Dear leatherbiz.com member,

Welcome to this first edition of 'Market Intelligence', leatherbiz.com's two-weekly discussion of those issues, trends and world events that are continually shaping our industry.

Consumer spending, fashion spending, development in raw materials processing and, of course, the hide supply situation - all of these have a bearing on how well a leather business is performing at any one time - and all will be monitored by Market Intelligence.

As you will find, however, Market Intelligence is not a news service. As a facility aimed at highlighting the underlying issues affecting the trade, it will take a much broader perspective, bringing historical data, future projections and informed opinion into the frame. The aim will be to give you an insight into the industry beyond the 'here and now', and in doing so help you and your business make better, more informed management and pricing decisions.

Market Intelligence is also here to help save you time. Because we have already located and disseminated the trend information that makes up each report, you won’t have to, leaving you more time to focus on the core activities of your business.

Of course, we will publish only correct and precise data, but the conclusions are open and ready for discussion. In order to make 'Market Intelligence' as relevant as possible to the needs of the leather trade therefore, we would ask that you send us your comments, information and criticism on a regular basis.

MARKET INTELLIGENCE 01/01

Present times are so much influenced the events of the recent past that it might be best to start some months back in order to get an accurate feel for today’s market situation. Although exact statistical data for the leather trade is only available in a few markets, some assumptions can be made without spoiling the conclusions.

In April 2001, world hide prices were very high, while skin and split prices were average.

This was of course largely due to the cattle disease epidemics which struck in Europe during the previous winter. Though admittedly these did disrupt European hide supplies in an eight week window between November and January, the long term threat posed by foot and mouth and BSE to world hide supplies was wildly overstated. In reality – and despite the best efforts of some businesses to talk up prices - the world situation was largely unaffected, making it inevitable that the long-term trends that have always governed the market would sooner or later begin to reapply themselves.

In fact, reading market reports of November 2000, prior to the confirmation of a case of BSE in Germany, it is apparent that the firm trend that had prevailed since July 1999 had already begun to run out of steam. Prior to then, the powerful engine of US economic growth meant that the European producers had been able to dispose of the bulk of their top quality raw materials, as well as most of their high quality leathers, while taking advantage of the extremely favourable exchange situation. Prices of high quality leathers were further driven up by the rise of the brand-conscious consumer in Asia and Eastern Europe, with the result that a vast price differential was opened up between high and low quality leathers.

When they arrived, the cattle disease-induced price rises perpetuated this trend - at least temporarily.

Because the ‘downstream’ pricing calculations made by the mass produced footwear and leather goods retailers largely ignored the price of the raw material, the tanners serving this end of the market found themselves being badly squeezed. By contrast, the tanners serving the upper end of the market found they were easily able to transfer the price increases up the supply chain. This was because the retailers driving their market used ‘upstream’ pricing calculations, in which the price and the quality of the raw material was emphasised. In fact, it could be argued that these tanners might secretly have welcomed the situation, as it served to underline what an exclusive product leather had been all along. Even as prices began to settle back to normal, this was widely regarded as being the scenario forever – a raw material in short supply serving a booming market. However, all that was about to change.

During the summer, as the threat of recession began to loom, so manufacturing businesses of all kinds began to find themselves with far too much capacity on their hands – and the leather trade was no exception. In the US, the impact was especially severe as the strong dollar, high labour costs, and superior price competitiveness of leather from the Far East in the domestic marketplace all conspired to make trading extremely difficult, if not impossible, for the country’s tanners.

The result was the high rate of casualties among US bovine leather tanneries that we have seen in the last few months, and which appear all set to continue. The increasing export of hides to China only confirms the fact that production is now rapidly leaving the US and that it will probably migrate eastwards from other production centres of the world in due course.

What this means is the hide market is now in a state of reaction to all the above events. The tragic events of September 11 will also have had an effect, further correcting the market to a total of 25-40 %. In real terms, the market has in most cases returned to its pre-epidemic levels.

Given the extent of the slump in prices and unfavourable world outlook, it would be easy for the leather trade to slip into the ‘herd mentality’ reaction that we saw in the first quarter and believe that both the market and the leather trade are forever destined to go on declining . However, that would be to ignore both the hard facts and past experience.

In fact, when one stops to look at the world kill, it can be seen that we are now facing a reasonably normal situation. While some regions are below average and experiencing lower than expected numbers (i.e. USA) others are now having seasonal upswings, as in the case of Europe, or could simply be described as being in a state of normality. Either way, for the foreseeable future, there is little reason why the world’s kill should fluctuate outside the normal ups and downs that we are all used to - barring new outbreaks of cattle diseases of course.

On the demand side, the market has yet to absorb the security stocks that were built up earlier this year and which are now lasting longer than anyone expected because of the downturn in the economy. As a result, raw material prices have fallen. Tanneries use expensive inventories first and refrain from equivalent replenishment in expectation of further falling prices, fewer orders and the general cash flow problems that can result from buying at the wrong time. With the possible exception of China, up until September 11, this trend has been exaggerated by the summer holiday effect.

The real question is: Are we now experiencing an temporary break in business, as occurred in the first quarter, or is the market really undergoing a long term decline in demand? One thing is for certain: globalisation is making the prognosis more difficult.

