Macroeconomics

There hasn’t been too much exiting news from the financial markets and the global economy in the last two weeks.

A year has passed since the collapse of Lehman Brothers and the market has seen sharp declines and sharp rebounds since then. Governments are now trying to find solutions to global regulations in order to avoid a repeat. Agreements have not been reached so far, but progress has been made, if one believes money can ever be controlled.

Asia (particularly China) and the emerging markets have survived the crisis better, but there have been more discussions about the danger of an asset bubble, and some are even comparing the situation to the situation in Japan 20 years ago. Although we think this is a little exaggerated we do see a bubble of liquidity, and the huge foreign currency reserves that need to be reinvested could become a threat to global stability again.

Unemployment is going to be the biggest problem in the future. Even with a forecast of further recovery there are few indications this will be strong enough in the coming years to offer enough newly established jobs to keep such a major problem under control. The recovery seems to be in place, but it also seems to be slower than it needs to be.

Consumers remain cautious about spending. With the end of the ‘cash for clunkers’ programme in many countries, car sales are still pretty flat. Also, classic consumer goods brands such as Nike are reporting lower sales and shorter order books. So the global economy might be recovering, but the development is simply not sufficiently strong to boost business activity enough to create the growth needed to generate sufficient employment and tax returns to cure the injuries caused by the recent crisis.

The US$ has taken a break in its descent against the euro. Declining ‘risk appetite’ (what a cynical expression for economic decisions after last year’s collapse) has lifted a bit of the pressure on the greenback and it gained a few cents against the euro. Oil is trading in a range between US$ 65/70 per barrel and it was move was the result of news about physical inventory. Gold is trading in a narrow range around the magical US$1,000/oz mark.

Market intelligence

The past two weeks were uneventful for most members of the leather pipeline. It seems the pipeline is trying to sort itself out like the rest of the world and the majority of businesses. After the crash in the last quarter of 2008, the agony in the first quarter of 2009, the sharp speculative rebound in the second quarter and the correction and settlement in the third quarter, the leather pipeline had been driven by exogenous influences, mainly from the financial market, for exactly a year now.

The crash in the leather pipeline was triggered by the collapse of the financial system, and the rebound mainly by the huge amounts of liquidity that were poured into the markets under the leadership of the Chinese government. Both phases proved to be exaggerated in the leather business. The freefall in prices and orders reflected the market realities as little as the sharp rebound we saw during the second quarter. Such market movements are nothing unusual and the fact that the pendulum swings too far and too fast either side was also seen in other markets. Everyone is now trying to find an equilibrium to reflect the realities, including a fair assumption of the medium-term forecast.

We discussed the levels of exuberance at the time and, from today’s perspective, the descriptions and conclusions were pretty accurate. The fortnightly Market Intelligence report started in 2001 and we explained in one of the first issues that our radar and analysis is not a short-term market report to watch the blips, but a report offering thoughts and intelligence that could be used as a possible handle for business decisions.

Assuming this exuberance is behind us and the amplitudes of the market reactions are diminishing, we would like to connect with our last issue where we listed a number of market situations as we saw them. We would like to take a look into the future with a timeframe of three to six months, although we have to admit that we are not in a position to come to a particularly positive conclusion.

We think everyone would agree that most of the market improvement in the past six months was in one way or another related to activity in China, the only place where leather production was performing in an acceptable way. We now know that this was, and is, largely related to the massive stimulus programmes injected into the economy and has led to stable and increased production and consumption in most business sectors including leather. It might not have been as strong as raw material imports seem to reflect, since a good number of hides and skins imported were only bought on a speculative basis, but activity in the Chinese industry has been higher and more stable than in the rest of the world, where productions have slumped and have not really recovered since then.

There is presently a big difference in opinion about economic development expected to take place in the coming months or years. At corporate and manufacturing levels businesses remain pretty cautious about the future. Many are trying to paint a positive picture for their shareholders, but reading between the lines one can see how many concerns there are. Hardly anyone is seriously expecting a short-term recovery in demand and production levels to what we saw prior to the crisis. These levels are presently the benchmarks on which we try to make comparisons or forecasts. If every company has lost 30% of its business and is now recovering by 5%, then it is still down 26.5% against pre-crisis levels.

Bubble bubble, toil and trouble

Serious analysts are now at least questioning whether the Chinese economy’s strong performance was actually based on truth or whether it was just the foundation for another bubble. There are worries about rising asset prices in China which could just be related to the massive liquidity injected into the system and the misuse of the same. Analysts are rightly mentioning that statistics in China should at least be questioned, so there is no guarantee that the money that has gone into the system has actually been used for the purpose for which it was designed.

