It seems that the world's economists have finally got it together and decided to agree about something: Yes, we are in a recession - but by the second half of 2002 everything should improve again. So, apart from the fact that it took the majority more than six months to come out with a coherent prediction, the time-scale has also been extended to give them a greater chance of accuracy - yet more proof that you need to be extremely intelligent to be an economist.

In the meantime, the economic data being released once again appears to be conflicting. While unemployment continues to rise in the larger economies (Germany, US, UK), consumer spending in those same countries remains surprisingly high. The US Federal Reserve's Mr Greenspan lowered interest rates again (good) but at the same time gave a pretty grim economic outlook for the country (bad).

So it seems we cannot use the old rule that rising unemployment and the threat of more job losses will lead to a significant reduction in consumer spending. Reasons for this could be that consumer spending is being boosted in advance introduction of the Euro notes and coins on January 1, 2002, while tax cuts in the US and falling energy prices mean an improvement in family budgets.

What about the leather pipeline? A general scan of the bovine market finds more price adjustments between various origins and the logical continuation of what has been a narrowing of price spreads. This mainly relates to those markets that were overvalued, and is confirmed by the sharp fall in the US market and the decline of the Zurich auction last week. And other than driving buyers away, attempts to close the price gap from the bottom end of the range have had little effect.

Having said that, sales were possible if prices were acceptable for tanners' calculations. Many are now willing to secure raw materials and are not betting on the hope of further declines, while the courage to reject price rises confirms the fact that tanners are not fearful about supplies over the short term. In other words, security considerations have been superseded by profits.

In general, trading activity has been at a reasonable level over the past two weeks, but taking a closer look at the supply chain, it becomes apparent that purchasing activity was focussed on specific lines. If one were in the position to trace interest or buying activity over the past few weeks, one would see that it was always related to successful supply chains predominantly involving European members at present. This is either driven by a finished product that is selling well (i.e. quality shoe brands or furniture), confidence in the raw material price development (sole leather) or industry related production outlooks (the automotive industry). These considerations are nearly always detectable in purchasing decisions.

Thus we can see broad-based aggregate demand has not occurred, instead activity is seen from the following sources:

1. Those tanners involved with successful supply chains and finished products that are selling well.
2. Those less involved with fashion and looking to the long-term (i.e. sole leather) that are starting to replenish inventories for long-term price reasons
3. After successfully reducing their inventories over the past few months, just-in-time type companies are replenishing stocks to normal or even higher levels

One market segment is notable by its absence from the above analysis: leather apparel. This sector is entirely off-season and therefore inactive, without the inclination or the means to take raw material positions at the moment. High fashion remains quite leather oriented for the 2002/2003 season and those with the right designs and customers are expecting an active ordering period starting from the New Year, and display a lot of optimism. With regard to the commodity end of the business, we will have to wait and see how the large retailers worldwide are going to act next year, since they dominate this part of the market almost exclusively. Generally speaking, they normally can't resist the direction shown by high fashion.

This situation was also reflected in that part of the skin market involved in leather garment production. The main tanning centres for leather apparel outside the Far East are also influenced by the holiday season, Ramadan and/or Christmas - further reducing activity. At the same time, many seem to be optimistic about the coming months for the reasons stated earlier.

Considering the fact that we should expect a further decline in the worldwide supply of sheepskins (foot and mouth in the UK, herd reductions in Australia etc.) skins seem to be trading at reasonable prices in most cases in neutral price territory. Split trading again appears quite normal with no more exceptional moves.

The positive view taken in an earlier report about collagen-related products seemed to be incorrect. The understanding from major producers is that demand for these by-products has not increased and consequently simply disposing of these products remains difficult - let alone talk of price rises. The reason why demand has not picked up in areas such as the Eastern bloc is unclear - the strongest possibility being that operators in this area are being prudent with inventory planning.

To sum it all up: 2001 is ending with raw material price levels which at the beginning of the year few would have dreamt of. Raw materials are at or near normal supply in all sectors with the exception of sheepskins. All the other supply hiccups were only temporary and raw material supply is no longer the main problem for the tanning industry.

The leather business over the year has probably been far better and more stable than many of those in the market would have us believe. The turmoil witnessed throughout the year was more down to questions of security or emotional decisions than rational facts. Decisions in the first part of the year were more supply related while the second half were more demand-oriented but neither were really tied in to the real situation. So the pendulum swung both ways but is now calming down with the oscillations reducing. Raw material prices now mostly reflect the equivalent leather price which allows businesses to return to profitability. Many of the blockages in the supply pipeline have dissolved and so nearly all the market tensions have been brought back to a balanced situation.

