Macroeconomics

The general turbulence in the financial markets has continued and the last two weeks were very much determined by these rollercoaster rides.

Stock markets, commodities and currencies were all jumping up and down and showed once again that the financial community is still not fully certain about the stability of the system. It also showed that the global ‘leaders’ are trying to play the risks down as much as the sensitive markets are still recognising every small change and threat.

The focus was still on the debt crisis in Europe. Some governments have already started saving projects and are celebrating their activities and efforts. Well, looking at what they are doing it is less real saving (spending less than what you earn), but rather a strange mixture of spending cuts and tax rises. However, nothing that has been published so far really reduces any structural debt and so the fundamental budget deficits will not be reduced.

Nevertheless, the typical political action is to overspend in a bid to please, and to deliver bad news in chunks in the hope they will not lose too many votes in the next elections. Europe, as well as other countries, has still not fully realised that it needs different concepts if there is a serious interest in getting national budgets back on track for the coming generations.

Meanwhile, international investors are worrying about where to put their money. The Chinese are said to be reconsidering their exposure in Europe, which has sent the euro even further down, while in the US the oil catastrophe has been making more headlines than the state of the economy.

Statistics delivered a mixed basket of information once again. US consumer confidence rose in April to 63.3 points, a third consecutive monthly rise, while the Institute for Supply Management (ISM) index measuring business sentiments fell by almost four points. Consumer confidence measured by the University of Michigan rose, while spending in the US fell and higher pay levels are being converted into higher savings.

Anyway, the corporate sector is still pretty optimistic in general at the moment, and a number of big companies are convinced that a general rebound in the global economy will be enough to offset the debt crisis in Europe.

The euro fell to below 1.22 and some days it seemed this could fall to 1.20. Eventually, the markets were so impressed by the EU members’ saving projects that the currency was able to recover slightly to levels of 1.23-1.24. At the height of the problem, investors pulled out of the stock and commodity markets and daily losses on the major indices were more than 3% for a day, which was nothing unusual, and they eventually rebounded. Oil dropped to levels well below $70 per barrel, but in sympathy it rebounded back to the mid $70s. However, markets still look pretty vulnerable today.

Market intelligence

The leather pipeline is finding it difficult to decide which direction the trend will take during the second half of the year. The gap between good market potentials and prices and profitability for leather producers is too wide at the moment and the indication as to whether higher leather prices or lower demand will be the stronger is currently missing.

Possibly, the Shoes & Leather Guangzhou trade show (June 1-3) will reveal more indications at least for the Chinese leather market or for the players in China. Considering that China is today the largest single market and producer of leather and leather products, the signal coming from that part of the world will be pretty decisive. Chinese producers have noted that the time for gold digging in the industry is over. Last year, which saw stable, or even growing, domestic consumption and more than favourable raw material prices generated huge profits and strong demand during the first quarter of 2010, offering the impression that leather prices would follow and that the good times would continue.

Since April the optimism has faded. Yes, demand showed only small signs that it was cooling down. Budgets and order indications for the rest of the year were also good, so the hopes for rising leather prices were high as a logical consequence. This paved the way for the approved system to buy raw materials and to sell the leather with a time lag in order to find good margins and decent profits.

So it was a while before tanners and product manufacturers realised that the retailers and brands were pretty serious in their positions on prices, and that the good market performance could not easily been turned into higher prices. At the same time, buyers were not amused or really prepared for the fact that producers were neither willing, nor in a position, to meet their prices targets. The good old days of overcapacity and inventories along the supply chain were suddenly over.  Buyers were shown the door when they indicated that their prices were not meeting the market realities.

This situation remains fundamentally unresolved and so far the real decisions about who will make the first move have been delayed. Everybody was hoping that the raw material market would sort it out and decline to levels that would allow compromises for both sides without losing face.

A perfect world

The best of the situation is that all of this falls into the period of low season and seasonal changes. This has granted people some time and now the tanners are fighting for their price increases so that they have a basis for their price targets on the raw material market. Chinese producers are not producing for losses. Never forget that. So they have reduced their raw material procurement to a minimum and have slowed their shipments so as not to get caught with overpriced inventories if the market is not wiling to accept what they need.

Well we should not focus purely on China; however, the automotive tanners and those in other parts of the world are not acting too differently at the moment. Everyone is dreaming of a perfect world now and people are doing their utmost to make it happen. In this perfect world they will succeed in their attempts to raise leather prices, just about reflecting the present raw material prices. After this, clients will have to be convinced that the raw material market will start to slide and widen the margins again to satisfying levels. So, this would give them the profits resulting from the low raw material price levels in 2009 and would allow them to benefit from increased leather prices in 2010 and fall back into profitability by adjusting raw material prices during the second half of the year.

