Macroeconomics

The holidays are starting to come to an end for the financial community, so media sources are starting to pick up more information and discussing the issues pertinent to the markets at the moment.

The biggest issue in the market at the moment is the question mark over whether the US economy might be preparing for a double dip scenario. The financial data being published at the moment is becoming more and more worrying. The Philadelphia Federal Index (Philly index) is at minus 7, and this suggests expectations for the economy in America are well below the magic zero level.

Analysts had expected the index to come in decent positive territory. The labour market is not doing particularly well and industry is not offering the number of jobs required to support the private consumption needed to generate growth. With the US economy depending around 70% on private consumption, more income and more spending money is essential in generating growth. Disposable income, particularly among the middle class, is shrinking and a lot of communities are already close to or experiencing bankruptcy.

The real estate market does not look as if it is out of trouble either. For many American families their homes are their main assets and prices reflect a lot of private ‘wealth’. All in all, the outlook for private consumption in the US is not particularly good. This means that manufacturers in Asia may find that their exports to the US could be rather flat for some time.

With the exception of Germany, the European economies are not showing the extent of recovery one would hope for either and there is a need for consumption and production to get back on track. The debt crisis is far from over and the realities are starting to catch people’s attention again. One thing to be clear about is the global economy cannot depend solely on huge growth rates in China. It needs to be far broader than this, and after a lot of excitement at the end of the second quarter, people are starting to become more serious about their plans and budgets for the end of 2010 and for the first half of 2011.

With the more negative outlook, commodity prices have started to ease. Oil and metal prices have fallen and oil prices have come back to levels in the mid $70s. We wouldn't be surprised if they come back to the low $70s pretty soon.

A big part of the discussion has been related to foodstuffs again. The heat wave in Russia, floods in Pakistan and China and the more vulnerable outlook for the harvest have increased the possibility of rising food prices. We dealt with this back in 2008 and believe that food prices and speculation around the prices will have a massive influence on global stability and the economic outlook.

It is impossible to evaluate what the floods in Pakistan may mean. One thing is clear: stable growth in the country has definitely been interrupted. Hopefully the disaster will not destabilise the country, which could destabilise the entire region. The floods in China might also have more influence than people are expecting at the moment. Yields have been falling again and the constant availability of cheap money seems to have come to an end for the short term.

So the post-holiday period is starting on a much more negative footing then when we left for the holidays at the beginning of July.

The dollar has corrected some of its sharp decline against the euro and finished the period at levels around the 1.27 level. However, we wouldn't be too surprised if people started to worry about the US currency again.

Market intelligence

The whole trade is directionless at the moment. People are just waiting for the trade to gather at the All China Leather Exhibition in Shanghai (September 1-3) to get a better feel for what we can expect in terms of market trends in the near future. Demand questions, in particular, will be in the foreground with supply having entirely commanded the market situation for quite a long time.

For the moment the situation remains pretty unchanged. The general global situation has been pretty steady and prices have not changed much. This was exactly what we expected. There are individual situations that are not particularly market related that have come about because of restructuring processes in the industry. We are talking in particular about central Europe where the ambition of the beef industry to control more of their by-product marketing is having a strong effect on market prices because it has substantially increased competition for raw material at the abattoir doors. Also, tanners realise that the number of suppliers is shrinking and that they are having to restructure their purchasing activity as well.

This was supported by the low kill over the summer. The usual fresh hide pipeline to the European tanneries was the worst affected. In this particular case the traditional selected items such as heavy bull hides saw very strong and stable demand from automotive tanners. If there are not enough hides to fill the drums on a constant week by week basis, the problem is the same almost every year: prices go up, but the lack of hides remains.

So in Europe we returned to a situation we had for a number of years before the financial crisis in 2008. A number of selected grades are dragging the total market level up and prices are losing realistic valuations in global terms.

The decline of the US dollar by about 10% from the top levels we saw earlier in the year added to the problem, so quite a number of pundits consider the vast majority of European hides to be massively overvalued and believe prices should come down by anywhere between 5% and 15% in order to bring them back into the range of alternative raw materials that are available in other parts of the world.

Rising resistance

A number of players are already saying that the tanning industry is no longer willing to support prices that not only prevent a profitable production, but are not in line with the general valuation. It might still be a bit early in mid August, but it seems that resistance is rapidly growing and that tanners are no longer prepared to buy hides amid rising prices just because they need them. It seems that if people have material to sell they will have to accept stable or possibly even moderately lower prices to get product moved immediately. Those who have more courage and more optimism for the future might decide to hold on to the hides to see what kind of demand customers in Asia will display at the leather fair in Shanghai.

While price levels for European female hides are still reasonably in line with international levels, male hides are definitely out of range. American steers are trading constantly and in a stable way around the $80 mark, and although premium European males have managed to obtain a certain premium, asking levels for standard products that are more than 10% higher are not being accepted by the customer base overseas. So the European suppliers are waiting either for an extended recovery of the US$ or hoping that the magic $80 mark for US hides will break and that tanners will have to pay higher prices, which  would make European hides attractive again.

