Opinions remain divided
MARKET INTELLIGENCE – 25.02.08
Macroeconomics
The last two weeks again provided excitement and change in the financial markets with the focus remaining fixed on the situation of the US economy. The concerns we have had for several years about inflation are starting to make the headlines more often and recent statistics delivered more worrying news.
The latest figures from the USA showed a 4.3% rise in consumer prices on an annual basis while in China prices rose by 7.2 % in January. Even though most officials are still trying to play this rise down and keep pointing out the slower rise in the core rate (excluding energy and food), the acceleration in consumer prices is worrying and there is no sign of it easing off. The consumers’ standpoint in the situation is a bit different. With rising prices for food and energy they are, or soon will be, demanding higher wages, which will only accelerate the trend rather than slow it down.
Oil prices eased for only a very short time. Two weeks ago the barrel was still trading in the $90-range; however, since then we have hit new record highs at above $100. Considering that the winter in the Northern hemisphere was pretty mild this year, this increase in prices is really worrying. As the “heating season” comes to an end, a number of households will receive their final bills, which will in most cases show a substantial rise. While this will have already seriously cut into family budgets for this year, financial plans will also have to be rewritten for the next year and as the share for energy and food — the basics — are constantly rising this will leave less in their pockets for other products.
Tighter budgets
There is little reason to believe that this trend of rising prices is going to reverse soon, which means that families will have to be very careful about their future spending and this is creating a vicious circle at the moment. If food and energy prices continue to rise, the average family has only two options. They can either spend less on other products or ask (and get) pay rises to compensate for the rises, which, in turn, will fuel inflation and absorb this higher income quickly at a later stage.
Increasing concerns about the economy, recession, stagnation, the housing market, etc., are not making the people at the Fed’s lives any easier and the deteriorating mood weighed heavily on the US$ again last week. Hopes for a recovery of the US economy later this year faded and the greenback headed back down to leave it only a cent away from the recent all time lows against the euro.
At the same time the recovery of the euro also seems too slow. The weak US$ is threatening exports, prices and wages are rising, and the housing market is deteriorating in many parts of Europe — all of which do not bode well for the future, and as a result forecasts for economic growth in Europe have been lowered by most of the financial institutions.
So, most of the hopes are still resting on the shoulders of the emerging markets and one will have to wait and see if they can absorb the problems of rising food and energy prices better than the established markets and can keep their economic growth on track.
Market intelligence
Our expectations that the last two weeks could have already offered more of an indication about the future trends were not fulfilled. Market activity continues to just stroll along and we were unable to find any new impulses. This might also explain why the market information we collected actually offered a wide range of opinions, with the optimists and pessimists further apart than ever.
It might also explain why the markets are moving so little. With opinions so very varied, the number of bulls and bears are cancelling each other out and therefore not much movement can be triggered.
Most of the market reports you read these days are taking either the bull or the bear position. We have delved into recent history a bit and read through most of the reports we could get hold of covering the last six months or so, in an attempt to figure out the fundamental facts that led the writers to come to their conclusions. It is pretty obvious that most of them had pretty similar facts but, for whatever reason, came up with completely different interpretations.
Divided opinions
Basically, it seems that most of the current positions derive from a fundamental conviction of a move either up or down, which is not based on a rational analysis of the facts they are writing about. So, you find quite a number of reports describing strong market activity with a fair clearance of the raw material produced, but at the same time voicing major concerns about the market conditions and consequently expecting the market to go down; while on the other side the same type of reports state that although there are insufficient sales and stocks are rising, the market is not in a poor state and that prices will increase rather than decline. In a way it seems that some of the reporting is a reflection of wishful thinking and emotion rather than the rational analysis of the hard facts.
We don't blame anyone, as we haven't done much better ourselves, but we have tried to figure out why the market is moving so little while most reports are stubbornly trying to justify their position with every issue published.
