Market Intelligence - 10.03.09
10/03/2009
Macroeconomics
The long road of economic descent has not yet reached the end; some even think the speed at which we are going downhill is still accelerating because the news is still quite frightening. Concerns are increasing that, at least in the old economies, the problems we are experiencing now will eat much more deeply into societies than a normal recession.
The discussion over the difference between a recession and a depression has become rather philosophical. The problems in the financial sector and the real estate markets, along with the problems in the automotive industry—a key industry in many of the western economies—have pulverized some of the strongest pillars these economies are based on. The serious threat of bankruptcy of General Motors and its subsidiaries would send shockwaves through countries like the US, Germany and the UK and there is a fair chance that they would not be the only ones.
Politicians and experts are still warning of further turmoil in the financial markets with a number of institutions still in danger. Their most recent results, and the effect on their stock market valuations, in combination with the continuing fall of property prices in many countries is keeping the risk level very high. This is not even including the potential risk of corporate and private failures, which can still be expected in 2009 considering the present state of the global economy.
Most western countries can expect their economies to contract in 2009. China is going against the trend and the government there has set a target of 8% growth for the current year. The government continues to offer large stimulus programmes to keep the economy growing and to prevent further social unrest. There are rumours about riots and demonstrations in the poorer parts of the country. So far it is fortunately quiet in the rest of the world, but rising unemployment and increasing poverty could become a dangerous threat eventually.
Interest rates were lowered again in the UK and the EU zone. However, cheap money can only offer a moderate support to economies there, because it is less a question of the price for money today than access to it. Many banks are bunkering short-term cash and depositing it with central banks rather than lending it to their clients. There is a massive overflow of short-term liquidity which is failing to find a home because the banks are not willing to lend it out, partly to bolster their own balance sheets and partly because of their fear about the ability of their clients to repay the loans.
The euro is heavily burdened by the massive problems in many Eastern bloc countries and rating risks of some EU member states. Due to the large exposures of western european banks, the massive problems of economies such as Hungary, Romania, the Baltic States, Ukraine and so on represent an additional risk for the euro zone.
Although the euro failed to fall much below the $1.25 mark, it looks susceptible to further falls. The oil price is unsteady at the moment, bouncing up and down in the $40 range per barrel. On the one hand, speculators are still concerned about the state of the global economy and on the other they are tempted to gamble on supply cuts in the recovery of the global economy.
Market Intelligence
A lot of the content from our last issue could have been copied and inserted into this one. Fundamentally almost nothing has changed in the markets and the situation is pretty much the same as it was two weeks ago.
From the European tanning industry one is hearing almost daily more and more depressing stories. Payment problems and even reports about closures, chapter 11 issues and even bankruptcies are becoming pretty common in the daily news. Credit insurance companies continue to cut the coverage they offer and even companies that are basically considered to be solid are starting to become affected. High stocks and few orders are still weighing heavily on business and sales activities and only the substantial decline in the kill is preventing the markets from any further major corrections.
However this has not stopped isolated sales from going through in Europe at almost impossible-to-believe price levels. Today many suppliers are paying the price of having given up the ability to be the controlling link between the beef and the tanning industries. Over the years more and more companies in Europe, processors, abattoirs and tanners have focused more and more on just-in-time delivery. Fresh hides, which had been a novelty in the early 90s, have become a pretty common product with the growing capacity and demand for leather in recent history. As a consequence, for many processors, life had become pretty easy and in many countries hides were just collected, trimmed, chilled and then moved as quickly as possible into drums in central and southern Europe.
Large takers were predominantly the automotive and upholstery tanners. With the sharp decline of their business, a lot of processors have started to have problems too. Labour, warehousing and finance are not available in sufficient quantities to many of them so a number are repeatedly being forced to dump material and to take whatever price is offered on the day the hides need to move out of the warehouse.
This has led to a tremendous price spread between those who have to move the odd lot and a few others who are still in the position to select from customers and markets. Every day new sales at record low prices are reported from Italy. However, it has to be mentioned that the above applies in particular for cowhides. Males in Europe are still doing better. Despite the dramatic fall in automotive production—traditionally the largest consumer of bulls—this market is probably the one closest to anything approaching steady. Sharply reducing kill numbers and decent demand from Asia for hides of up to 40kg during the month of February have cleared quite a number of the existing stocks. Although production is down in Europe the basic demand for fresh hides is enough to clear most of the hide production available today.
It also has to be said that the European hide market was bolstered by the firmer US dollar and the price levels that have been maintained in the United States. Tanners around the globe are buying quality at the moment and with the similarity in price between European and American hides, the European ones presently offer the better deal. As we have mentioned already in previous issues, the domestic leather market in China is also favouring raw materials from Europe at the moment.
