Macroeconomics

At the beginning of the period it seemed that the financial markets could enter into a period of more stability again after the shockwaves which went through the market in mid-August. However, as time progressed, the concerns returned and by the end of this week the bad news was taking over again.

Weak economical data in particular from the US triggered rising concerns that the economy could return to recession and we could end up with a double dip situation. The debt crisis in Europe is becoming an endless story and the latest news about the situation was not promising at all.

With the deteriorating situation came concerns about the stability of banks. Share prices of many leading private banks in Europe dropped sharply with the confidence finishing. The numbers were not as impressive as after the 2008 prices, however banks were not lending money to each other anymore and increasing amounts of Euros were deposited with the ECB. The last thing the financial markets need today is the fading of trust.

As a consequence, stock markets started to nosedive. In Asia, where the economical situation in the emerging markets is definitely much better, the concerns about the export business to the US and Europe started to increase. In the meantime countries in the Far East have to deal more and more with the evil of inflation. Rising prices for food and other basic consumer needs were lifting inflation rates in China, India, Thailand and Korea to levels far above the acceptable numbers. Official figures were talking about levels of 5% to 8% and the people in the street sense much higher price rises.

All in all the economical outlook for the global economy has darkened further and several institutions as well as governments have trimmed their expectations for the growth of the global economy.

The currency market has still not fully decided what to make out of it and the US dollar was still bouncing within the existing trading range which we have seen since the beginning of the summer, between 1.40 and 1.45 against the US dollar.

Oil prices recovered decently due to financial investments and traded between $5-$10 higher than the lows we had seen already.

The political situation in Libya started to settle with the rebels celebrating their victory over the Gadaffi regime. This has kept the situation in Syria open for the time being and the EU has imposed the ban on oil imports from the country.

Market Intelligence

The timing for this report is definitely not the best. At the time of writing most people have already departed or are just preparing their luggage for the trip to Asia or Shanghai for the international leather fair. A number of people have already been travelling for a while and a few reports and statements which are available at this stage are still not delivering a clear picture. It seems that the necessary information and opinions need to be gathered this week for a better and clearer picture about the future of the leather pipeline.

So far at least we feel pretty confirmed in our opinion that the leather sector cannot avoid the impacts of the uncertainty about the general situation and future of the global economy.

We are now starting to see the return of our concerns about raw material and leather prices which we had first seen in the first half of 2011. Prices had gone too high in our opinion in the normal and logical consequence is that manufacturers and retailers are trying to escape higher material prices – or in short, they are trying to protect their profit margins by lowering the material costs. Since there are no big saving potentials in labour costs, they have used the summer break to check alternatives and solutions to reduce or hold material cost steady.

Since the raw material market hasn’t given the impression of readjusting, people along the pipeline need either the reduction of the use of leather, or the substitution of it. This applies in particular to the global brands of the retailers who are selling outside the emerging markets. This is still a great deal of global consumption despite all the fascinating growth, in particular in China. The US, Europe and Japan still account for the majority of consumption in these regions, and retailers are not confident that they can convince their customers to spend more money in times of crisis.

We hear from many manufacturers, in particular footwear firms, that they do not see any room for price increases which would be desperately needed by the tanning industry to return to profitability. Consequently, designers and product managers have been asked to check for solutions in design and materials. Final decisions have not yet been taken, but in the coming weeks they will definitely happen and the big question is going to be if the strong domestic demand in China can compensate for the problems of price and outlook in the rest of the world. We are sceptical.

Apart from these more general problems, the market also had to digest news from Italy, where two of the largest tanning groups have been accused of various kinds of tax evasion. Workers seem to have been paid ‘in black’ for a longer period of time to save tax and social welfare costs. Actually this is a widespread common agreement between the labour and the companies, not only in the tanning industry but in other industries as well. The workforce is looking for more cash in hand and the companies try to remain competitive by lowering their gross labour cost. On top of this there were also reports in the newspapers about additional tax evasion activities which have been strongly denied by the companies in question. Regardless of the result, for the moment it is increasing the level of uncertainty and the companies will tie up a lot of their energy and management resources in handling the problem with officials. Last but not least, one has to expect that this problem is not going to be limited to the two big firms now mentioned, but this could also spread far wider and will certainly become a general political issue in the country.

