Macroeconomics

The last two weeks have been dominated by talk about the G20 summit in London. On one hand the results were not overly impressive. The free world has to accept that governments feel they are entitled to regulate the global economy more and are trying to close the few loopholes that still exist. As much as this may meet with general acceptance, it should be remembered that, so far, there has always been a solution to the problem for those who wanted to find one. Finance and business is quite creative. On the other hand, we should remember that regulations, which most Europeans like, mean more bureaucracy and administration. The way this is done and the implications in terms of cost and efficiency are familiar problems for many of us.

The drama we have been experiencing in the financial world over the last year was not so much a problem of control or regulation, but a matter of greed and a lack of integrity. It could be that the politicians’ intentions are rather selfish and that their only tool—dumping more money into the system—will become pretty expensive in the future. It is still difficult to understand why so much liquidity is being pumped into the markets. Money supply is not really the problem these days. Banks around the globe are hardly paying any attention to their clients for deposits anymore. There is no lack of liquidity, but there is a lack of sensible investment and a lack of borrowers who have convincing business concepts or that offer the impression they can repay their debts. Let’s just hope we are not laying the groundwork for the next investment bubble.

In the meantime, the optimists have gained some support in recent weeks. Stock markets gained further strength after the G20 meeting and many commodity prices continued their consolidation with more manufacturers starting to replenish stocks at the deflated price levels they can be bought at today.

China’s production index for March rose to 52.4 from 49 in February after shrinking for several months in a row. This possibly confirms that the policy of stimulating the economy could work with domestic demand rising, but export orders could be better.

Home sales in the US were better last month. The purchasing manager index also halted its decline and a glimmer of hope started to penetrate the markets.

Not much improvement has been seen in Europe yet with most manufacturing and export data still proving weak.

The European Central Bank (ECB) has confirmed its political independence and lowered the base rate only by 0.25% while the market expected a 0.5% cut. While the ECB did leave the door open for further cuts, its commitment to financial stability is much greater than other central banks. The US$ traded within a narrow band between 1.32-1.35 against the euro and the markets have still not really decided which way to go. Oil prices were able to sustain their recovery and the barrel is trading back at levels around the $50 mark.

Market intelligence

Nobody has been talking about anything apart from the Hong Kong fair, the impressions people got from the trips and reports from Asia. The APLF show was—at least as far as we are concerned—not really surprising. The show is shrinking in terms of exhibitor numbers and organisers are responding with a more compact set-up and narrower aisles.

The present crisis was reflected by a lack of carpets on the floor of many aisles. As far as visitors are concerned it is the same old story: whether the sheer number of visitors is important, or whether it is the quality of visitors that matters. In our opinion, not many familiar faces were missing this year. However, strolling around the booths of overseas exhibitors and speaking to leather sales people, feedback was rather mixed.

Those offering higher quality shoe upper and bag leathers were pretty pleased with the number of clients and reported a decent level of orders and trials booked. Meanwhile, those trying to promote upholstery leathers were less enthusiastic. So this left us with pretty much the same impressions of the leather markets that we had before the fair.

With only a few Chinese tanners actually exhibiting, everything depended on the few representatives from Chinese tanneries walking around the fair, although the responses were rather confusing. While some were talking about better leather orders and higher production, others were not seeing any real improvements and remain pretty concerned about production in the near future. These statements also simply confirmed the knowledge we already had. While tanners producing mainly for the domestic market in China are still reasonably busy, those that are more involved in the export business were much more concerned.

Fears continue

One thing is certain at the moment. Due to the vulnerable situation in the consumer markets and the uncertainty about developments in the second half of the year, retailers are constantly delaying their orders and/or slicing them into smaller portions, so that volume producers are not getting the programmes they need to fill their productions on a stable base for a longer period of time. Retail for consumer goods is still much better than the general mood in the global economy would suggest and only the US and Eastern bloc countries have really seen remarkable declines so far. However, the fear about further job losses in Europe and other parts of the world is worrying retailers more than the issue of consumer spending for later on in the year.

Sales in the leather pipeline are only in part reflecting the situation. Speaking to a large number of global sellers, there are again many political and strategic issues that are having a significant impact today and are making a number of people worry that the market could be misleading them again.

In the last few weeks we have seen quite strong activity as far as raw material purchasing was concerned. Again this was mainly focused on the medium and higher end of the range and the US suppliers enjoyed the lion’s share of interest. The weaker US$, price adjustments and aggressive selling during their trips to Asia resulted in higher sales, which were reflected in the weekly reports from the US. Europe, which had a strong first quarter, lost some ground but still saw potential for some sales, either to regular buyers or to new accounts that are still interested in buying and testing hides they were unable to afford in normal market conditions.

On closer inspection

Speaking to more intimate market experts, we noticed two other interesting comments made by a number of them. The first is that a number of sellers are reporting growing activity from Chinese traders who are looking to buy better quality material, import it into China and in many cases turning it into wet blue. For many, this raises questions over just how many of the recent purchases are really covered by leather orders. There is a fair chance that a good portion of the business seen in the first quarter of 2009 is based on speculation and an inventory shift from producers of hides to traders in China has taken place rather than it being bought and produced against leather orders.