Fundamentally, their outlook is not too bad. The only problems are timing and the rules of a weaker market. Regarding timing, tanners are actually caught in a double bind; they want the raw material market to come down, but not before they have locked the higher leather prices in. So now they are sitting in their offices and are having to tell their suppliers that raw material prices are too high and need to fall to a certain level to make them attractive again. But they also have to keep suppliers optimistic enough to hold their asking levels and not let the market slump before the contracts and prices are safely locked in.

This is not easy, but so far we would say they have done a good job. Most sellers agree that the market is ready for a correction, but most are convinced it will only be a minor one, so no-one is busy slashing prices. People are just leaning back and waiting for the acceptable bids to come in. So far it has worked. Business slowed down, prices eased moderately in most cases and nobody is concerned. So, the perfect world is still intact. But can a perfect world be sustained in this trade?

Small steps

Well, maybe one day, but we can’t see that we have reached that time yet. So far, it can only be perfect for one; the one who is benefiting from rising or from falling prices. It would actually be something new if things developed the way they are planned or desired, although at the moment it seems that almost everyone would favour a moderate decline in raw material prices without any increased and or high volatility. This would, however, require controlled “greed” on either side as any exaggerations would, from our point of view, lead to sharp reactions.

At the moment it seems to be in the buyers’ hands, and if they can guide the market in their direction without pushing too hard it might be possible to reach the 10-15% decline that most consider to be the healthy correction needed to find a safe basis for the start of the next season. If this is the target it will depend on the discipline of buyers not to try to do this in one hit. Since there is no large accumulation of unsold hides yet, moderate and controlled bidding and buying would give the sellers and the market the necessary handle to slowly move back to prices that can be accepted and calculated and that lead to healthy profitability again. A moderate and timely price development would not put leather contracts at risk.

However, a lot will now depend on leather orders and expectations for the second half of 2010. The corporate community is still wary that the debt crisis in Europe and government decisions could cause serious problems for the consumer and, eventually, for producers.

Apart from the situation in the leather industry, speculation in the commodity markets has not only pushed hides and skins higher, but many are already talking about a commodity bubble in many raw material markets. We know how sensitive the hide and skins market is to the trends in the commodity markets and, if new regulations stop or reduce speculative investments in the commodity markets, the market for hides and skins could quickly suffer. Fortunately there are no future markets in this sector, so the physical supply and demand is still in command and will cushion any decisions for the future markets. However, a reaction in sympathy would not come as a surprise.

In the meantime it seems we are now living in a two-fold market. While there is still a shortage of specialties for automotive leather and luxury accessories, the more common and regular materials are already facing some market reactions and declines. So markets from the US, Australia and Europe are already reporting the first declines and corrections. Some are not yet admitting this, but it is pretty clear that some shippers are already taking lower prices to make sure productions continue to move. They are not betting on a market recovery in the short term.

As discussed before, a lot of this is currency related. A number of exporting markets in South America, Africa, Australasia and Europe are pretty much or totally currency influenced, so the US market faces the strongest headwinds and other markets are still finding reasonable protection in the firmer trend of the US$. However, this is traditionally short-lived and the buying markets also know about the financial markets. We are already hearing that Chinese buyers are firmly asking for their share from currency movements.

Mixed reports

The splits market has not produced any major news, at least not that we have heard. We would even say this market is extremely quiet. Hardly anyone is talking about shortages, price movements, fashions, alternative uses or anything that could rattle or shake the market. So it seems that supply and demand are pretty much in balance and presently the market is waiting for similar indications for a new direction, as is the hide market.

Skins are still the most positive sector. Most origins and grades are still experiencing decent demand and in many cases even firmer trends. Goats for ladies’ shoes are still a strong performer. Fine wool skins remain scarce and new season spring lambs in Europe are still hard to get. The long, cold winter has delayed production and this has resulted in pretty strange price quotes on the market. A spread of $5-6 per skin between asking levels have not been usual in the past weeks. Tanners in need of this kind of material don’t really know what to believe and what to do. So, we heard little about any business and, if there were any confirmed trades, they were at the lower end of the price range.

In the coming weeks, we will be waiting for feedback from the Guangzhou shoe and leather show. It seems that a lot of Chinese tanners, and the whole industry, are now waiting for the buyers’ reactions regarding higher leather prices. If there are indications for a rise and any potential for higher levels later in the year, demand could quickly recover. With the limited inventory around this could soon have a positive effect on prices again as this is just what sellers are waiting for.

If, however, buyers’ resistance to higher prices and volume commitments persist and decisions are delayed further, the Chinese tanners will not support the market and with the upcoming holiday season in Europe the pressure on sellers to tease buyers with lower prices could quickly rise. We have to admit that at this moment we still favour the idea of further price corrections before the market will bottom. A risk for a slump in prices would only arise if reports about delays of L/Cs or shipping requests for buyers are heard. So far everything is based on rumour rather than on fact.

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