Not often has the end of the calendar year - in many cases also the end of the financial year - brought such a sense of equilibrium and market tranquillity. Even more poignant after all that has happened in the leather trade during 2001. The New Year is always a good moment for a new start and is also the ideal time to try and look to the coming year.

However, we don't want to fall into the trap of offering forecasts for the next 12 months. History has taught us that peering into the crystal ball for long-term answers is foolish. The raw material trade in general is too difficult for researchers and analysts to unravel it, and this of course applies to hides, skins and leather.

It is important to emphasise that in Market Intelligence the aim is to offer ideas and start debates that are open for interpretation by others. We hope that it can provide a useful guide in the current overload of information and help to avoid the confusion of the day-to-day and look more objectively at the true picture.

In order to do this we need to work out some basic assumptions for the leather business, several of which will inevitably be controversial:

• Hide prices are currently at absolutely fair value levels
• Raw material prices and finished leather prices have no short term correlation and if there is a measurable relationship, it is unproven
• Raw material and leather prices should always be valued in US$ for easy comparison.
• Global total raw material supply will not change significantly in the years to come. Local or grade fluctuations can be ignored if producers are flexible enough.
• For the vast majority of those involved in the leather pipeline, the customer fixes the price not the seller (with one exception - the butcher). Change is unlikely here until the problem of overcapacity in global manufacturing is solved.
• Manufacturing overcapacity inflates raw material prices (subject to physical supply limits) and deflates finished product prices.
• Raw material procurement can never be adapted to the leather or leather product contract volumes. So a back to back coverage can not be achieved.

There might be many more but in the above list we hope to have chosen some of the most important ones. After such a list of assumptions one might expect a list of solutions. Unfortunately, this goes beyond the scope of this edition of Market Intelligence.

Considering that the raw material market over the years has always fluctuated by +/- 20% and sometimes even more, the general thoughts given above can only hope to offer some kind of support to navigate the ups and downs while limiting the danger of surprise. They may also help to explain why the joy of a great deal one day is only a very small part of the whole.

This edition of Market Intelligence will finish by leaving theory behind and giving a practical example of how a manager who deals with raw materials recently outlined to us his strategy for 2002. He is not part of the leather industry, but offers an insight into how the problem of commodity purchasing can be managed by a business over time. It should be added that his work is not subject to interference by the company owner or an external audit.

An excerpt from a presentation of the company strategy follows:

"We are currently operating at good margins. Our raw material costs account for between 30-60% of total costs. Prices for our raw materials have fluctuated by 36% on average each year over the last five years. Prices are currently 20% above their five-year low and 47% below the peak. The possibility of covering ourselves with future options is not available.

Through benchmarking we have found that we are cost effective if we run at a minimum of 92% capacity and this year's target is to increase productivity and cut costs by 4%. We think this is realistic.

At present prices we have orders for five weeks of production and our sales department is confident of securing sales for a minimum of 6-8 production weeks at similar prices soon. Consequently, if I can cover all my raw material supply today for the next 3 months I can lock in the profit for the next quarter.

Using the extremes of the past five years as a guide I have market opportunity of 20% against a risk of 47%. We have good financing facilities and it seems that in the first quarter 2002 we will hit the bottom of the interest cycle. Consequently my stock financing costs are negligible vs. the price fluctuation of the raw material (5% interest per annum against 36% average price movement).

So, my present and next quarter policy is firstly to cover all my needs for existing and planned orders. That is easy because I can rely on my reliable and existing suppliers who guarantee this. In addition I will buy anything at prices which are below today's market level from non-regular suppliers. This protects me and my regular suppliers from the risk of short-term price increases. While I do not know which way the market is moving, each percentage point lower reduces my risk of overpaying from 20%. This at almost no cost since my financing costs and storage costs amount to less than 2% for the quarter."

Sound familiar to the leather business, or not? While the extract does not include the entire presentation, the model would seem to offer some pointers for those involved in the business of buying commodities:

• Take advantage of relatively stable prices and low financing
• Manage the situation by locking profits in
• Look to solve the short-term supply situation first
• Analyse in manageable periods such as one month or one quarter
• Avoid speculation on long-term prices that could expose the company to unacceptable risk

The peculiarities of the leather industry and its raw material supply mean that the relationship between demand and supply is indirect. There is limited physical supply and no futures market. However, some still manage to apply the system outlined above. A future Market Intelligence report will analyse other strategies and costings.

We would like to take this opportunity to wish all our readers best wishes for the holiday season and a healthy and successful New Year. Let us hope that next year will offer us fewer tragedies and epidemics and a strong demand for leather products combined with abundant availability of raw materials. The present picture does at least promise a better prospect than a year ago.