Due to the low kill there hasn’t been a pile-up of hides yet and suppliers are not yet forced or willing to consider much lower bids. However, we are quite convinced that the meeting in Asia will trigger a new direction.

We understand from a number of people that what we discussed back in the spring is now starting to happen. The higher raw material prices are forcing tanners to ask for substantial increases in leather prices. Although we understand that in some parts of the industry these attempts have been successful, we understand that many manufacturers of shoes, furniture and other products are starting to substitute leather in their productions. We hear that a number of manufacturers of children’s shoes and furniture are using alternative materials for their forthcoming collections and suppliers have been advised that the volume of leather business will shrink.

This might not yet apply to the premium car market. The top brand names in Europe are still enjoying pretty good order books for the coming months. However, while some people are saying that premium leathers in other industries are fetching higher price levels, we understand that the car manufacturers are returning to the idea of using splits and PU again for parts and panels where leather is not totally essential.

Problems ahead

We are unable at the moment to understand how much the flood disaster in Pakistan will affect the industry. We understand that, until now, leather producers haven’t been too badly affected in the sense that not many tanneries have been flooded. On the other hand, the country’s livestock population has taken a significant beating. A lot of animals have been dying and some people are talking about levels of 20-30% of the total population.

The consequences of this will reach far beyond simply missing raw materials. Normal life in the country will definitely be affected. Private consumption, which has risen so much in recent years, will not recover for quite some time. This will definitely not be the key factor in terms of the global supply and demand balance, but it certainly should not be ignored.

The conditions for the rest of 2010 are different from earlier in the year; at least that is what we think. The business is based on expectations and budgets and there is now at least a decent probability that things will not be as good as many anticipated in their budgets. We saw a dramatic and much faster recovery after the financial disaster in 2008 than anybody was hoping for. It was not evenly spread it and there wasn’t good news for everyone, but in the end it was never as bad as people expected it to be during the last quarter of 2008.

We still consider profitability within the pipeline to be the biggest threat for the industry. As we have mentioned a number of times before, leather as a material has got a certain upper price limit, at which point it will be substituted. So price is having a very sharp influence on demand when it passes a certain level. Leather in the vast majority is still not a luxury product, but a commodity material used to produce a range of consumer products.

The ‘V’ price structure we have seen since the end of 2008 has reminded people that great price volatility is not good for business. Talking to the tanning industry at the moment the biggest concern is more sharp price movements during the coming season. Despite the need for raw material prices to come down to allow profitable manufacturing of leather again, no-one has any interest in any major correction. Talking to a number of tanners, almost everyone is dreaming of a slide of about 10% in prices followed by stability for the rest of the season.

Sharply higher raw material prices would create almost lethal economic problems for the industry and sharply falling raw material prices would create another new round of price discussions for finished leather.

It is unusual to get what you dream of so we are now looking with great curiosity at how the leather pipeline will prepare for the next season following the cycle of correction before the summer holidays.

Glimmers of hope

The splits market is still in the same doldrums as the rest of the market because of the holidays and the summer season. There is a bit more interest at the moment because with raw material prices for hides having gone up so much, splits have become an attractive alternative again. We understand from a number of industries that split leathers have been sampled again and that suppliers have been asked to look for cheaper alternatives, which would make splits a viable option.

If prices really go up, gelatine and collagen products will be a factor again. So this market could see some positive influences in terms of demand for splits as well. To cut a long story short, we are reasonably positive for the splits market in the coming season.

A long time ago we talked about garment leather becoming a fashion item again. Product we saw on the catwalk more than a year ago is now entering the shops and although we would not call it the main trend, leather garments are certainly not the no-go they have been for quite a while. Demand for skins remains reasonably steady and strong and both double face and nappa seem to be attracting decent interest.

Price is an issue as usual as the main producers of garment leathers in China and the Middle East are constantly looking for supply within a certain price and quality ratio. The Ramadan holidays should increase supply a bit, but in general it seems that warehouses are reasonably well cleaned up.

Answers on the horizon

We hope that in our next issue, which will be published the week after the Shanghai fair, will allow us to be a bit more exact in terms of our expectations for future trends. For the moment we are still not expecting any major movements ahead of the show. Our gut feeling tells us that leather demand is still reasonably decent. There is absolutely no indication of a major crisis in the short term for the leather pipeline except possibly profitability. This should protect the market from any major surprises in the near future.

At the same time we think that those who are extremely excited and positive should realise that trends always come to an end. A recovery has taken place and has brought us to where we were within 15 months. But nobody would be surprised if, despite all the enthusiasm, the situation cooled down a bit. There are good reasons why the world could now enter into a phase of increased volatility and the consumer could start to watch his wallet with greater care. A number of people will definitely have less money to spend and others might be more cautious about what they spend their money on.

This might not touch the basics, and this includes some leather materials, but if food becomes more expensive there will definitely be less money for other consumer products. We sincerely hope that the markets will try to handle the situation with limited emotion, which means there will be a fair chance of building stability in the market in the months to come.

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