Market Intelligence—03.11.08
04/11/2008
Macroeconomics
The financial markets are giving us no chance to take a breath. Although we saw at the end of the period that stock markets were beginning to have some stability, all markets still remain very volatile and few believe that it is time to sit back and relax.
Over the last two weeks stock markets and currency markets have been bouncing up and down. There is still a dramatic shortage of US dollar liquidity, a lot of carry trades need still to be unwound and a number of US investors are still in the process of bringing overseas investments home.
Daily moves of 5–10 % on the stock markets and 3–5 % on the currency market became pretty normal and added to the uncertainty of participants.
Meantime commodities also continued to decline and oil prices fell to close to the $60 level. Almost all industrial commodities, which had been seen by our beloved experts as being on an ever-rising track only six months ago, are now falling in expectation of a recession and now the same people are falling over each other to lower their target prices for the coming months. Well, the only thing one can possibly say about the market and prices is that the influence of speculation prompted by acces to ‘cheap money’ has now faded and prices seem to reflect the market realities much more. However, a lot can still happen as plenty of hedge funds may still go under and nobody knows which kind of positions still need to be squared; this could trigger more market turmoil soon.
From the stock markets one could believe that the worst might be over. Last week stocks stopped their rapid descent and started to settle on the lower levels. However it may still be too early for the same reasons as apply to the commodity markets. In addition there are still a few traps around so it is way too early to celebrate.
After banks needed to be bailed out, the focus is now shifting to entire countries. Little Iceland was the first, but Argentina and Hungary followed quickly and a number of others are on the list. Money which had been pumped into emerging markets in recent years has now been called home. Falling share prices and political uncertainty are causing locals to shift their investment abroad too. So, a number of currencies have already been falling for a while, and external loans to countries that were called ‘tigers’ not long ago look pretty unsafe now. If further countries fail, it could be another big threat to the banking system.
As if that were not enough we still face another big problem—the credit-card crisis specifically in the US. Consumers are overspent, which is not only weighing on future consumer spending but remains a big threat to banks and credit-card companies. If the consumer must stop spending it will actually be the final nail in the coffin of the US economy and the financial house of cards will take its final hit and tumble.
We can only hope that the times of wild speculation are over and that the markets get time to settle down. And we can only hope that speculators are not looking into the chances of betting on a final crash. Money is ruthless, and this is what everybody should bear in mind.
Market Intelligence
Most of the trade was this week focusing its interest on the Lineapelle leather fair in Bologna. The other important trade show in Highpoint in the US, which is an upholstery show for the US market only served to confirm that the US consumer will be very cautious about spending in the near future. Most manufacturers and retailers have been pessimistic about business for 2009. Since this was not much of a surprise, it did not move the market very much.
If there was anything of interest it was that better quality materials are holding up much better against actual prices. Upholstery tanners that are known for better quality materials have at least returned from the show not completely pessimistic and although their order books are still short of ‘good enough’, they have definitely returned with something in hand. For the mass producers in the lower-price section, the situation is different and many of them failed to achieve either enough orders or the prices they wanted.
However, none of this is really surprising; that the upholstery market will be very difficult for the months to come was already known and the financial crisis is doing little to support furniture and automotive purchases.
Great depression?
Consequently most people were not expecting much of the trade fair in Italy and many thought that they would just go to get even more depressed than they were already. This applies in particular to raw materials suppliers.
Arriving to the show early on October 28, all expectations seem to be confirmed. Until 10 o’clock, hardly anyone was seen in the aisles and people on the stands were talking more to each other than to any visitors to their booths. So at that time the few people around had already written off the event. As the day progressed, it got busier and by around lunchtime the fair was reasonably well attended and the workforce was busy enough to entertain clients and to speak about products and orders.
On the second day the situation got even better and between 10 and four o’clock the show was as busy as ever and there were absolutely no complaints from the vast majority of exhibitors about insufficient traffic at their stands. By the third day the show is traditionally already over, so people used the time to have social contact, to refresh trade relations or to meet any friends who were still around.
