Macroeconomics

At the day of writing this issue we just finished a week with the highest losses in the stock market since the melt down of 2008. On Friday some – better than expected – data from the US labour market helped the markets to gain a bit of stability.

This might be forgotten on Monday when the market will have to digest loss of the triple A status of the USA which has been announced by one of the large rating institutes on late Friday. When this issue is published we will know how the story continues. With the holiday period in the leather pipeline, we will extend this section a bit, because when we started many years ago we aimed not to think too much about the daily gossip and market blips, but to try to look a bit further ahead, to analyze a bit deeper, to trigger individual thinking and to deliver handles to come to personal conclusions about the leather pipeline. That was still in the days when facts where slightly more important than news, which has been sharply reversed since then – at least for many, but hopefully not all.

Well, our regular readers know that we are more surprised at how long it took to happen, rather than the fact that it happened. Today’s world is a media world. Information cannot only be obtained at any time; it can also be spread, and what was first only the internet has today been boosted by blogs and social networks and literally everybody can publish at any second news and opinions. You switch the television on, you connect to the internet, you read the news or your favourite magazine on your iPad or you are still one of the old fashioned people getting ‘the paper’ delivered to your doorstep – in the end it is more the daily volume of opinion than the quality which counts today. What is read today is forgotten tomorrow and every minute new information and opinion is released – either because people need to produce the product (news) for commercial use or because individuals love to exhibit themselves and today have an immediate platform for it. By the way: we know exactly what we are talking about.

What has this got to do with the last week? We think that for years the fundamental problems in the financial world were obvious. Economies and businesses require balance. That is a fundamental fact. Imbalances need to be balanced and the system handles it – always. However, the deeper you press the scale down on one side, the harder it swings back when you lose the power to hold it. We have a lot of expressions to describe blips: bubbles, exaggeration, and Mr. Greenspan even invented a new description never heard before, “irrational exuberance” – in the end all the same.

“System seriously out of balance”.

This has been and still is the situation as far the debt situation is concerned. What had been hidden debts in the corporate sector (which led to the 2008 crisis) were part of a much bigger problem on government level and that’s what we deal with in 2011. Nothing new, just one day the system can’t hold the scale down anymore.

The weights on the scale are the sum of facts and opinion. Publishing opinion means supporting individual interest and the on the scale, opinion has gained while facts have been lost in the addition. Those responsible for politics and economy are not the ones who want to sell bad news. It is not in their interest and investors don’t want to hear bad news, so they work in a symbiosis which has led them away from the realities. One should never forget: opinions may influence, but facts rule in the long run. Let’s see if there is a chance that those responsible understand that their list of priorities is not ‘please and then manage’, but ‘please by managing’.

Getting away from philosophy. The hard facts were falling stock markets which wiped a significant paper wealth out. Most of the paper wealth of investors made in 2011 was erased. Commodity indexes sank drastically and most since the crash of 2008. The USD played yo-yo and bounced again almost daily, with investors considering it to be a safe-haven in the morning and junk in the afternoon. With the downgrading of the USA on Friday night, the risk of a further decline of the USD value is sharply rising.

Strong performance was only seen by some small currencies (CHF, NKr, CAD f.e.) and gold. Gold, although not delivering any return seems to be the last investment of any confidence at present.

Market intelligence

Until the middle of last week we were in the subdued market condition had anticipated the holiday season. European tanners were almost all on holiday, either gone already or just leaving. Also in some parts of Asia, such as Korea, tanners shifted into a lower gear. The rest were using the period to sit on the sidelines to analyse their business, using it for maintenance and just run production at reduced seasonal levels before the production cycle starts again after the summer break. The markets were steady and the leather pipeline had actually made itself cosy and comfortable for the rest of the summer.

If there was anything worth mentioning, it was that some players were mentioning delayed payments and less ambition to receive shipments. What runs smoothly in a rising market becomes a problem in a weakening environment. The summer time and the initial weeks of September have always been critical for payments in Europe, as turnover is low in the second quarter with steady overheads. Many leather customers do not pay in the summer vacation and tanners who haven’t got the necessary financial resources immediately run into trouble.

In the past, this was covered by the relatively low raw material prices which had stretched the financial resources of the industry, but with the levels we have reached in the first quarter of 2011, the situation has significantly changed and money has become increasingly tight. An issue which we have addressed already a number of times.

So far, so good and many had just taken seat in a comfortable deckchair when the financial markets started to rattle. Well, there is not much one can do. For a private business the rumble does also not mean anything right away. It doesn’t bring or cancel any orders right away, it doesn’t bring any money in and nor does it pay any invoices and if there is any influence it could come from either currency exchanges or  energy or raw material cost. With raw material (hides and skins) being the biggest part of calculation in the leather production and being immediately effective, a lot of people are now taking a great deal of notice of whether the price drop of many commodities will also spill into the leather pipeline.

Two days might not enough to judge, but those tanners (mainly Chinese) who continue to have their finger on the market pulse tried to test the situation by sending ambitious bids to their suppliers. From what we were able to understand, until Friday night most suppliers were not too attracted by the attempts and mentioned their reasonable sales positions combined with low kills. However, they were at least interested and their main reaction was to get back into the deckchair, because if people are bidding in such turbulent times it means they still need product and this is good news. Normally buyers totally disappear in such conditions and the very last thing they would do is to bid for hides until the dust settles.

