Macroeconomics

In the last two weeks the financial markets returned to the normal pattern we have seen since mid summer. The general consensus is that the crisis is behind us, although a number of experts continue to issue warnings. However, investors are busy doing what they did a year ago and the markets are definitely much more optimistic than some of the analysts and experts.

Recent forecasts for 2010 published by various government institutions, banks and other international authorities are painting a positive picture for the year to come. Most expect moderate growth for the Western world and the continuation of quite extensive growth in the emerging markets.

This is reflected in the financial markets with the stock markets and commodity prices rising, and future markets for interest rates and commodities predicting much of the same. Prices for long-term energy contracts are seeing steep price increases and the money markets are also expecting sharp interest gains during a time frame of three years and beyond. This is definitely linked with the fear of inflation as many understand that the massive injection of liquidity into the markets will eventually create inflation, prompting a need to push up interest rates sharp and fast.

Financial markets are generally assuming that everything can be predicted and that movements will be orderly and according to expectations. History and experience tells us that, in the vast majority of cases, market expectations generally fail and something happens to destroy most of the market assumptions for the future.

For the time being we have to deal with further injections of liquidity into the system, low interest rates, the fear of inflation and, with the recent positive outlook for 2010, strong speculation for rising energy prices in 2010. At least for oil the market is in conflict with the physical realities where oil supply is still abundant and producers can hardly understand the recent rise in the price per barrel. The market finished last Friday with prices being pushed back into the mid 70s.

The development of the US$ is presently totally linked to commodity or, more accurately, oil prices. Consequently, the greenback is falling and almost reached the expected 1.50 level against the euro. The pound sterling is one of the weak currencies and is continuously under pressure.Last week’s media reports were full of predictions for an ongoing decline of the greenback including justifications as well as positive readings of the decline for the international market imbalances. This was readily picked up by investors and speculators and, since it has been so easy to make money by betting on commodities and against the greenback, it seems the trend can hardly be stopped in the short term. The only thing that generally speaks against this development is the historical fact that when everyone bets in the same direction the opposite frequently happens. Looking at the massive short position on the greenback and the long position held on commodities it would not take much to see a major correction.

In the meantime, nothing could change investors’ appetites; both good and bad news from the US economy was read the way people wanted to read it. The news from the US was almost all positive suggesting that that the US could be out of the crisis sooner than Europe. However, for ordinary people the problem of taxes in response to the massive budget deficits and risks of further increases in unemployment when the stimulus programmes run out remain.

One way or another, predictions and plans for interest rates and energy costs for companies in 2010 are pretty difficult to make and it is advisable to stay in close contact with the markets.

Market intelligence

In the last two weeks some of the seasonal increases in leather production and demand have been seen in Europe. At the start of the first week, the Chinese were still enjoying their autumn holidays and it took until last week to bring them all back to work. Since they were expecting raw material prices to decline (correct) they were not in a rush to think about any purchasing activity on the market until last week and some of them preferred to wait for a better response from their export clients. For upholstery tanners the upcoming fair in North Carolina, ITMA Showtime, will also have a major impact on their plans for the rest of the year.

In general, the market mood is slowly improving. The constant flow of positive news about the global economic recovery is slowly shifting into the leather industry. Common opinion seems to be that the situation is not deteriorating anymore, but there is still uncertainty about the extent and the timing.

The market was influenced by three major issues during the last two weeks. It all started with a larger wet blue trader operating in many low cost countries in Africa and the East failing and being forced into receivership. This did not come as a surprise for most pundits in the trade. The low-quality market had already been in a deep crisis for a long time and those that were caught with too many stocks and productions in the pipeline have not really had a fair chance to recover in the past year.

Demand and prices for low-quality material never compensated for the vast losses created when prices slumped in the last quarter of 2008. So either large amounts of capital need to be injected or banks pull the plug, which is what seems to be happening right now. While it is bad for them, we must also consider the side effects which will possibly burden the general industry as well. Banks and credit insurers will now watch this sector even more intensively and will definitely question the valuation of inventories held by processors, traders, tanners and manufacturers. So 2009 balance sheets will be monitored more closely than ever before and banks will probably try to reduce their exposure or ask for more collateral.