With all the negative expectations, we have to admit that most people we spoke to had been impressed by the size of attendance and the quality of visitors. As usual, in a general crisis, leather can become a thing of pleasure and, since shoes are still a basic product and accessories can be a small treat in difficult times, it seems that this might be the case again this time. Since Bologna’s focus is on side leathers and fashion is probably the core issue, we had confirmation again that in these difficult times classical items of high quality are still the ones that most catch manufacturers’ and retailers’ attention. Fashion and products were almost completely focused on better and higher quality leathers.
Orders continue
Tanners that can meet these expectations were quite happy about the results of the show. Nobody was complaining about the lack of visitors and from their regular buyers people were reporting that everybody was talking about the difficult times and the financial crisis but at the end there was not yet any indication of a major downturn in orders. Tanners had to fight for their leather prices, but with lower raw material costs, falling energy and chemical prices as well, the situation is definitely better as far as margins are concerned than it was when we were in the middle of all the global hype.
The only remaining concern for successful businesses was that the financial crisis could become so deep in the end as to destroy even this high-end part of the leather market.
Cause for concern
This was the good news, and many will complain that we are again over optimistic and painting a picture that is too rosy. And they are right. There were also the depressed faces of those came particularly from two major sections of the leather pipeline. One is certainly everything related to upholstery. Whether it’s furniture or automotive, things are really bad. Global activity in this area is definitely substantially down by a figure of around 20% compared to a year ago. This number could fall even further in the months to come because of the sharp drop in production in the automotive industry and further production cuts cannot be excluded.
If this happens, we would see leather production falling by another 10% or 15%, which would mean a cut of almost one-third on the production levels of 2006 and 2007. This cannot take place without substantial changes, and it is clear to everyone that there are closures and reductions in capacity ahead. The problem is not only a lack of production, but also the burden of expensive stock. These factors are combining to make the life of producers in this field pretty rough these days. Only a handful of top-quality manufacturers of furniture leather are still admitting that they are making more profit from their better margins than the hit they are taking because of insufficient orders.
Supply side headaches
As a direct consequence of the above, suppliers of raw materials from the US dollar area represented the second community that was extremely depressed at the Lineapelle show. Most suppliers were just busy in their fight with clients in Italy about the renegotiation of old contracts that had been based on a US dollar exchange-rate of approximately $0.20 more versus the euro than we have today.
The general market decline of raw materials and the change in currency rates mean a great number of tanners are unenthusiastic about accepting containers that have already arrived or shipments on the water, not to mention outstanding contracts. We heard all kinds of horror stories around the show and watched a number of groups round tables that could be identified as suppliers and customers; one could see how dramatic the negotiations were.
Most people are talking about buyers asking for a discount of 30% on the original contract price. Everybody can understand that this is neither fair trading nor acceptable in international commercial relations. The volumes of containers involved could mean a severe hit for many suppliers and it would not come as a surprise if some export traders found themselves unable to handle the problem. It is absolutely unacceptable that European buyers are using the rise of the US dollar as an argument because everybody is in a position to hedge currency issues. However the main driving force is of course revenge because suppliers also played this game in 2006 and 2007 when the raw materials market rose and they were asking for price adjustments.
The second argument is always, that these kind of arrangements have been done between others, and so the buyers risk being at a competitive disadvantage compared to competitors next door. Again business morals are being completely destroyed. The trade should think about some public action and arbitration; a neutral institution to list this kind of dispute in public might be a good way to stop this never-ending market reaction by individuals.
Trouble with banks
The financial markets are still another big problem. A number of people from various countries were reporting a lot of trouble in their relations with their banks and commercial transactions. Some were complaining about their inability to cover foreign currency transactions in the past weeks and others, mainly from countries in Africa and South America, mentioned concerns about the quality of their local banks and the risk that payments coming in from customers overseas could be ‘lost’, with banks searching desperately for liquidity. This is of course a very difficult subject because it could reduce trading activity even more than the general market problems and would definitely also increase the cash-flow problems within the industry.