Because most mass produced consumer products, including those made from leather, are manufactured on ‘push’ principles, (i.e. they are manufactured without any final guarantee that they will be taken as ordered), they suffer from a pipeline 120-180 days long. By contrast, high quality ‘pull’ furniture/automotive products that are essentially made to order benefit from significantly shorter lead times. What this means is that only a minor (i.e. the ‘pull’) part of the equation can be used as a reliable indicator of the market situation. Where the bulk of production is concerned, the risk element of production is held almost entirely in the hands of the manufacturer.

Most of the present market turmoil is related to insecurities surrounding existing orders from the USA, many of which have been put on hold due to the September 11 terrorist attacks. While US consumer confidence has undoubtedly taken a knock, the suspicion remains that some manufacturers and importers are using the current economic uncertainties as an excuse to offload their problems further down the supply pipeline.

The question is therefore, is world-wide demand really significantly down? The USA reported a decline of 2.4 % in retail sales in September, while in a poll in a German Sunday newspaper, 75 % of readers said they had no intention of reducing their consumer spending. China’s economy is also expected to grow by 5-8 % this year and also 2002, while many companies supplying the Eastern bloc markets are beginning to speak cautiously also about an upturn in business. Moreover, the European premium car manufacturers have said they are not expecting a sharp drop in orders while some are even planning to increase production, as are the Chinese automotive producers.

When one stops to consider that total production volumes world wide are not reducing, it becomes difficult not avoid the conclusion that the market is wrong when it says demand is down by double digit figures. In fact, what we are seeing is not just a downturn, but also a shift in production from one market to another, with China being the main beneficiary. A split in the market between leather destined for luxury and normal consumer products can also be discerned. One may therefore reasonably deduce that the depression we have seen in levels of demand is only isolated.

However, this does not answer the question of how deep and how long the depression is likely to be, as none of the variables outlined operate in a single dimension. Experience also shows that when ‘group think’ takes over, as was the case in the first quarter of the year, the results can at best be misleading.

All of this leads to a classical model: That when sellers sell too cheaply and aggressively to generate turnover, the market will enter an exaggeration phase. Prices will deflate, and only then will levels of consumption begin to regain lost ground. Confidence levels will increase only after a time lag, as will prices. Those buyers who do not operate on a long term cost-averaging basis will likely be caught out.

The same principle applies as much to other leather raw materials as it does to bovine leather. Though we have seen similarly large rises in the price of top quality hairsheepskins, the remainder has remained much more stable.

Right now, fashion appears to favour lambskin nappa leathers while goatskins also appear to be making good progress from their historical lows. So one may reasonably expect that these sectors will continue to be influenced by the normal ups and downs of the marketplace, as well as the production and fashion seasons.

The changes taking place in the split markets are equally interesting. Due to the sharp decline of US soakings, it would appear that less splits are now coming from that origin. Most of the shortfall is now being made up by the market they were in any case sent to – China. As stated previously, the total supply and demand equation has not changed – on the sourcing of the production. In view of the additional supply, the increased demand in China is even more astounding – as is the fact that splits neither gained significantly in value in the first quarter nor have they fallen dramatically in the past few month.

The outlook is equally positive for collagen splits and by-products. Soakings in the USA for lime split productions are reduced while the general avoidance of gelatine of bovine origins in Europe has also largely been forgotten. The seasonal winter demand for sausage casings from Eastern Europe is also increasing – a variable which should eliminate many of the sales and outlet problems that producers experienced in the summer. Though prices have yet to benefit, there is some hope that this by-product could once again figure in tanners’ calculations – possibly as early as the beginning of next year.

One area of interest for garment and garment leather producers is the present political and security situation in the Middle East. If the military unrest persists in the area, as seems likely, a lot of production could move elsewhere. Various companies are now looking to shift their procurement out of Pakistan and also India, and for many companies and their staff the region could become a 'no-fly zone'. China, Türkiye and Korea might benefit in the garment sector, while Brazil, China and Eastern bloc countries might also benefit from the resultant relocation of shoe production. Some production could return to Italy and Spain, where it would be greatly welcomed.

Talking about the general hide market and price movements of the recent past is very easy, as it can be seen that everything that has happened in the market in the last year has followed the classical spiral pattern. Some markets were frontrunners and those which resisted adjustment in the end had no option but to fall in line. It simply meant that the adjustment, when it arrived, was much more painful.

These issues apart, the final market also still needs to understand the situation and conditions that apply in the CIS and also some other Eastern bloc countries. In Russia, export duties continue to make hide exporters lives extremely difficult. Those unlucky enough to have bought hides at abattoirs during the summer at fixed prices are now facing huge losses. This is because against the backdrop of current market conditions, little will be left for the raw material after taxation.

Many have tried to circumvent the problem by producing wet blue, but this was of no help either. Prices are still miles above competitive markets and reports about the quality are not encouraging either. All in all, we are now reaching price levels close to the point where the last price rally in 1999 began. At these price levels, leather is fast becoming more competitive than many other materials.

Top quality hides may face a more difficult ride, however, mainly because of the large inventories of luxury products that have been built up, and which will consequently take longer to clear. The only quick fix could come from China and Russia, as the previous front runners of the US and Japan look destined to remain in the doldrums for some time to come – as does Europe.