Macroeconomics

In recent weeks there has been a strange sensation of déjà-vu. Oil and other commodity prices are rising, stock markets are firm and the US$ is almost in freefall against the euro. Although the levels are different, the scenario and market reactions are pretty much the same as a year ago. And everything is based on speculation.

Following the facts, the best we can see is a slowdown in terms of the economic decline. The western world is still facing the major problems of recession. Among these problems are unemployment and the huge budget deficits that are unlikely to be repaid without stealing from the taxpayer’s pocket again. This will not support consumption or investment at all.

Stories about the credit crunch are being told over and over again, although there is no lack of liquidity in the system (this can easily be seen by the overnight deposits commercial banks are holding with the European Central Bank), but banks haven't got their balance sheets under control and they have a lack of confidence in the real economy, where they would normally lend money. So there is no lack of liquidity in the market, but there is a shortage of safe investments.

Investors are not really keen on hard investments in business, but prefer to pour their money into the stock market and, even more, into the commodity market, where they believe they will get quicker returns. Of course, this offers a much easier departure than pulling out of a real investment in a commercial enterprise. Many analysts and investors are convinced that the bottom of the recession has already been reached and that a turnaround is just round the corner. Well, if that were true, one should invest rather than speculate and businesses and companies would easily obtain finance from banks or investors. But the fact is they are not finding it and banks are parking their money. Investors take the easy way out by investing indirectly in stocks and commodities and companies are still struggling to find the credit resources they need.

But wasn't this one of the reasons we ran into such deep trouble about a year ago? At that stage we lacked sound investments into new businesses and solid investments into existing ones. The easy money did, at that time, the same as the easy money does today. We should be careful and watch out that we don't run into a similar disaster again. At the moment it seems people are starting to forget again.

As far as the hard facts are concerned, we are dealing with rising unemployment almost everywhere and, with GDP diminishing all over the western world, we are seeing news about enterprises going bust or companies asking for taxpayers’ money almost daily. In the meantime, politicians are spending the money of future generations in order to win the next election. These politicians are supported by many people who think we should not worry about future problems, who believe it’s easier not to bother worrying about how the next generation will deal with it. This is the present situation for the old economies at least. And they have more to lose of course.

The situation in the emerging markets is a bit different and this particularly applies to China and, to a lesser degree, India and Brazil. In China the government does not need to bother about the next election or about financial resources because of the massive trade surplus and vast domestic markets that can be used to bolster demand for the local industry. For the moment, this puts it into pole position in the global race and, if they play their cards right, the old world will struggle to retain its position. No one is facing up to the fact that the state cannot save everyone’s job and that things will not become comfortable any time soon.

Oil is back to US$66 (the highest since November 2008) and the US$ is down to 1.41. General Motors is bankrupt, along with a few others (politicians are spending taxpayers’ money to please everybody again) and the figures are poor all round.

Market intelligence

The last two weeks were a reflection of previous weeks and the market bonanza continued in the superior quality supply markets. The Asian buyers, particularly the Chinese ones, continued to perform strongly and bought hides at moderately higher prices.

The European suppliers only got a small part of the share of better prices, because the US$ fell steeply against the euro and the decline ended only at a rate above 1.41, which makes for a loss of almost 5% in just two weeks. The sharp decline came on the back of fears that the US economy could lose its triple-A rating.

In the meantime, Chinese buyers were still buying a lot of raw material. The weekly export sales figures were impressive again and exceeded the weekly slaughter by a lot. European suppliers were reporting strong buyer performance and good interest from Asia as well. European buyers were much more reluctant to get involved and joined the party only when it could not be avoided.

The victims that have been hardest hit by the global recession are said to be the most active automotive tanners. There are claims that a number of them had reduced the inventory of medium to higher-quality hides by too much and are now in need of replenishment. It is pretty much the wrong time of the year with the kill being very low all over Europe and cattle weights being at their lowest levels of the seasons. This obviously pleased the butchers who have been able to make a profit and to squeeze abattoir prices higher despite the fact that the market situation has only been influenced by isolated conditions.

Another factor in Europe is the strong performance of the Chinese market. Prices could not benefit from the strong demand because every US$ added to the price was immediately absorbed by the decline of the US$, but for many shippers it represented a market that was better than it actually is and, with old stocks rapidly melting down, their courage to buy hides in a competitive market was certainly increasing.

With this kind of market and the prices being up by 20-30% compared with their lows it might be a good time to discuss where we actually stand these days and to think about a realistic outlook for the coming weeks and months. The main question is how much we can trust the recovery of raw material prices and whether there is a real glimmer of hope for tanners and leathergoods manufacturers for the rest of 2009.

For the time being, we can say that tanners were well advised if they shared our opinion about staying in the market even when it was at its worst and to moderately build inventory when raw material prices had fallen to record lows. No matter how good or bad the order situation might be now, a balanced stock of inventory at low prices is decent insurance for the time being and offers a relaxed position compared with the present market situation.