This is not all; many suppliers continue to confirm that credit cover on their European customer base is getting smaller and smaller and the big credit insurance companies are reducing their coverage continuously. If cash were not a problem already, the restricted volume of trade—in particular for those companies that are thought in the main to be sound—is weighing tremendously on the situation.
Anyway, looking at the situation and the problems in the market the trade show in Bologna delivered better results than anyone would have expected before their departure. It may be too positive to think that this will be enough to lead us out of the doldrums.
Consumer reaction
Noone knows how consumers are going to react in 2009. The only thing one can say is that there is a good chance that at least in the field of shoes and accessories things will not be as bad as many think today. In particular producers in the Middle East and also in Asia still see domestic demand growing and this might be possibile compensation for some of the losses which they definitely have to expect from their export business.
The split market has not seen much of a change. However, suede articles made from splits might be a fashion trend that could eventually boost split demand. We would say it is still far too early to see it as a turnaround possibility in the split market, but at least it would open a few more doors for the still existing stocks of wet blue splits. The situation for gelatine in Europe remains unchanged. Gelatine producers were at the Bologna fair trying to buy more gelatine splits from European tanneries. This is pretty much new because those buyers never found it actually important enough to look for supply before because they always had enough raw material supply from their regular producers, namely from the automotive industry. With the peak production cuts already done and expected to continue for the months to come, they have obviously found it appropriate to check what alternatives they might have for their high-season production.
The skin market did not show much variation. Lamb and sheepskins still see a bit of headwind, mainly because the calf skins market is not as positive as it was until September. So prices and margins are becoming more and more important; prices for this kind of material are under pressure, without having seen much of a reaction so far. Small goat skins suitable for good quality suede are still finding good and strong demand and most suppliers of the origins which can provide this kind of material were reporting good sales and a decent forward position for 2009.
Slow down
For the weeks to come we believe that business is going to slow down. Tanners with courage and cash have taken a chance on the show in Bologna to buy whatever they were able to get at the right price from suppliers who are in their confidence. This applies in particular to European suppliers who still have tremendous support from the currency market. European hides from many origins look remarkably attractive today and they are not far from their historical lows.
Tanners with good experience know that, and are taking the chance to replenish inventories for quite some time ahead with their desired raw materials at prices that, in the long run, definitely appear to offer an advantage. Consequently we think that the better quality players in the market have done what they had to do. Buyers and sellers have taken a position that will balance their needs to sell and to buy for a least the next three if not more months.
For the rest the situation will look increasingly difficult. There will not be enough business for all tanners and consequently not enough buyers for all sellers. In particular shippers from origins that struggle with fancy relations today could have a pretty rough time ahead. The only chance is that the currency situation goes through another tremendous change, but for the near future that seems at least to be pretty unlikely
Consequently one has to expect another sharp correction of prices from a number of origins, namely from the US. Together in line again with international market levels, corrections of 10% or 15% could be needed. It’s unlikely that this will stimulate demand outside those who have already done their homework. So for a while raw material prices will still stay under pressure, in particular for the medium-lower grades. For the better and top-quality materials, the situation will be much better.
Leather attractive in price
For the longer term one has to be aware that the price of leather is becoming increasingly attractive versus alternatives. That means that the normal cycle in the leather business is still intact. At levels where leather is too expensive—and this is what we saw about six months—demand falls and profit margins in the industry shrink so much. However reaching levels again where good-quality leather can be produced and meet customers’ expectation, it will quickly become attractive enough again for business to pick up. To sort out the problems of the financial crisis and the return to a regular and normal commercial situation will take longer. In any case this kind of crisis always lays the base for a better future and, unfortunately, we always need these kind of painful periods to sort business out again.
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