Macroeconomics

The financial markets have calmed down a bit over the past two weeks. The stock markets, in particular, settled and some experienced quite significant gains during the last fortnight.

The situation for general market liquidity also seems to have normalised and interest rates are on their way down again. Unfortunately, in most cases, only to the levels of the national banks; many commercial banks are not passing them on to their customers. Quite the reverse, in fact. On enterprise levels they are even trying to raise interest rates arguing that corporate risk levels have gone up. A lot of businesses are complaining bitterly that access to credit is increasingly difficult and banks are piling up cash reserves for their own balance sheets rather that lending the money to keep business activity alive. A lot of government aid is not being used in the way it was meant to be.

China continued efforts to stimulate the economy by reducing its basic lending rate this week by 1.08% to 5.58%.

Commodity prices are still on their way down and a lot of products are facing a similar implosion as the raw materials in the leather pipeline. This not only includes standard articles such as grain, metals or oil, but also recycled products. Traders and shipping lines are reporting that vessels are returning from their Asian destinations without the paper, plastic, computer waste and other products being unloaded.

In general, the mood is still pretty negative and the limited statistical data available did not offer much optimism for the immediate future. Consumer spending fell 1% in the US and the real estate market confirmed the weak performance with a drop of 5.3% on sales of family homes. Most retail groups in Europe were more optimistic about the Christmas shopping season and polls showed expectations of results similar to those seen a year ago.

Following a great fear of rising inflation in the first half of 2008, it is deflation that now poses a threat. The possibility of shrinking retail sales in 2009 could increase overcapacities. As a result, producer and retail prices would drop in an attempt to fill capacities and consumers would spend less in the expectation of further declines in prices. If this happened, growth would become negative, unemployment would rise and economies would be in trouble for a long time. A past example of this happening is the crash in Japan during the early 1990s.

The political world is in a state of emergency again. The ruthless and terrible attacks in Mumbai have shown that there is hardly anywhere in the world where one can feel safe these days. Terrorist groups are doing all they can to destabilise regions and societies.

Protestors in Thailand are still occupying Bangkok airports and around 100,000 tourists are, for the time being, stranded in Thailand. The good thing is that the protests have not been violent and protestors in the airports are not armed. However, most expect army intervention soon and one can only hope that it does not end in violence.

Oil prices have stabilised and the currency market has also calmed. The US$ is now stable in a trading range of between 1.25 and 1.30 to the euro.

Market Intelligence

A fortnight ago we were talking about drama in the market and were still hopeful that it could be saved from collapse. Unfortunately, we were too optimistic and we experienced a dreadful meltdown that ended in complete paralysis. The Thanksgiving holiday stopped trading in the US almost by mid week and other markets lost the strength to trigger any further activity.

The situation can only be described as chaotic. Price is the story for today. For the lower-quality end of the raw material market, price levels quoted are hardly covering production costs and the price range today between the high-quality section and the low end is so compressed that purchasing lower-quality hides does not make much commercial sense anymore. This is actually another proof of the fundamental lack of confidence in the market.

Morals start to slip

However, the biggest problem today is the almost complete lack of business morals. Even the top names in many markets are reportedly ignoring existing contractual commitments. Tanners with good reputations are now being accused of breaking contracts and blackmailing suppliers. The option they are giving is this: either you lower the price by ‘x’, or we will either not pay for the material or we will not open our letter of credit.

What has already been happening on trader levels in recent weeks has now also spilled into the top class producer levels. The trade is now wondering how it can deal with such a situation. The answer may already be there as a lot of suppliers have given in, triggering a total loss of market orders. While respected names were, until recently, trying to protect their reputations and draw a line between themselves and the ‘crooks’, the situation is now somewhat different. This is because they are seeing others walk away from existing commitments and taking a chance on saving large amounts of cash and widening margins, either by renegotiating or cancelling contracts and covering it through other suppliers.

While buyers must of course be blamed and accused for their behaviour, sellers should also understand their responsibilities. Those that are accepting these attitudes must not complain about the consequences. The big, well-known suppliers, at least, should uphold the standards. The long-term damage will definitely outweigh the short term gains, no matter how serious the problem is today.

Why are we in this mess?

Since there is very little that can be done, and because the present situation in the leather pipeline has also been experienced in other markets, it is far more important to understand why we have arrived at this point and to assess what realistic options we have for the future and for 2009. Although many may have the impression that demand and business are completely contracted, a lot of tanners are still enjoying steady business and taking the best possible advantages of the present situation.

