MARKET INTELLIGENCE – 12.11.07

Macroeconomics

The financial markets have not really calmed down and those hoping to see a settlement of some sort have been disappointed in the last two weeks. The uncertainties in the subprime market, which had been mainly focused on the private housing sector, are now spilling over into the commercial mortgage and derivatives markets, so that liquidity in this market has also dried up and the simple fact is that nobody can now evaluate risk anymore. The central banks are continuing to pour liquidity into the market to soften the consequences, but, if this will ever be enough is anyone’s guess as nobody knows how big the problem is yet.

In the meantime many CEOs from financial institutes have been sent home with a golden handshake after they published substantial write-offs which made their third quarter results look pretty shabby. Not a bad deal really — getting a multi-million US$ payment to leave after already having received a nice bonus based on results which, as we know now, were not actually real. This is what one would call a win-win situation, but it is not really doing anything to boost the average man on the street’s confidence in the fairness and functionality of the system we would all like to support.

In the financial markets this has led to a correction in the stock markets with a weaker US$ falling to new record lows against many other currencies and hedge funds now shifting their money into the commodity markets — gold and oil in particular — thus pushing them above fair market levels as there is not much to be made in the corporate markets anymore. This has triggered the US$ to spiral further and pushed prices for key commodities up even higher with all explanations to justify the current market prices failing to provide a valid reason for this. It will be interesting to see how they are going to get out of this one. However, there is one factor that could change everything. If the oil market collapses there will, for the first time, be hardly anyone complaining — except for the producers of course — and the hedge funds could, in the end, possibly still reap the glory they think they deserve, although they may have to pay for it with big losses.

Most of the world is still struggling to cope with rising energy prices and even the Chinese government has decided to raise petrol prices by up to 10% in order to prevent a fuel shortage, as Chinese producers had been producing horrendous losses at the present prices for crude oil and the selling prices of the distillates.

The Turks have moved into Iraq to fight against the PKK, Mr Musharaf has finally declared democracy as null and void in Pakistan, protestors are out in the streets in Georgia and Mr Putin has flexed his muscles again by blackmailing Germany’s Lufthansa to either relocate its cargo hub in Russia from Kazakhstan or lose the right to pass through Russian airspace on its way to Asia. In fact there is nothing that we could call sensible regional policy or anything that would encourage improved global stability. As 2007 starts to wind down one can’t say that the fundamentals for a calm and silent 2008 are getting better at the moment.

Market intelligence

We had expected the past two weeks to be exciting after all the rumours and news out of Italy. Well, that was pretty wrong. With holidays in most parts of Europe on November 1, the vast majority of players decided to take a break and disappear. Since neither the media nor the latest rumours circulating delivered any further news on the subject that first came to light in the last week of October, people took the chance to take a rest either in the hope that the dust would settle quickly or simply to take time out to think. Some maybe also took the opportunity to ‘tidy up their files’ while no-one was in the office for a few days, but this is only a hypothesis. So, in Europe at least, things were exceptionally quiet for a week and the following week was dominated by gossip and talk rather than real business. In Europe many people have lost ground which they are now trying to regain. So, as far as the situation regarding illegal business practices was concerned there was not much news other than reports in the Brazilian media that a number of people related to the leather pipeline there have now also been arrested over suspected money laundering operations.

Complications in Europe

The situation in Europe is more difficult due to a number of problems which has led to a two- or even multi-tiered market. The problem with such a market situation is that every story and piece of news has some truth in it, but in many cases they don’t fit every individual situation. So, many of the prices which are being quoted and the information about inventory positions being thrown around are being aimed at individual targets rather than as a rational analysis of the situation. We are also faced with the fact that with the wide range of prices these days there are many people that are unhappy. Buyers feel that they have bought or are buying too expensively whilst sellers do not think that they are getting fair bids and prices from their customers.

So, what has actually happened and where do we stand in Europe today? Basically the problem had already started in spring when the US$ was still trading around the €1.35 mark, leather business was still in the final lap of seasonal production, the pipeline was rather empty and some of the specific raw material items (e.g. heavy hides and calves) seemed to be in short supply. With all indicators pointing to strong leather business for the rest of 2007 and the lower slaughter in summer, most sellers were not at all worried about the market and if they were not able to place material they were not too bothered as they expected little price risk in the market. On the whole most ignored the fact that raw materials have limited prices and that the US$ is still the benchmark for market prices. The general boom in commodity prices added to the confidence of European butchers and processors that their future would continue to be bright.

This led to slowly rising inventories going into the summer combined with an accelerating fall in the US$ rate. While the prices for the various European origins are usually reasonably well synchronised, the situation got out of balance over the summer.

Combined events

The first crack to appear was the FMD problem in the UK. Suddenly English hides only had the European (mainly Italian) market left and contracts and shipments to China got stuck and quickly started to fill the pipeline.

Crack number two was the sharp downturn in the activity of quality vegetable tanners in Italy who mainly use high-quality heavy French material, but also absorb a reasonable quantity of salted material from the south-eastern parts of Europe. Suddenly this material also had to look for new homes right in the middle of the holiday period and this started to fill the pipeline too.

Crack number three was the declining US$, the importance of which is traditionally underestimated by the European suppliers (see above) who mainly sell their product into the European markets. With the falling value of the US$, prices for European hides started to drift further away from international levels and the gap between the market prices in Asia and the levels in Europe widened constantly for many grades.

Crack number four, and probably the final shot in the arm for the optimists, was the rumours about the VAT fraud activities in Italy. Everybody was aware that it happened — and probably still does. Maybe no-one knows how it was carried out or who might be involved, but will it ever really be unravelled and lead to serious consequences?

