Background

There were few major macroeconomic developments of major significance during the second half of May.

The currency market remained expectedly volatile while the weak US dollar had to be supported by the Japanese Yen. On Friday (May 31), however, the slide of the dollar was halted temporarily by better than expected economic results. This was against the background of the dollar losing up to 8% of its value in relation to the Euro and the Yen during the previous three-month period. If Friday’s events signal the beginning of an orderly retreat from this situation, it is to be hoped that it will be long lasting.

American consumers were still full of confidence and continued to do their job in supporting the international manufacturing base. A rise was also seen in the US Purchasing Managers Index, which climbed by almost seven points. Orders for durable goods meanwhile rose 1.2 % while anecdotal evidence from contacts in the US suggested that the prospects for import and export business are better than they have been for some time.

In contrast to the deteriorating situation in the Kashmir and the continuing conflict in the Middle East, the prospects for stability in Europe and Russia were given a major boost by the military and political treaties signed by the US President George Bush during his visit to the region. At the start of the World Cup in South Korea and Japan, meanwhile, hopes were raised that the tournament could provide the jump-start that the Japanese retail sector and wider economy needs to turn the corner.

The hide and skin market failed again to deliver any major surprises during the period, indicating that levels of supply and demand were in equilibrium.

Those imbalances that were in place, however, showed no signs of going away. This was especially the case in Europe where tanners relying on heavy male hides for their production continued to experience severe supply shortages – a situation exacerbated by the arrival of the spring public holiday season in continental Europe.

Almost all other hide types and origins exhibited only minor variations with small corrections being witnessed during the period.

The weakened US$ continued to disadvantage European hide producers exporting to Asia while some Japanese tanners and importers took the opportunity presented by the stronger Yen to ramp up their purchasing activity. In fact, reports were heard of attempts being made by tanners to buy now for August shipments - the preferred Japanese season.

Various sources from the US and Europe reported increased interest for dairy cows from Korea and China. Though little of this business has yet to be finalised, the reports at least gave some hope that there will be more interest in cows during the summer months - a situation that would not only fit well with our expectations but also coincide nicely with the summer production gap in Europe.

Despite its wider problems, India was reported to be showing renewed interest in fresh supplies with more letters of credit for hides bought in March/April being issued during the period.

As far as leather production was concerned, the general situation that has prevailed for the past months continued unaltered, with automotive leather production for the successful brand names remaining extremely buoyant. Furniture leather production in Europe started to slow in line with normal seasonal patterns while side leather production entered its downward seasonal cycle.

Conflicting information was received from the garment sector. While some sources talked of a Russian embargo on Chinese leather garments others reported the first orders of the season from Russia being placed with China. The raw material market will tell us quickly who is correct.

Having reviewed the various hide sectors, let us now take our customary look at other parts of the business.

The split market worldwide now appears to be completely sewn up.

Huge export sales from the US to various destinations and steady demand in Europe for local supplies conspired to create a situation where almost everything available has now been snapped up. Those who tried to keep out of the market also caved in, finally booking their needs.

And while moderate price increases were achieved, the fact that they were secured only on the back of the late covering of existing leather sales meant that it cannot be taken for granted that prices for finished split leathers will rise in sympathy. The continuing relocation of leather production to Asia meanwhile was reflected nicely in the reduced availability of splits in their historical centres of production of the US and Europe.

The lamb and sheep skin business meanwhile took its traditional pre-summer break and although good quality double face lamb production continued to be low, so too were levels of demand, with Turkish customers displaying particular price resistance. As a result, prices in the UK eased.

We gain the impression that the current competitive price of nappa skins will be rewarded with a corresponding rise in the demand for this type of material and its related finished leathers next season. We also expect that by mid-summer, interest in good quality sheepskins will be improved. For the moment however these types of skins remain difficult to shift.

In term of the wider marketplace, we predict that margins will continue to be squeezed and that raw material should become cheaper by 5% to 10%.

By any yardstick, we are in a classical situation for the time of year, with leather producers finalising their existing contracts while engaging in feverish activity to gauge what likely levels of customer demand – and therefore their prices – will be during the second half of the year. As we have mentioned in previous issues of Market Intelligence, the fact that retailers are unwilling to raise their prices means suppliers are constantly having to find new ways of compensating for raw material or production cost increases. Of the 15-30 % rise in raw material prices seen over the last season, at least half will need to be passed on in the price of the finished leather. It can not be assumed that further increases will be absorbed in the same way - either by the tanners or the leather goods/footwear producers. There are simply no more gains they can make in terms of improved productivity or reduced costs to make this a possibility.

Indeed, what we are hearing from all over is that the chance of increases of leather prices for the time being are very limited. Therefore, tanners can be expected to try to resolve the problem by developing new articles of similar quality, using less expensive and more mainstream raw materials. Since we are only at the beginning of negotiations and so far only very few- if any- decisions have been taken, no prediction about the success of this policy can be made. A big problem for any tanner - if not the biggest problem of all - is knowing what the starting point for next season will be.

Having said this - and remembering that many tanners do not operate at, or even near, a sufficient margin - one can easily see how tricky the situation is. In the final analysis, we have to consider two potential scenarios for the second half of the year, neither of which is particularly positive for the leather manufacturer.

That the world economy will continue to recover.

As a result, leather business will continue to be good and tanners will balance their need to fill production with sharply calculated prices. Continuing strong demand for raw material prices will keep average price levels high.

That the world economy will stagnate, or recovery will be slower than predicted.

In this case, demand for consumer goods worldwide will slow during the second half. Tanners will not secure enough leather orders or face problems in satisfying the orders they have. The only relief to the situation will be a consequent fall in raw material prices.

Though much less likely, there is a third scenario. And without trying to raise our readers’ expectations too highly, here it is:

That world consumer demand will rise and leather orders arrive in large volume.

World slaughter levels increase significantly during the second half of the year with concurrent moderately declining raw material prices. As a consequence, the pressure is kept off leather prices and tanners’ margins widen to very profitable levels.

Let’s hope the dream becomes a reality.  Whichever way it goes, you’ll here about it here first in Market Intelligence.