Weighing it up

Let’s start by summarising the facts we have before us today:

l        Global demand for commodities has increased substantially since the beginning of 2009

l        Commodity prices have risen by 20-50%

l        China is the main driver behind the demand and Japan and other Asian countries are also driving demand for some other products. Surprisingly, Korea is driving demand for hides

l        China admits that a lot of the market activity for commodities is strategic and does not actually reflect the present demand of the local industry

l        China has had to make decisions about the investment of its currency reserves

l        Retail consumption is better than one would have expected under the present economic conditions, but it is down with the exception of China, where the government has stimulated demand and where the general sentiment is significantly better than in the rest of the world

l        Despite reasonable sales of consumer goods in view of the global recession, sales of leathergoods and leather consumption is way down and the only discussion is whether it is a bit less than 20% or a bit more than 20%. Upholstery, garment and automotive leather has been hit much harder than shoes, bags and leathergoods.

l        With the sharp decline of raw material prices the demand and focus of interest has shifted up the quality scale and the consumption of quality material has moved deeper into Asian productions.

l        Raw material sales are exceeding physical consumption by 20% or more, but are not being distributed at the same rate over the various quality levels. High quality material is being distributed more, while low quality material is being distributed far less.

As usual, this list may not be complete, but we think we have covered the main topics and the ones that are affecting the market most today.

Since we are now at the beginning of the holiday season in Europe, and generally in the low season of leather production, a lot of people are raising questions about what this will mean for the summer and for the rest of the year.

Data shortage

The first issue is, of course, how trustworthy the statistical data that comes out of the different markets is. We are still living with just one official publication, the USDA numbers from America. While the sales numbers may be questioned, the shipping numbers are more reliable. So we all have to assume that cancellations are not being taken into account and that, if we actually looked at the adjusted numbers, the figure would be significantly deflated.

However, looking at the shipments for this year, it is obvious that at least some of the inventory has been reduced, but certainly not as much as many would like to make the market believe. For many shippers it would take a really big step with many significant shipments to get their situations in line again. This is also the simple explanation as to why a number of players are enjoying the steady price rise as this is the only insurance policy that contracts will be honoured and shipments executed.

We are not getting any quick and reliable data in Europe these days so we have to depend on the information we get from some of our more reliable sources. The information is pretty much the same everywhere. The massive stocks that were burdening many of the shippers have been reduced significantly and the sales position is more than comfortable at the moment. This has eased the cash and warehouse problems for many and, despite the sharp decline of the US$, it has given many European sellers and butchers a fair bit of confidence.

Even in the southern hemisphere—where traditionally the cheaper hides are produced—some relief can be sensed, but definitely far less. The logic is simple and well known. With the decline of raw material prices and the minor difference between the good and bad hides, demand has shifted and has favoured the better quality hides. This might be misleading as far as the overall situation is concerned, but it is proving what we predicted early on in the year. Good quality hides will benefit most from a recovery.

Scepticism remains

This situation could be misleading. It might suggest an overly optimistic market. A balance of supply and demand could be achieved at the moment in the higher quality markets. However, with the reduced consumption and with demand that must be considered to be partially speculative in view of hopes for a swift global economic recovery, a question mark remains. Is the hope of better times ahead really realistic? We are still sceptical.

We are still in deep trouble in most of the large consumer markets across the globe and unemployment is expected to rise. A lot of jobs are only being temporarily saved by large government investments as, in addition to money issues, there is reasonable doubt that the products they are making will be bought in sufficient volume to keep them afloat. In many cases the problems are structural and one cannot realistically expect global consumption to really pick up in the short term.

A lot of hope now rests on the Chinese economy and perhaps on a few other countries. However, can we really believe that the crisis will only be solved there? We don't think so and, as a result, we are left with the hope that leather products will be one of the few items to remain on the shopping list. For the short and medium term we are sceptical about the global market being supported consistently by the Chinese appetite for commodities. This is not enough and the products made need to be absorbed by consumers outside China as well.

With only a moderate rise in raw material prices so far, the risk of a sharp setback is certainly limited, but the assumption that a complete turnaround has already happened is, in our opinion, too premature and optimistic. Tanners are unlikely to accept any further rises and sellers are too comfortable with their positions to fall back into any of the pessimism seen in recent times. However, it is worth noting that, outside Asia, very few tanners are comfortable with present production levels and profitability is far below normal levels. A lot of leather prices have fallen sharply and a further rise in raw material prices would cause big problems for tanneries if they are not already facing them.

Reserving judgement

The splits market is delivering more positive news. Suede seems to have become an important item in the fashion market and, with the decline of splits production suitable for leather, supply is not what it should be. Also, heavy weight splits are hard to find and some of the large stocks seem to have been liquidated. So, splits demand is better and the trade is starting to talk about them again. It seems the massive pressure on the market has had at least a bit of a lift and there is a chance that the right products will achieve a slightly more regular flow.

Skins have not really benefited from the global activity. As the bulk of the global production is either of lower quality or for garment leather, few products are finding a specific use. High quality nappa skins and high quality linings are less affected. However, the rest continues to suffer. Some are expecting a better move over the summer, but we aren’t really sure yet.

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