The second comment was that a number of players reported rising interest from international trading companies for better quality origins. When we went around trying to verify this statement it was quickly confirmed. During times of high hide prices, trading companies still find their positions in the market by organising their businesses between origins that are, for various reasons, not so easily accessible for direct buyers or where financial issues, security and reliability apply. So a number of players are involved in the Eastern bloc, Africa and South and Central America. With the falling hide prices, better quality hides have become more popular and affordable and lower quality hides have lost a lot of their market share, which has consequently affected business for trading companies that are still sitting on stocks of lower grade material. The outlook for a recovery within this segment is still not particularly good.

In order to maintain some activity and to meet their customers’ interest, they are now trying to get back into the established markets, particularly in Europe. This is not an easy game, of course, because slaughterhouses and larger processors in these areas have already had their own sales organisations for a long time and see little reason to sell their products for trading purposes.

Talking to some of the suppliers, they confirmed these stories and added that this is also the reason why abattoir competition has become so fierce in many parts of Europe when at the same time the US$ is falling and business is not giving the impression that the market is ready for a sharper move upwards. Quite the reverse; revenues in euro are falling rather than rising at the moment. Buyers’ resistance against higher prices is still strong and so far successful while the US$ has lost more than 5% of its value since mid-February. However, in an attempt to find more activity, traders are again using smaller collectors and processors to get back into the market and to get hold of material. The result is the same as usual. Prices for hides at the abattoir door are going up although there is no real market reason for this. At least someone is happy—the slaughterhouse.

The truth of the matter

Coming back to the market in general we are still left with the question of how good the market really is and whether a sustained recovery can be expected. Looking at sales statistics from the US and adding the information we got from our European sources, we can easily come to the conclusion that Asian tanners were actually buying more than their leather businesses require. This even applies when we consider that sales and shipments in the last quarter 2008 were under par and that the leather pipeline has been emptied. Replenishment was definitely required and this logically begins with the better value hides. This alone would not really justify any concerns about the market situation. Manufacturing stocks have been too low and producers with an optimistic outlook were willing to restock on the price levels we reached.

The question is whether leather business in the second quarter will allow producers to continue their purchasing activity. So far, we do not really believe that any of the hide producers already have a solid sold-ahead position, which would allow a regular product flow. We think that, until now, we have mainly seen a shift in stocks from the first step in the pipeline to the second and a break in weekly sales and shipments could quickly return us to a market with fundamental problems in the second quarter. This statement does not apply in the same way for all weights and categories, but as a general statement for the bovine section it makes sense.

So, in our opinion, careful short-term monitoring on a weekly basis is still necessary to ensure that the appropriate decisions are made on both sides. However, for the moment it seems that the real market truths have not been fully reflected by sales activities in recent weeks. Despite all the positive news from the shoe and leathergoods market, we are still suffering from the sharp downturn in automotive and the weak performance of the upholstery sector. Since there is very little expectation that the automotive business will recover in 2009, the total supply and demand balance of raw material supply and the production of leather will be affected for some time.

Looking ahead

This opinion is largely a short-term position. Medium or longer term, we think that the situation could be much more positive or may be only just different. A lot depends on developments within the global economy. However, the prospect of greater stability in the leather pipeline is not too bad. Supply is moderately declining.

Demand could go one of two ways if we look to later this year or the beginning of 2010. Option number one is that the global economy will recover, which would mean better demand and rising orders for consumer products including leather. More raw material would be needed and raw material prices could climb again on an expansion of production and consumption.

The second option is a flat economy. The massive amounts of liquidity that have been poured into the markets by governments could create another huge liquidity bubble because of the lack of reasonable investment in production. This would result in serious inflation. With the value of money shrinking, prices normally rise and another escape into assets including raw materials would be the result. So, some time from now to the end of the year it would be wise to make sure that one owns enough stock to be protected against either direction. Only if you believe in your business, of course. Considering that the Chinese are usually shrewd business people, this could possibly explain why they have already been active for some time. They are possibly already considering something in this direction.

Splits and skins

The splits market has not been the subject of much focus in Hong Kong. As a result, we were unable to get much information or news. Wet blue splits are still not really in favour, which comes as no surprise considering hide prices. The low production in automotive and upholstery continues to restrict the supply of lime splits in Europe, which is still being answered with pretty high, but steady, price levels for this product. At least there is some relief for tanners who are still soaking.

The skins market is rather twofold. Fine wool skins are still experiencing good demand and it seems that lining producers are the only ones fearing that there is not enough supply at the moment. So they are trying to spread their wings into origins beyond the standard ones. The rest of the market is quiet and prices are also pretty low. Nappa garment leather is not doing very well and goat skins are facing some headwinds because small calf skins have dropped in price by quite a bit.

Short-term outlook

For the coming weeks we remain fairly cautious despite our long-term views. It seems that the immediate appetite for bovine hides could be well saturated. With only the Chinese really showing purchasing courage at the moment, and taking into account the fact that they usually take a break after the first quarter, it could become a bit quieter in the next few weeks. In Europe we are heading into the Easter break and the following week some players will meet in Bologna again for Lineapelle. Although it is not as important a fair in spring, it could give us a greater indication or confirmation about the relatively positive performance of high-quality fashion leathers. Another positive meeting would certainly pave the way for a strong performance of this sector in the coming season.

Europeans also need to watch the currency markets for euro trends, which always have a strong impact on the market in this part of the world. Warmer temperatures could also reduce slaughter numbers and change the minds of some sellers about their existing inventories. For the short term, we think it might be better to stay on the sidelines and think about strategies for the rest of the year.

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