Almost all producers in western Europe that have a good sales network in Asia at their disposal are confirming not only good sales, but, more importantly, very decent shipments since the beginning of February. This has not yet cleared enough of the overhanging inventories of cows, but it has helped at least to keep product moving, to stabilise the market for the time being and to ease some of the pain as far as warehouse space and financial resources are concerned.
Supply outstrips demand
This leads us back to a concern that we reported two weeks ago. There is only a limited amount of hide demand in the world and this is much less than the number of hides produced. With the hide price-levels we have reached now, price is becoming a less important factor. The price ratio between leather and lower quality hides can no longer justify the purchase of cheaper material. This has become an increasingly important issue and tanners are covering their needs with constantly better material at the moment. This explains why we hear of pretty good sales from some of the privileged European quality origins to the Far East. Most of these hides have historically been almost completely absorbed by the European tanning industry, which controlled the top-quality raw material with great jealousy and was never really willing to let these resources disappear into the Asian markets.
With the terrible situation in particular in Italy and generally high raw material inventories, tanners are simply not in the position any more to keep their hands on these resources and Asian tanners are readily and with pleasure taking the chance to buy this better quality product.
Since we do not see any major increase in leather consumption so far and the outlook for the global economy is not at all promising, the use of better quality hides is actually cannibalising other raw material sources and we think that, in particular, US suppliers are feeling the pain. Sales from Europe are substituting quite a number from the US at the moment. This might have been realised too late. The weaker US dollar before Christmas and a flurry of sales after the big slump of the markets in the last quarter of 2008 promoted sales for a few weeks as US hides were more competitive then. The recovery of the greenback and falling raw material prices in Europe have erased the advantage quickly and for the last six weeks or so European hides have again ousted a good amount of US material.
Price spiral
As we have already mentioned in the last weeks this has put the US market in danger and since we are now heading towards the second quarter the risk potential for prices has again significantly increased. If demand does not pick up quickly and US sellers find decent demand during their trips to Asia around the APLF exhibition, we could quickly see a new trigger to the price spiral on the downside. The worst case scenario would definitely be if sellers lose confidence during the trip to Hong Kong and see their only chance to move enough product for the killing season by putting prices down so far that the material becomes attractive enough to substitute others again. This would consequently bring other supply markets under pressure again and recent history will repeat itself. In another few weeks from now we will know.
Another negative factor which should not be forgotten is the issue of finances. Not only are markets limited due to reduced demand but a lot of sellers are also having to treat their customers with great care because credit and cash have become extremely tight in the tanning industry, and across the whole of the leather pipeline.
There may be more interested buyers around, but this in itself will not be enough to relieve the problems because credit insurance facilities are not sufficient. Also sellers lack confidence in buyers and in the payment terms they demand. Sellers often prefer to hold onto their raw material rather than sell it with the risk not getting paid.
If this general negative sentiment leads to another raw material price reduction we could enter into another problematic period in the second quarter, because the problem of renegotiation of contracts could quickly return to the markets as well. With the tremendous losses many people have had to bear over the past months it would not require much to create significant problems to a number of global raw material shipments. Even worse than the question of price adjustments would be the fact that the raw material flow would be disrupted again and if stocks start to pile up again into the hotter season it would be a problem.
To ease the pain
Now, having been so pessimistic, we would still like to stress that it is our opinion that the situation—at least for shoes and accessories—is definitely not so bad that it would justify a full horror scenario. Shoe orders are still expected to be good, although they are late and may be even further delayed. Small leather items are also said to be still moving reasonably well despite the certain deflation of the luxury bubble, which has blown up in the past years.
The split market is starting to feel the effects of reduced supply. There are still good inventories, but the sales of splits and substantially reduced production are starting to ease some of the pain in this market. Demand for gelatin and collagen remains reasonably steady and this is limiting the production of splits for use in leather. The massive decline of soakings in the tanning industry is also cutting the supply of splits dramatically. A bit more fashion for suede is also reported and this is helping this market which has been so bad for such a long time. However with the price of hides today the potential for a real improvement in the split market is rather limited.
In the skin market we see some seasonal activity. In particular Chinese buyers are looking in Europe for winter-season skins due to bigger size and long wool, and are sniffing around trying to catch some of the skins produced since December. Price is a big problem because the price levels they have in mind will not even cover the cost of collecting and processing the skins. However, the market is made by those who can buy and pay and those who need to move their product because they can’t store them when temperatures start to rise. We expect a reasonable amount of business in the weeks to come, but we do not suppose that sellers will be happy with the returns.
Asian journeys
For the weeks to come we think that most of the focus of interest will be on the reports from the trips many sellers are starting to make into Asia. It will not be easy to get reliable information about the real successes; deals will probably only hit the news if sellers have something extraordinarily good to report. Sellers will have a pretty difficult time if they do not come with something extraordinary to offer, and this means in price or in quality. Tanners will most likely continue to focus on higher-quality raw materials.
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