Some actually believe that quite a lot of the money has gone into speculative investments and the stock or real estate markets rather then into the modernisation of production facilities or the infrastructure projects for which it was intended. This would actually suggest there is a great risk of an asset bubble and, as a logical consequence, a pretty large risk of bad loans for Chinese banks. Some have also pointed out that the Republic’s 60th anniversary on October 1 was another reason for the government to camouflage economic realities in the country.

Most factories in China are still reporting 0-30% declines in exports and hardly anyone is reporting or predicting a significant increase in orders for the next season. Despite the huge potential of the domestic Chinese market, such declines in exports cannot be compensated for and this also applies for leather products. The logical conclusion is that an increase in leather business during the coming season is unlikely.

In addition, we might see recoveries in stock markets in the Western world, but when we realistically look into the future, we still have to expect higher unemployment and tax hikes to cover the huge budget deficits most governments have created. This is definitely not good news for short-term consumer spending in the Western world. The IMF (International Monetary Fund) has just published its predictions for a very slow recovery in Europe until 2011 at least. It also expects increasing unemployment and difficult financing conditions for companies in Europe in the coming years. This is not a good environment for an increase in consumer spending in this part of the world. And, quite frankly, the situation in the US does not look much more promising for the short term and for the next shopping season.

Many people are impressed by the general market activities for raw materials and resources and are taking this as an indication that big companies and investors are feeling positive about the near future. The merger in the beef industry in Brazil and Chinese ambitions to control more raw material resources in energy and metals are considered to be positive indications. This might be true for the long term, and we must not forget that China has to serve huge masses as well as reinvesting its large amounts of currency reserves. They are taking action sooner rather than later because competitors from the old economies are now busy dealing with their present problems at corporate and governmental level. Consequently, the activity to control more resources should be seen as a long-term strategic action rather than a short-term belief in the business outlook.

China is definitely controlling more than 50% of the global production of leather products today. As a result, it has the biggest impact on the situation in the leather pipeline. Chinese firms buy most of the raw materials and also produce most of the products. However, they don't consume the majority and global consumer demand is still the determining parameter for price and production.

If the general analysis of the present situation is correct then we should not expect much positive news for production and demand until well into 2010. We might note some seasonal increase in Europe, but in general it is hard to believe we will see production levels rise, so raw material prices should react more to speculation than to a serious fluctuation in demand. While we do not believe there will be a substantial improvement in demand, we must be consistent and predict a pretty flat situation for activity in the leather pipeline.

Serious improvement could only really come about if there is another wave of investment and activity from China. The dominance the country has achieved in recent years in terms of leather production has given it such high leverage that without another round of major investment, like the one we saw in the second quarter, it is unlikely to generate much of a positive influence.

Getting the price right

Another factor is price. Speaking to large retailers and brands they see absolutely no reason for any increase in product prices. Raw material prices may have fallen too far during the first quarter for standard leather, but they have also increased too much in the second and third. The recent slide in prices seems to have brought many origins and grades back into normal frames, but we still see room for further correction—if not in general then for certain grades, because we are not seeing all prices in fair correlations with the real value of the material.

The splits market remains fashion-driven and suede selections, in particular, are still experiencing good demand. Prices are at least stable, if not moderately rising, but it should only be a matter of time before fashion influences fade and demand starts to ease. Bologna leather fair Lineapelle, which is traditionally a trendsetting event, should offer us an indication as to whether suede will have another season or whether the price levels of grain leather will force a retreat.

The skins market is just about stable. Some markets, such as the UK market, are seeing moderate increases, but lamb and sheepskins are still so economical that the price variations are rather philosophical. In spring we were talking about there being more nappa leather on the catwalks and indeed a bit more leather is being worn by celebrities these days, which normally has an impact on general fashion and consumption.

Price can’t be the prohibitive factor today. With the temperature falling in the northern hemisphere the weeks to come will tell us whether leather garments are really seeing a certain comeback in street fashion. Some people are reporting fading demand for suede goats. While some of the favoured origins are still holding reasonable order books, buyers are expecting fashion demand to decline during the next season, which could potentially bring the easy spell for suppliers to an end. It is a bit too early to know, but the Bologna fair should be able to give us a better picture.

In the coming weeks we expect more of a correction mode for raw materials. China is on holiday and in two weeks part of the trade will gather again in Bologna to exchange opinions and to check trends. We are not too optimistic about the general tone of the market with the exception of quality and nature. In difficult times quality and style dominate. Manufacturers who are putting natural and quality leather in the foreground could possibly have less trouble.

If, however, leather is just a material, quality and nature can’t be clearly determined by the consumer, and price is a major issue, leather could have a more difficult time. If raw material prices actually fall again and the summer was just a blink in the price trend, there could still be a good chance of holding commodity leather demand stable on the levels achieved. However, if raw material prices do not allow attractive offers we could possibly see leather suffer as a material again.

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