offs in the financial community will also have an effect on spending in the luxury markets, not to speak about the general wealth which has been destroyed over the past weeks.
Despite the fireworks on the financial markets on September 19 after the US government had announced plans for a huge rescue package, we all have to assume that global consumers will not spend as freely any more. Most likely, demand will focus more on the essentials and not on the extras. This is all right for shoes, but still bad news for upholstery leather.
Questions about cars
Automotive remains a bit of a question mark. Mobility is still an essential for most in the world, but the car market has a number of specifics which have a strong effect on the demand for leather. Generally the purchase of a new car can be postponed for quite a long time. Second the options (including having leather upholstery) can be individually decided. Traditionally more expensive cars are leather equipped while cheaper cars are not. For the time being—owing to high energy prices—the trend is certainly to drive smaller vehicles that consume less gas and the only question is if buyers will spend more money on other options, such as interiors. A more important question for the short term, however, is if consumers will decide to buy new cars at all or if they will postpone purchasing decisions for as long as possible to check what kind of alternatives are offered by the car manufacturers.
Excepting the hype for hybrid cars (which are not the gas savers that many people think) not much is on the market yet and car manufacturers are presently pushing development hard to make up for the negligence of past years. However, the real innovations will hit the market only after 2010 at best.
This leaves only two options. Car sales are going to be flat for a while and consumers will continue to opt for smaller and cheaper alternatives, or car sales will recover medium term when the dust has settled and the consumer is willing to spend more for leather upholstery or bigger cars. A certain fundamental demand is also secured from the leasing market where cars have to be replaced after the leasing contract has expired. This leaves the leasing company with a lot of cars which are not absorbed on the second hand market, but that is another story.
As of today it seems that the automotive market will have a rough time for a while and productions will be cut, except for some isolated models or brands that have attractive offers. A bit of support for the leather manufacturers may come from the ‘special offer’ attitude that often comes to the surface when business is poor, but this will certainly not lift the general pressure on leather prices. Until then, the production pipeline is pretty much jammed and producers everywhere are trying to reduce stocks.
Part of the furniture
The situation is pretty similar in the furniture market. Demand has fallen rapidly since the first quarter and this has delivered another lesson, that leather furniture is not an essential. Not to speak about the harm to the image of leather caused by the cheap rubbish thrown on the furniture market over the past years. So, before the automotive industry, the furniture leather market had already taken a beating and the jam in the pipeline there has already been in evidence since the spring. We can see how bad the situation really is from the announcement of a European tanner of good reputation to cease production for a full month in October. The last thing a tanner does without emergency is to stop production, and even less at the start of normal production season in autumn.
For the upholstery market time is quickly running out. The high season of production normally starts towards October. Apart from the seasonal rise in orders and consumer purchasing activity, there should also be stimulation from a number of trade shows.
Asking around, we haven’t found anyone who is reporting any pick up in orders or interest, and so it is left to the trade shows to offer some stimulation. However, even if these exhibitions prove to be a success, it will be some months before new models hit the shops and catch the eye of consumers.
The picture in China
It’s also possible to form a picture of how poor the situation is from looking at tanning activity in China.
Due to longer shipping times, business normally picks up there in summer, but there has been no sign of this this year. Even today there is no demand seen from this part of the world, which has been so dominant for some years. Tanners are still consuming inventories they have been holding since the first quarter in expectation of a normal year of production.
So, in the best of all cases the leather upholstery demand can only pick up with a delay of at least four to six weeks versus a normal production year.
What we see also in the present market conditions is something that we have already discussed in previous issues of Market Intelligence. Leather prices and, as a consequence, also raw materials prices have got limits, upper and lower, between which the price always varies. This is more pronounced for upholstery, because of the sheer consumption of leather per product unit, and less for shoes. With the sharp rise of production costs that we have seen since mid-2007, the correction for upholstery leather and raw materials was an inevitability. The problems in the financial markets were only an add-on to the situation.
Blocked pipeline
So what we have to deal with at the moment is a classic jam in the supply chain and production pipeline for upholstery leather, including automotive. As far as we are concerned it will take time to sort this problem out. Smart money and buyers are already taking advantage of knowing very well that, for upholstery material, prices are well below the long-term average and will arrive these levels very soon.
Any company that can be confident about its production and has got deep enough pockets to take advantage of the situation will find a tremendous opportunity to build low-cost raw materials stocks over the months to come. We believe that this situation will most likely persist for the rest of 2008 until the pipeline is cleaned up. If the global crisis is not resolved by the rescue plan and the liquidity injections of this week, it might even take a bit longer.
The final question is if the difficult situation in the upholstery sector is going to drag shoe-related hides down eventually, or if this market segment can remain unmoved by the crisis in upholstery.
The split market is now finally seeing changes. Mainly in Europe where we had been advising already for quite some time, that the demand from gelatine production is increasing, prices for line splits have gone up sharply. In some cases, prices have more than doubled. It is only a question of time when this is going to spill over into the leather-related split productions as well and this will reduce the pressure on prices to some extent because more splits will end up in gelatine production and fewer will come to market for leather production.
If there is a bright spot then we have to say it is still in the skin market. Not that we see sharply rising prices or a bonanza of demand, but interest for skins is still okay, and demand for goat and sheep remains quite decent. In particular tanners in the Middle East and in China are presently searching actively for adequate supply.
Shoes to keep the market steady
For the coming weeks we still believe that the market will remain pretty nervous. Directions are absolutely not clear. We are still of the opinion, that the leather business for shoes remains good enough to hold the market and demand levels reasonably steady. The other side is no indication that the problems in the upholstery segments will be over very soon and it would be something like a miracle if within the next weeks this market were to return to normal.
However, as mentioned above, smart money and strong hands are already starting to prepare for the future. In private, a number of sources are confirming that if they are willing to accept certain price levels, large individual sales can be made and strong buyers are willing to absorb extra inventory from safe sources to build decently priced inventories for the future.
As we already said in a previous issue, it has always been a good investment to own adequately priced raw materials stocks. If we see no more turmoil on the financial and currency markets, considering that we are approaching the high-season kill in Europe and the crisis in the upholstery market, we would be surprised if the market were not to stay under buyers’ command for some weeks still. Maybe by mid-November the dust will settle at whatever the levels are going to be for upholstery hides at that time.
In particular for medium and better quality hides, the situation will be a relief, because the price reduction will enable manufacturers and tanners to use better quality material for a reasonable price again. Again it might be wise to act according the old stock market saying, that you should buy on bad news and avoid trying to hit the bottom.
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