The question is for how many buyers and sellers this applied. Rumbles in the financial market don’t change the facts in a day apart from the mental and psychological disposition and there are still the same numbers of shoes, cars, bags and sofas ordered and still the same number of animals killed for beef consumption.

The disruption we saw in 2008 was related to the meltdown in the financial markets and in the shortage of liquidity which was seen. In 2008 the market was also pretty much burdened with unsold products in the pipeline. In 2011 a lot in the financial markets might look pretty similar to three years ago, but at the moment the pipeline is still reasonably empty until the end at retail level. The car industry for example is in many instances working against order books and has not yet built the unsold inventories which were sitting in dealerships, parking lots, international seaports or at the end of the production lines. This can obviously change very quickly and it would just need orders to be cancelled, but this is not the case today.

A major factor also remains the domestic consumption in the emerging markets. In China they see the problems of Europe and the US and it is definitely something which is going to hit export production, but for the local individual the situation in his home country looks significantly better and inflation lest those who have got the money to think about purchasing now rather than later. A similar situation applies also to many other countries still.

So, the hard facts with limited kills and reasonable order books are still valid as of today.

This is leaving things pretty much to two sectors of danger when we look into the third quarter. One is psychology. In case the financial markets continue to be in trouble, stock markets will continue to fall, the confidence in managing the debt crisis in the USA, Japan and Europe falters even further and credits will become a problematic issue for the private sector.

The leather pipeline has become pretty used to a very steady and problem-free product flow since mid-2009 and many might have forgotten already how quickly this can be disrupted. It doesn’t take much to bring the flow to a hold and let’s not forget that the price level for hides and skins is still pretty high.

In case financials play a major role, we will have to watch if any of the rumours about payment problems are going to materialise after the summer holiday. Customers who don’t pay are not only failing to meet obligations of the past, but they also cannot take what they had planned for in the future. Suddenly hides and skins which had been sold become available to the market again and this can actually disturb the balance of supply and demand significantly.

A lot of potential market problems have been, and will be, absorbed by the reduced kill. The beef demand is far away from what the forecasts were and consumption is at this moment not meeting expectations. This might change after the summer with the weather getting colder again, but for the next eight to 10 weeks it remains a major issue.

One can see how fragile the situation for the leather pipeline has become now. With all the optimism from the first half of this year, production orders have run to a pretty high level and with the present market situation it seems to be unlikely that players are going to make quick decisions. Most of the decisions on outstanding orders and programs will be postponed or slowed down before making any commitments to brands and retailers until they have a better picture of where things are going to go on consumer level. This applies mainly for the Western world, while producers for domestic brands and domestic retail in China remain pretty happy. They can also take the full benefit of the rising RMB which makes imported raw materials cheaper at the moment and gives them a better margin for production.

For the rest, one has to assume that a wait-and-see position is what most people are going to take in the near future. Only those who were fully confident about things in the long run might see the present situation as another good chance to secure raw material before things recover. However, this will most likely be restricted to only a few pretty strong hands and decision makers. For the rest there is now a very good excuse to postpone further decisions until trade gathers again in Shanghai in the first week of September. Asian buyers and manufacturers want to see their customers and suppliers face-to-face to understand better what kind of positions they are in and the suppliers and customers like to see their manufacturers to know how healthy their order books really are.

The coming weeks will in any case leave a lot of room for market theories and guessing and one couldn’t be surprised if the relaxed position moves to a more nervous market feeling from next week on.

The split market is finally said to be under a bit more pressure and there are more and more voices, in particular from China, who are talking about the difficulties in the drop split market. On the other side of the coin, we are going to face more demand from the food industry and the final wrap-up of the split market might only be possible by the end of September when the activity in the tanning industry and the situation in the food industry for the winter half are clearer.

The skin market is traditionally not reacting so sensibly and quickly. For the time being certain types of skins continue to be in short supply and this means that, in particular, there is still a decent level of interest in wool skins suitable for shoe lining and garments. However, the tricky thing about the skin market is that production of raw material and demand for finished products have totally different timeframes and so producers have already made decisions far before the financial turmoil began. We will watch the situation very carefully, because we also know that the skin market – once reacting – could see pretty severe reactions in the end.

It seems that it is pretty useless to make any kind of predictions for the market at this stage. The financial situation will most likely not dictate what is going to happen with many commodities and that will also include hides and skins. Since the physical balance of the market is still reasonably intact, we don’t expect large and extended movements. After the experience of 2008, the global society will continue to make any effort to avoid a similar scenario. However, they may build further financial shelter, they may pump more money into the markets, they may deliver strong statements, but at the end it is pretty obvious that only common effort and a clear commitment and strategy to settle the debt crisis will prevent the economical world from further turbulence. Even if the strong measurements and decisions are taken, however, it will mean that the simple consumer in the street will definitely have less money in their pocket. It will be either less government payment or higher taxes what will eat into the pockets of many consumers. This will not only hit basically lower incomes harder, but it will certainly also bring a lot of political tension and social conflicts with it. That is never normally good news, because it means that the feel-good factor of many people is further declining.

So for the short-term one may still trust in market stability for the leather pipeline, but for the medium longer term, the level of alertness and prudence should be rising.

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