Without judging the issue, it is reflecting the problem of competitiveness in the European tanning industry. Italy for example was coping with the problem of rising costs with the continuous devaluation of the Lira. This option disappeared with the introduction of the Euro and despite all the recent problems, the strong performance of the European currency has made the cost problem for the bulk manufacturers even bigger. With increasing bureaucracy, higher standards and cost for pollution and labour standards, the leather industry, in line with many others, has constantly lost ground versus the competition from the Far East. For those who couldn’t escape into the market, there were not many alternatives left.

This should be definitely been no excuse for any illegal activities, but it might explain a little bit why slowly and surely almost every option is being used to safeguard companies and jobs.

Apart from all this rather negative information, not everything has turned sour. For the time being luxury companies are still reporting record levels of profits and the automotive industry and the premium segment are running full speed thanks mainly to the export business to China. No order has been cancelled so far and the production forecasts for the rest of the year remain pretty high. All the premium car manufacturers are forecasting record outputs for 2011 and will remain extremely busy the months to come. The big three from Detroit saw strong August sales too and hope now for a good rest of the year. The same applies to the luxury brands which are focusing in particular on leather items. So, here we just have to be afraid of any severe economical turmoil which could have an immediate effect on sales and production (see 2008).

The general domestic demand in the emerging markets remains strong and so far the consumer in countries of crisis remains quite unconcerned by the worries of the financial markets. Many believe that it is a kind of fatalism: better to spend and please yourself now and enjoy it before the real problems come.

At this stage we are also less worried about consumption, but far more concerned about the problems along the pipeline. This applies mainly to financial issues. The number of concerns and rumours about payment problems is steadily rising. While in Europe credit insurance covers start to become an issue with the high level of prices and the relative amounts on the invoices, in China many reports are heard about leather wholesalers and shoe manufacturers not meeting their due dates anymore. A frightening amount of business is made on extended credit terms, and considering this, one has to see the increasing risks.

All in all it is still a bit early to get to final judgments. After the summer break where the media and the financial community preferred to take a vacation, the number of statements is now rapidly increasing again. Most of them are not good and whether the crisis is actually back or is talked back does not matter much at the moment. In the Western world the confidence and trust in the system and the capabilities of those responsible is quickly fading. The image of financial market players has reached drug dealer status. Whether this is justified or not, it is destabilising and opening the door for all kinds of increased regulation and decreased individual freedom. That will not harm business and consumption in the short term, but if we can’t turn around quickly we will see the bad consequences later.

For the moment, we have to wait now for the month of September which is always pretty decisive for the coming production season. Many consumer product fairs, the initial review of sales after the summer and the further development on the financial markets will lead the way for the months to come. As long as the consumer continues to remain unconcerned by the economical risks and shopping in China remains strong, one hasn’t to be too concerned about the short term future. Adjustments, yes, because the producers need to return to a profitable base, but there is still no evidence for a collapse or substantial correction yet. Money remains the main subject to watch out for.

The split market is also undergoing some revaluation. Split prices are fading, but rather in sympathy with the general tone of the market than with a serious demand problem. Lime splits are still doing better and rising food prices support this segment while wet-blue splits face a similar uncertainty as raw materials.

The skin market is still possibly the best performer. The general shortage of sheep and lambs in the main producing countries keeps supply under tight control and leaves manufacturers little option than to pay the equivalent price levels. The stable wool market adds to the reasonable performance of the relative origins of skins. The season of good lambs ends now in Europe and so the late comers are now determining the market situation. Prices are fluctuating little and some declines seen over the past weeks have been compensated again.

The next weeks will be focussed on the impressions of those gathering at trips to Asia and trade shows. We still believe in a correction period to make leather competitive again and to bring the raw material prices back into a profitable zone which allows manufacturers to obtain a reasonable margin on their production.

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