MARKET INTELLIGENCE – 11.02.08

Macroeconomics

The last two weeks remained as turbulent as the ones before as pundits in the financial community continued to fight over whether or not the US economy is heading towards recession. The Fed, at least, thought it appropriate to lower interest rates once again and most of the financial community now expects further cuts of anywhere between 1% and 2%.

The US government presented its new budget with a whopping $400 billion deficit, which no-one in the financial community appears to have really noticed. But, considering that the US economy is not really very strong, there does not appear to be an end in sight for its current military activities, and the fact that foreign funds have had to finance the country’s double deficit, these facts should surely be enough to make people think twice. Maybe the US government could ask the world to convert this indirect finance into a direct service fee for military and oil conquests? Could this possibly be a new business idea for such a service and consumer society? Although this might seem a bit cynical, there is no doubt that there will have to be a lot of positive developments in the States to cope with the escalating problems of the double deficit.

Optimism rises

Global investors, however, are again much more optimistic about the situation. A great number are already betting on a recovery of the US economy later this year, while they expect a slowdown in Europe later in 2008 and consequently expect the ECB to change its interest rate policy towards lower rates later this year. This is also what a number of analysts are forecasting in their 2008/2009 outlooks these days. As a consequence the first whispers are beginning to circulate about large funds starting to be reinvested into the US$, in expectation of a recovery of the greenback later this year.

The euro failed to break the 1.50-mark against the US$ for the second time and some are now wondering whether we might have already seen the highs, just under the magic mark of 1.50, in this particular cycle. It is indeed a bit of a risky game, as there is still not much in favour of the dollar except speculation, which tired of the one-way street we have been following now sees more potential to make money by going in the opposite direction, rather than betting on levels of 1.60 or higher.

The stock markets are similarly undecided and are changing between freefalls and rebounds day by day, or week by week. Buying on dips and protecting gains are still balancing each other, while it is indeed impressive that, despite the gloomy outlook in the States, the Dow Jones has been corrected much less than the European or Japanese indices.

Oil prices also eased a bit as a result of a jump in US inventories, but the price remains high and is bound in the range of $88-92.

Chinese freeze

The freezing winter in the south of China has caused a lot of trouble for those who wanted to spend their Lunar holidays at home with their families. Our sympathies go out to them as it must be pretty hard spending your time on a frozen station platform instead of celebrating the festival with your family. From a business standpoint the cold wave came at the right time. Many of the factories would have had to close down due to broken water pipes, power failures or blocked roads which would have stopped both workers and trucks from reaching the factories. So, there has been far less of an impact on many factory owners.

Market intelligence

It is not a great challenge to think about the leather pipeline at present. There is very little happening and what is happening is all taking place behind closed doors and is not public knowledge.

With Asian players either preparing for or celebrating their Chinese New Year and certain parts of Europe taking a carnival break not much actually happened as far as buying was concerned. Aside from the holidays it still seems that buyers are still pretty much taking a wait-and-see approach.

Not much is happening on the price front either. In the USA prices are hovering around the present levels and, looking at the various available reports, a market poll would seem to put the odds at 50/50 for a move up or down. In Brazil some price tags are even higher than before, while after the reopening in Australia prices are said to be almost unchanged. In Europe the price spread is becoming even wider as isolated, smaller producers/collectors/processors are offering pretty cheap lots in an attempt to move material, while larger operations with adequate financial resources and warehousing facilities are still trying to maintain their positions for better times to come.

In discussions within the trade, not only are opinions different so are people’s moods and gut feelings about the future. Optimists and pessimists are all throwing their arguments into the ring, but none of them are really very convincing in their presentations.

Tighter supply

The strongest argument of the optimists is the lower kill all over. Most large beef processing countries are reporting falling or reduced kills and the margins don’t seem to be satisfying anyone, anywhere at present. The kill in Brazil could also be hit by the blockade on Brazilian beef by the EU. This would only go into effect in March but, if it comes, it will be interesting to see which country will slaughter the extra numbers to fill this gap.