Finding the fraudsters

As if that wasn’t enough, the tax police in northern Italy have been out for another intensive investigation of the tanning industry in the Veneto area. We have discussed VAT fraud in the area before and in the past year a number of people have already been arrested and prosecuted. However, the extent of the action this time has impressed everybody. About 20 people were arrested and more than 140 companies investigated after a morning raid. The biggest problem today is that most people who are familiar with the business in Northern Italy believe that the vast majority of companies in the tanning industry are involved in the operation in some way or another.

VAT fraud has been widespread and pretty much systemised, and many people know about it. The big question today is how the Italian justice will deal with it. It is likely that only a few were actually involved in the organisation and handling, but one way or another it seems many tanneries in the area took advantage of the situation and bought this kind of ‘subsidised’ product occasionally at least. During visits to the area, one could easily see that many people are scared they will be pulled into the investigations. With a good number of people arrested and, as far as we understand, being kept in solitary confinement, the question now is how much they will tell police about the system and the operation. The next step will then of course be how much evidence can be gathered to prosecute more people in the area.

The side effects will also be important. The tanning industry is an important sector in the area. It is a large employer, taxpayer and job generator for related industries. Banks are also heavily involved in the sector and, if the police find more evidence for criminal activities, it could hurt a number of companies, and failures cannot be ruled out. In an area where the industry is very closely connected, a domino effect will most likely be the result.

Many locals doubt that officials will risk a general implosion, which would hurt whole region in the country tremendously. Some believe investigators will try to figure out who the key people are and try to find private arrangements which have a certain monetary advantage. Some people are even saying that some private arrangements have already been concluded and will be the basis for further solutions. If, however, the authorities need to prosecute more important players in the industry it could have a very deep and negative impact on the Italian tanning industry. Let’s hope that only a handful of criminals have been involved and that the situation can be cleaned up and finished quickly. Those who have run their businesses in an orderly, legal way should at least have a fair chance to return to fair competition in business. They have been the ones that have really suffered for quite a few years now and they deserve for this kind of unfair competition to be stopped quickly.

Positive reviews from Lineapelle

Last but not least, Lineapelle was held in Bologna last week (October 13-15). There is an ongoing discussion about whether there were more or less visitors compared with a year ago, but we don't think this is actually really of any importance. It is the quality and the quantity that counts in the end.

As usual for trade shows now there was one busy day and others where things were quiet as far as traffic is concerned. The first and last day in Bologna saw fewer visitors around but, talking to a number of exhibitors, people were not complaining about the quality and the value of discussions, even on days one and three. The middle day saw visitors from all over and it was pretty busy; many were complaining that they couldn't finish what they intended to do. Good advice would be to stay longer if you have so much on your agenda.

Most exhibitors considered the show a success. Let's not forget that the fair in Bologna is actually held for tanners of shoe, bag and accessory leather. It is a trend show, showing high-fashion, and is basically still the core for leather fashion in the world. If there was a single conclusion to be drawn from the event, it was confirmation that high-quality leather, natural leathers and eye-catching designs are still attracting enough interest and demand to keep those who can comply busy and successful. Hardly any of the fashion and high quality producers were complaining about orders and visitors. Some summarised the situation as ‘back to basics’ and were displaying leathers in their ‘original form’, which met with interest from buyers.

The quality issue

Now many will complain and say this is only a small part of the leather industry and that not everybody can make fashion and high-quality leather. This is definitely true, but it does not prevent designers and manufacturers for the global brand names and retailers thinking about different solutions rather than just complaining about prices and asking for cheaper and more commodity products.

Looking at retail shops and big shoe chains, many of the shoes that are on offer today in the low and medium price segment are actually an insult to the consumer rather than proof that somebody is capable of designing and marketing a natural product. Too much has been sacrificed for the sake of industrial production and there is limited expertise in terms of leather cutting and shoe production. There are different ways of handling the selection problems of natural leather and of making sure the consumer can actually decide between leather and non-leather products.

We have been dealing with this quality issue in previous issues, but after having seen again what can be done in leather production and the level of quality and design that can be made, the industry would be wise to make sure that its product is different and can be clearly defined by the consumer buying the finished product.

