Research recently published suggested that the rundown of stocks by firms following the tragic September 11 attacks accounted for as much as 2% of GDP growth in the US in the fourth quarter of 2001.

The increased trading levels that we are currently seeing in the first quarter of 2002 are certainly encouraging, but the critical question remains: Is this merely the replenishment of stocks to pre-September 11 levels with companies assuming demand remains static, or are there expectations that demand will rise?

As yet there is no proof of increased demand, so in the same way as we were cautious in overplaying the slump at the end of last year, so we should be equally wary of becoming overcome by optimism as prices rise again as companies purchase more raw materials.

As far as demand-side data goes for the last two weeks, the figures are mixed. Retail sales in the US for January declined by 0.2% but rose by 1.2% if declining car sales were eliminated. According to the latest index, consumer confidence in the US fell (from 93 to 90.9) despite analysts expecting an increase.

Car sales in the EU declined in January by 1.1% compared with the same month in 2001. Steep increases were seen in the UK (9.3%) and Denmark (13.1%) while most other countries reported declines or unchanged levels. Retail sales for January in Europe declined quite significantly except in the UK.

However, most politicians and economists continue to be moderately optimistic about the world economy for the second half of 2002.

Under the present situation it might also be wise to analyse the foreign exchange markets (especially the firm US$). Various hide origins in the Euro-zone remain the most attractive in the world market despite the fact that the gap has narrowed in the past days. Anxiety in the foreign exchange markets about the rising trade deficit in the US should be followed carefully as exchange rate fluctuations have a strong influence on the trade. Concerns about the increasing disparity between the big economies (the US, Japan, Europe) are also threatening the valuations and trading ranges of their currencies - as has already been seen with the Yen.

So far, there is no clear market opinion about this economic trend, but there is a consensus that the different fundamentals at play in the world’s most powerful economies will result in major foreign exchange shifts over the next quarter or so.

Although most of the world’s leather production and manufacturing base (in Asia) spent the last two weeks on holiday, that did not protect the market from further tensions. Bovine raw material markets continued to climb with the US market taking the lead. European markets in general reacted only late in the day with a considerable time lag. At the beginning of the period prices were consistently firm - surprising in the US with their main buyers from Asia on holiday. A relatively low kill-rate in the US (with little prospect of improvement) was met with surprisingly high purchases from mainly Korean tanners who were buying hides even during their vacation.

The concern, mentioned in the last Market Intelligence, that the return of the public debate about BSE could affect the kill in Europe was borne out. The additional reduction in slaughter due to the carnival season in continental Europe certainly did not help either. All this resulted in isolated bottlenecks in supply that were even more pronounced by individual sellers reducing their offerings and supplies. In Europe price rises were isolated to automotive related hides, which were in short supply due to reduced slaughter rates.

Apart from the automotive leather tanners European markets were reported to be exceptionally quiet until a few days ago when demand suddenly increased from almost all markets.

In our opinion the trigger for this sudden increase in demand is less related to substantially increased leather orders than mounting news of lower kills in many parts of the world. There are rumours of a strongly reduced kill in Brazil with prices responding in a way that mirrors the US and Europe, while there has also been an extension of the seasonal period of low (or non-existent) slaughter in Australia.

The sheepskin business was exceptionally good for premium quality nappa. Tanners from Solofra, known as the main centre for top quality production, were reported to have bought aggressively from premium origins such as South Africa. Turkish tanneries were in desperate search of lightweight double-face material, already attempting to secure new season lambs in Europe even though the slaughter has not yet started.

It can now be taken for granted that the positive outlook previously given for good quality garment nappa leathers as well as top quality doubleface garments for the coming season is confirmed.

Split business continued on a steady basis with South American suppliers asking for higher prices and European levels remaining stable in most cases. European producers of lime splits still complain of the unresolved problem of disposal of by-products (shoulders and bellies). This problem could even worsen if improved business in hides eventually results in higher soakings in the months to come.

Can we now say that there have been significant shifts in the market? Regular readers of Market Intelligence will remember that we focussed for quite a while on the question of when and by how much demand for leather and leather products will increase. Once again the market has taught us a lesson and the answer came from the opposite angle - supply. The firmer market trends and disturbances in the demand/supply equilibrium we have seen were not demand related but actually influenced by issues of supply.

Long-term security for tanners in terms of raw material supply has been scuppered by a reduced kill rate. Even tanneries that do not yet have the long expected leather orders have had to take the decision to cover their raw material needs if they do not want to be caught out and confronted with prices that preclude competitive price calculations.

Having said this, we have already admitted we have yet to see evidence of improved leather orders, or even better leather prices. On the contrary, we hear of low levels of production in tanning centres such as Tuscany and parts of Spain. Also the Asian bovine leather garment business is still in the doldrums and some European furniture makers are said not to be in top gear despite this being their high season.

What kind of market scenario can we expect in the near future? With the benefit of a clearer picture following the oriental holidays one can be quite safe in predicting further raw material price increases. Certainly for the near future. There are various arguments for this assumption: Not only are short-term expectations for the kill not good, we should expect an increase in leather orders over the coming weeks. Some leather purchasers will doubtless guess the reaction in raw material markets and try to secure their business before that happens. It is important not to overlook the fact that some members of the leather trade have a vested interest in rising raw material levels. With a tighter supply situation their intentions are likely to materialise. The end result is that those who haven’t taken care of their raw material procurement in time might find themselves having a hard time over the weeks ahead.

After the price rises we have seen in hides predominantly used in automotive leather and Asian side leather production, the next movement could come from the garment leather industry. Assuming that the industry’s interest in high quality garment leathers spills over into mass production, tanners in Korean and China should also benefit from some better business, despite the present pessimism. This could push lighter weight dairy cows, which in many cases are still at the lower end of their classical trading range, back to normal levels. For other categories of hide we expect the valuation gap between the different origins and types to close further (see the last edition of Market Intelligence). Rising raw material prices and shrinking margins normally force everyone to deal intensively with all options and not only the preferred ones.

Looking further ahead - and that’s what we try our best to do - we are a bit concerned that the leather business could be entering another rollercoaster ride. The current squeeze in supply could spur a very rapid upswing in asking prices which needs to be matched by increase in consumer demand or leather prices if it is not to end up in a cul-de-sac.

Considering the global economic situation with overcapacity in production and manufacturing it requires a good degree of courage and optimism to expect this. If retail sales or price competition mean that leather and leather product prices fail to rise adequately, we could see raw material prices go over the edge again in the medium-term, falling somewhere in the second quarter.

In this respect, however, it should be noted that the market is effectively split between businesses that work to "just-in-time" and those on long-term contracts. In the former case price reactions are almost instant as there is no supply buffer, while in the latter contract positions often have to be renegotiated to cope with changes in the market.

In conclusion these are not easy times for those involved in the leather pipeline. A delicate touch is essential, as businesses are likely to find that long-term decision-making is compromised by external factors that force unintentional, and sometimes unwanted, reactions.