As a result the reduced supply of material is already hitting the steady flow of fresh material here and there. As much as suppliers are trying to use this argument, few buyers appear to be impressed by it and, in fact, only the small group of tanners who depend on fresh hides are being scared by the situation. All of the others must still be feeling quite relaxed in view of the impressive volumes of salted and wet blue offers circulating the globe, and they have plenty of options to choose from.

At the end of the day, the last two weeks haven’t given much of a true impression of the real situation, but with the return of the Asian tanners within the next ten days we should get a clearer picture.

Italy remains uncertain

In the meantime, most eyes are still focused on the situation in Europe and Italy in particular. Is the situation starting to calm down or is it just the calm before the storm? Once again there aren’t many hard facts about the financial situation, although a number of sources expect the final showdown on the dal Maso Group to be pretty close and now believe it is just a question of whether there is still a chance for a voluntary agreement to pay some creditors or whether it will be a simple case of bankruptcy. One significant worry is whether this is going to be followed by more problems in this area, or whether lower raw material prices could ease the pain and have a positive effect on the financial state of the industry. Until the situation is made more secure, many sellers are not only finding it difficult to find buyers, but also to avoid running into more payment troubles.

In such a situation many of the prices being quoted from the Italian market can come as no surprise. A number of suppliers are still heavily discounting prices to move product. This doesn’t apply to large quantities, but even isolated, cheap trades are not delivering any comfort or confidence to buyers.

But, although the overall sentiment remains pretty negative one can see that the market is not in trouble all over. Some reliable sources have reported fully steady demand and shipping on a number of grades, in particular for dairy cows. Other hide types which are reasonably priced, such as certain ox/heifer types, are also finding enough demand to clear productions. In general one can say that suppliers that are not demanding a significant premium and have built a global customer base can still place most of their productions without too much pain.

So, what we are seeing is still a restructuring of the business and leather pipeline as production shifts and the material flows change.

a)     Rising production in the Middle East and Eastern bloc countries is not supported by sufficient local supply

b)     Production capacities in Europe (Italy) and China are shrinking either due to economic problems or effluent policy.

c)     Some of the production of leather has shifted from bovine to ovine

d)     Splits still remain out of fashion

e)     Consumption remains flat and under massive price pressure in the standard markets, while strong growth is still seen in the emerging markets.

Tricky times for Europe

Since these changes have happened or are happening within a pretty short period, the time that the pipeline has had to adjust has been very, if not too, short as we can now see already in the raw material field. Suppliers are losing customers and markets more quickly than they can find new ones and the infrastructures needed to deal with new potential markets are not in place and cannot be built in time. For many smaller and local suppliers in Europe it is going to be a difficult time unless we unexpectedly see a quick and sharp renaissance of the European industry.

As long as the global economy does not enter into a major recession and the difficulties are limited to the USA and maybe later to other ‘old economies’, then the growth potential for consumer goods in the emerging markets will compensate for this.

Consequently, we are now waiting to see how the business and global activity develops after the current holiday break. Material in the leather pipeline behaves like water: It finds its path. When it is needed then it will eventually reach its destination. Since it is mainly the EU market that is burdened by unsold stocks the development of the US$ is also going to play an important role. If the trading range moves to between 1.40-1.45 rather than the 1.45-1.50 we have been seeing, the majority of European prices will already be pretty competitive and will not require any further adjustment.

Splits fail to move

The split market still hasn’t moved out of the doldrums. Stocks continue to rise and are starting to become a burden for a number of producers and we can’t find any signs that there could still be a change during this season.

The skin market is making further progress. The shift from bovine to ovine raw material which started about a year ago is slowly starting to have an effect. Last year skins were very cheap and hides were expensive and in an attempt to find cheaper alternatives ovine raw materials started to substitute bovine wherever this was possible. With production now in full swing and wool also in strong demand, skins in general are finding good and strong demand and it would not be a surprise if prices advanced into the spring.

For the coming weeks we are excited to see how business and confidence develops when general market activity recovers in Asia. We can’t say that we are overly pessimistic. One can’t actually expect any recovery, and a sharp rise in raw material prices would actually heighten the industry’s problems, but we would not be surprised if the current issues start to fade and the general feeling of pessimism slowly disappears. This might not be across the board as structural problems have still not been sorted out and the global leather world is in a period of transition, but the fundamental and general situation has a fair chance of slowly improving.

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