This subject has been brought up over again, but with the industrialised productions of today, manufacturers have no real understanding that with the materials they use more attention will be needed if they are to defend their positions and the materials they produce. However, this does not mean they have to accept every demand from retailers and marketers.

So, for the better quality producers the show in Italy can definitely be called a great success. Hardly anyone complained about orders and business outlook. The only real complaint was that there was not enough good quality raw material available at the right price. Has that ever been the case?

Mixed messages

The few upholstery tanners around gave a bit of a mixed impression. Demand for good quality material in this sector is reasonable, but definitely not as good as it is for the other segments. Raw material quality and price is an even bigger issue in this sector and the biggest problem is how to deal with the medium and lower selections. Cheaper leathers can still be sold, but never at the price they need to fetch and medium-quality leather is still facing the same problems we have been seeing for a long time. Either it is too expensive or it's not good enough, so many tanners are still complaining about never-reducing stocks and problems with this part of production.

It was interesting that a lot of visitors from the Far and Middle East were seen. Their presence is growing from show to show and this reflects how the leather business is developing. Production and consumption are moving further east every year. The strong euro is making life for European tanners even more complicated in terms of competition with manufacturers in other parts of the world. It is already surprising how long the industry in Europe has been defending itself against the problems and producers must be admired for how long they have been able to fight the battle.

Last years’ problems, the increasing difficulty in accessing finance and capital, the falling US$ and the shift of global consumer consumption is making it more difficult for the industry every day. We think that we finally need to get ready for further major restructuring, probably in the next two years. The best case scenario would be that this is done by quietly cutting production capacity, but in the worst case we must expect a number of involuntary shutdowns.

Some good news

The splits market has been able to maintain some of its dynamics. Good quality suede leathers were still seen in quite good numbers and with more demand from non-leather industries, supply is not burdening the sellers. There is enough demand to absorb the splits that are actually produced if they meet what the market wants today. How long this fashion will continue nobody knows, but from what we have seen and discussed it is likely there will be at least another season where splits will be used in various productions. The biggest problem today for manufacturers is getting the right product, as tanneries are still not producing grains for the sake of satisfying splits buyers’ requests.

The skins market also showed a better performance. A number of visitors from Asia were reporting that nappa garment leather could see better demand than before. Well, it would not take much to call it better than before, because there was hardly any for quite some time. However, as we reported back in the spring, there is now more nappa leather in garment fashion, and the shoe and accessory business is using more and more good-quality sheep and goat leather.

When we add the demand for linings and look at the pretty low prices for many skins one has to be pretty optimistic about the potential and the possibilities for sheep and goats that comply with market demand for the next season. We have already heard reports of good interest and demand for European lambs and some are saying that many warehouses are already pretty much cleaned up. Prices for some origins, such as those in the UK, jumped by $.50 to $1 in the past couple of weeks and will be interesting to see whether this will be supported by buyers in the weeks to come.

A word of warning

It seems the market decline we have seen since mid August has now stopped and hide prices have found a floor again. In particular, the crazy movements in continental Europe have started to correct and most of the global hide origins have found a fair value again. Currency movements will still be an issue, but demand for some specific materials, in particular top-quality and extra-heavy, is still good enough, if not too good, for the volume produced.

However, people have hopefully learned their lesson that pushing prices too far will be punished quickly by a decline in demand. Global consumption is definitely not strong enough yet to allow prices to move significantly higher. Raw material prices have recovered from their destruction after the financial crisis but, despite general speculation, the valuation of leather raw materials is still determined by finished leather prices. Only inflation and a sustained recovery of consumer demand would allow raw material prices to move to a new, much higher, plateau than where we are today. Sellers should be happy with what they have today and not try to play the markets. In our opinion it is far too early for that yet.

On the other side, buyers should definitely not bet on another collapse of raw material prices in the near future. And it seems they aren't anyway. The round of buying seen in the last weeks was clearly indicating that at a certain price level the tanning industry is happy to keep stocks on a regular level. Consequently, we are not expecting much movement in the market for the weeks to come, but we have to keep an eye on any possible further developments in Italy and on the financial markets.

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