Let’s go back and see what has changed in the past six months using what we know today. Price is normally defined as the reflection of supply and demand. Taking a more sophisticated approach, we know that commodities prices also involve a certain amount of future expectation which either inflates or deflates the price rather than simply reflecting supply and demand. Until the end of the first quarter of 2008, we obviously had a pretty large percentage of positive expectation for prices. Producers were expecting demand to expand further and raw material was secured according.

This explains the tremendous forward positions that were actually run, particularly by sellers in the US. We know today that expectations were pretty high and that when they were not actually met, manufacturers started to postpone shipments. The last weeks show that expectation influences prices, and that expectations for the near future are entirely negative. This could be as wrong as it was about six months ago. What we definitely cannot estimate is how much expectation affects actual prices.

Declining demand anticipated

Most people believe—and this is why raw material prices have taken such a nosedive—that the retail outlook and global demand for consumer goods in 2009 will be significantly less than in 2008. However, there is no extra proof of this so far. There is still no evidence that stocks are increasing at the retail level, which could force retailers to reduce their actual order volumes for the coming seasons. At the moment everyone is extremely cautious in either delaying orders or passing them on securities levels. We have seen the results of this in the markets in recent weeks. The only thing we know for sure, and this is nothing new, is that automotive and furniture upholstery has faced declining demand in recent months.  

We also need to discuss the ‘China effect’. As with many other commodities, China has become such an important factor in the global markets that global supply and prices are almost dependent on the situation in this huge manufacturing hub. It is commonly known that Chinese businessmen have a strong ambition to gamble; not only on a private basis but also in business. This means that their willingness to bet on the future is much higher than in other markets. Unfortunately, not everyone responds as gentlemen if bets turn out to be wrong. In all fairness, we must admit that other markets, including some in Europe, face a similar problem. Consequently, the gambling effect is another factor to add to the general situation of supply and demand plus expectations.

We still feel there are good reasons to believe that the effect of expectations is as exaggerated today as it was in the first quarter of 2008. It will take some time for the influence of expectations to fade before we can get closer to more realistic reflections of the real supply and demand situation. What was once a large sold-forward position has now become a large stock position for producers and shippers. It will definitely take some time for this to be digested and the sooner the pipeline returns to a more realistic analysis of the situation the better.

Timing is not particularly good as we are fast approaching the long winter holiday season. Most people do not actually care too much about this analysis at the moment and would rather stay in a state of depression and hope for some relaxation during the break. This will not help those disposing of stocks and, if worse comes to worst, their panic will continue.

Fears for splits and skins

There is no real need to speak about the splits market. With hide prices at the levels they are there is absolutely no need to discuss what splits could be worth today. Only demand for gelatine remains strong and of this there is sufficient supply. Many are already wondering if it could become a realistic alternative for a short while. Maybe the players involved will discover this pretty soon and this would then correct split prices and support hide prices.

The sheep and lambskin market was not as clear as in recent weeks. However, it would be ignorant to believe that the present situation in the bovine market will leave the ovine market untouched. Prices will come under pressure pretty soon if it has not already happened. In terms of sheepskin, we must also consider the wool market, which is suffering a meltdown for most commodity items.

Activity to slow as holidays approach

We are finally entering into the last month of 2008. The last week of the year will be almost completely closed because of the Christmas break and most productions will close a week earlier this year because of expectations for orders at the beginning of 2009. The Chinese New Year break follows pretty soon at the end of January. Productions, with the present decline of orders, are pretty well covered with raw materials. Everyone seems quite happy to deal with today's problems rather than worrying about what will happen in the New Year. This means they will be little chance of relief for the raw material market in the short term. Sellers will be afraid and buyers will feel comfortable.

With a massive decline in raw material prices so far it's pretty unlikely that the majority of prices will fall much further. Maybe they could, but it seems that many sellers have given up the fight against the present situation and have decided to wait and see how things develop rather than just selling at any price. There still might be some odd lots that had been stranded somewhere support support and, if these are resold in the next weeks, they could still create a few additional horror stories. But in general we don’t expect the bovine market to deliver many more spectacular declines. It doesn’t take much courage to say that considering the prices we have already reached.

Evidence suggests that we will now run into an almost idle market until 2009. The only exception will be if certain ‘strong hands’ think about long-term opportunities and quietly secure a decent part of their production for well into 2009. Sooner or later this will happen.

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