We have to say that the pundits we talk to regularly are not doing much better either and we have to respect those who are putting these reports together for their courage in expressing their opinions on paper, which can always be pulled out and checked, while the verbal daily gossip is usually forgotten the minute a conversation finishes. The biggest problem most people have in writing any kind of market analysis on a regular basis is that it relates to a fixed time frame for which they need to either expect or forecast something. With the raw material market having lost so much of its short-term volatility it is almost impossible to make short-term predictions of any significance when the market is hardly moving except for coincidental short-term variations.
Apart from trading activity most of the leather pipeline will actually favour such a market and they should not expect too much breaking news and information from those who are still trying to deliver some coverage of market activity and background information.
Three factors dominate
Flipping through all the reports we also realised that the man influences on the market trend seemed to have been just three factors: First, the currency market with the weak US dollar, which has hit prices in the markets suffering most from the rise of their currencies against the greenback; second, we believe that the biggest victims have been, or are, the markets which are in the majority focused on sales and relations to tanning centres in Europe; and third, the shift in fashion away from expensive lightweight bovine material to either cheaper alternatives or other substitutions.
Anyone who has been hit or affected by any of these three factors has not only seen the biggest variation in prices, but also the biggest effect on market opinion. The rest of the market has seen a correction since the last sharp move from last spring and summer and not much more since then.
Reviewing the last two quarters, another result that can be seen is the fact that it is only those supplying markets which were entirely focused on the ‘regions of crisis’ in Europe as well as areas in China (Fujian and Wenzhou to name the largest ones), which have seen the harshest governmental controls as far as environmental policy is concerned, that have really struggled to dispose of their raw material productions. Most of the others have been able to deflect any other significant headwinds, as long as they were willing to accept that there was no room or valid reason to ask their clients for higher prices, and sales have been sufficient enough to clear what was produced.
Consequently, any market problems have so far been isolated to regions or individual companies that were not willing to accept the market realities. What is also true is that buyers have been happy to stay with their trusted suppliers rather than to take any chances with new ones trying to dispose of material they had failed to place.
No move in sight
Returning to the bulls and bears situation, we still can’t really justify any major move in either direction as yet as none of the arguments have really changed. The fact remains that excessive global production capacity has faded, or probably better said many drums are no longer turning today. The boost in demand has declined and hides and skins didn’t secure their share of the commodity price boom that many others enjoyed in 2007. We would even say that they suffered as a result of the rise of others — due to increased production costs.
On the other hand, we cannot fully agree with the position of supply-driven arguments, to which many are subscribing, that the key to a firmer market trend lies in supply. Beef producers’ margins are shrinking and the slaughter is declining in many parts of the world. We absolutely agree that this is going to prevent the market form falling much further, but we cannot see that this could be an argument for substantially rising raw material prices in the near future. As long as leather prices do not rise sharply, the tanning industry will remain too sensitive to margins and financial problems to base production on substantial losses. From what we have heard, prices for leather products are not set to increase significantly, which would have been needed to support raw material prices moving outside the variations of the normal market trading range.
The split market is not showing any change, news or variations. Standard splits are still suffering from low demand and are not finding the homes they would need for normal product flow. The upcoming fairs and shows will indicate whether splits can make a return to productions and stimulate demand. There might be some better usage of splits in the automotive and associated industries, but this is still future potential and will not support the market in the short-term.
The skin market is in the hands of Chinese buyers. Nappa is still the main story and the substitution of calf and kips is still also part of the game. Prices are generally steady-to-higher for all skins which can be used in these sectors. In April/May the new season will start and it will be interesting to see how the double-face market develops. It seems that, here as well, a lot of the Chinese tanners have done their homework and — if fashion allows — more production could shift from Turkey to China. This would change the global supply chain logistics quite a bit and it will be interesting to see if and how this could be handled.
A waiting game
For the coming two weeks we are again sitting on the fence, waiting to learn more about the market. A number of fairs have or are taking place, and tanners around the globe now have to make their decisions about their raw material needs for the second quarter of 2008. Despite all of the economic doom and gloom, consumption in the emerging markets is still rising at a decent pace and there is no real problem seen for global leather demand. So, we are still facing structural issues which could lead to short-term market variations, but it seems we need to be a little more patient before we can really decide if there is any argument for a new and longer term direction for this market.