Another problem is the adjustment in abattoir prices in Europe which has been too slow by far in international terms — i.e. a fast correcting market — and this is further widening the gaps. With a big part of the business based on fresh material and forward sales on regular programmes, prices are frequently not based on the daily market realities but more on the position of individual sellers. Those who are focused on the European markets recognised too late or ignored the fact that their unsold material or goods filling up the pipeline have reduced outlets and as a consequence they have had to deal with the international market realities. This process can take a long time as we have seen in the last six months, and suddenly we are now seeing a market for regular, mainly fresh material with a constant product flow which leaves a lot of unsold and increased positions of salted material, which in combination with a higher slaughter and a reduced US$ rate is not a great position for many. As a result, the value of this material depends purely on the need of the owner to sell it. This has now led to  completely confused market conditions in the ‘old world’ with a spread between the highs and the lows of more than 10% or even 15 % at times between similar quality raw materials.

An anxious market

All the above has created an environment of fear and anger in Europe. Fear for those who can see the end of the year in sight and are still holding stocks which realistically can no longer be moved at anywhere near acceptable price levels; and anger from those who are now hearing about the amazing bargains available every day, which they have missed by purchasing their normal and regular volumes on time.

These times of high emotions never really do any good. Most may remember that about 9-12 months ago we had a similar situation but the opposite way around. Most buyers were afraid of not securing raw material at least at any kind of a realistic price level, while sellers were shouting about the daily sales opportunities they had missed by dealing with their regular clientele when the day of negotiation had come. So, everybody’s day comes and the unfortunate thing for the leather pipeline is that prices had been pushed too high earlier and now we are ending the year in the usual volatile situation which results from this.

All these factors made the market sound pretty upset, in Europe at least, and overshadowed most other markets and situations which weren’t really all that bad. Even with the problems in Italy the normal seasonal recovery of production in the north seems to be underway. Most people are reporting that tanneries are looking much more active than before and the drums are rolling. Some are even saying that more better-quality orders for upholstery leathers have come in and that the order books are better filled for the months to come. Looking at the USA’s export numbers to Italy in the past weeks, there must be more than one tanner willing to take advantage of the weak US$ and the adequate prices of US material. This would be logical anyway looking at the volumes. Either as a result of many with short-term confidence or some with long-term confidence these prices should be secured.

Also phone calls to other markets such as Australia haven’t actually brought any negative feedback. Economical hides from reliable suppliers are still being easily placed at today’s market level. Currency is also an issue down under, but the demand for material is not. With the vacation break approaching fast in many areas, many producers seem to have cleaned up their productions and hardly anyone is complaining about shipments or enquiries.

Problems in Brazil?

A bit of a question mark remains hanging over the biggest bovine producing country in the world which is — at least at present — Brazil as we are getting a lot of conflicting reports from there. It is also suffering a lot from the weak US$ which is hitting export revenues badly. The question now is whether the rumours about building stocks are true or whether the product flow is still good enough to prevent excessive inventories. One thing that should be noted is that if prices in Brazil are not adjusted they look expensive in comparison to many of the ‘bargains’ one is hearing about in Europe.

A downturn in consumption?

Prices have corrected and many raw materials are no longer over-valued or over-priced — despite all of the complaints. The only question one has to answer now for the coming months is whether global consumption can hold despite rising energy and food prices which will be a burden on many budgets this winter.

So far many are now seeing a slowdown in the fantastic growth they have enjoyed in the last two years, but the level still remains very impressive and good. With corrected raw material prices, calculations for volume producers have improved and so the fundamentals are in much better order than they were six month ago.

Better news from the split market. Not, that all the stockpiles have been sold and moved, but many are reporting rising interest at the current low prices and more and more bits and pieces have been sold. Heavy splits are still in short supply in some places. We fail to find an explanation as to why better interest has been reported, because we don’t know for which kind of leather fashion it will be used, but even if it is simple speculation it means that somebody may know something or thinks that it would not be too bad an idea to buy something nobody wants at the moment. We will monitor the situation to see if this is a blip or the beginning of something better.

The skin market also had some better news to report. Many of our contacts spoke of Chinese buyers touring continental Europe. This is remarkable, because they normally only come in January to secure their supply. Talking to Chinese players they mention decreasing numbers in the domestic supply and a good outlook for next year’s nappa fashion as to why people are travelling early and buying our sources. Another reason is certainly the unsettled situation over the UK supply. Although a number of skins are finding their way through odd channels to China, a smooth supply from one of the largest supply bases in Europe is not guaranteed for the beginning of next year, so, it seems that some have decided to check out other options and secure some material before the supply is gone. With prices still being pretty low there is also little risk involved for the buyers, and sellers are quite happy to see other options with the traditional markets in Turkey and Poland being almost non-existent.

A hard market to call

It is quite difficult to make projections for the coming weeks. The market still needs to sort itself out. The currency effect on some markets has been pretty hefty and nobody knows what is still to come. Political issues are not really positive either and if the financial markets do not offer more stability and there were a sharp downturn in stock markets it would not be a great help. However, these are all the external influences we had in mind and the fundamentals for the leather world don’t look too bad. Demand is steady at high levels, fashion still favours the product, and the emerging markets are still growing at a very high rate. Profitability is not yet back to where it should be and some are certainly still suffering from the past, but the calculations look much better today. There is still a bit of a backlog of material in the market place and some of the more expensive and spoilt origins may still have to suffer to reach safe ground and it might take more time than we thought to sort out, but in general we still believe that there is no reason to complain too much. The risk in the general situation and the possibility of further external shocks has certainly risen, but for the leather pipeline the fundamental price risk has already diminished.

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