The period under review (September 21 – October 1) was full of surprises. Unfortunately, most of these were of the unwelcome kind that served to underline just how fragile the world economy is at present.

In France, the consumer confidence index fell from 17 to –19 points (that’s minus 19) while the Chicago purchasing manager’s index tumbled nearly seven points to 48.1. The German IFO index meanwhile was down six points to 88.2 and the OECD economic indicator fell for the fifth consecutive month by 0.1 of a point to 116.2. For the USA, the OECD reported a decline of 0.5 and for Euroland, 0.3.

Stock markets endured one of their worst quarters of the past 50 years. The German DAX was off by a phenomenal 40% while the Dow Jones index bumped to one of its lowest points of the past 5 years.

There were positive indicators for those prepared to find them. The US unemployment rate fell 0.1% to 5.6% while the country’s service index also climbed slightly. But only the greatest of optimists would construe this as a meaningful sign of recovery.

With a war with Iraq now looking inevitable, oil prices have become higher than we have been used to in recent times, stabilising at around $30 per barrel. The dock strike at the West Coast ports also interrupted the flow of raw materials and consumer goods in and out of the US.

Despite the impressive growth rate of the country during the first half of the year, more and more reports are warning about China’s future due to rising unemployment, the return of deflationary pressure and bad loans which could endanger the country’s banking system.

So the worldwide economic recovery that had been forecast for the previous year would appear to have come to nothing. Indeed, the talk now is of another mild recession this winter - at least in Europe.

At least the currency markets remained stable, with almost no major changes between the leading currencies.

We find it extremely difficult this time to find a start for Market Intelligence (MI). The outlook for the world economy is so bleak that it is difficult to arrive at a rational forecast for the leather pipeline.

But start we must, with our usual review of the raw material markets. In general, the outlook we gave in the last issue of the MI would appear to have been quite accurate.

Premium quality hides and skins easily held their price levels as producers and sellers remained well sold forward. Manufacturers of leather and leather products in the superior quality line also had no complaints about their order position, and this little niche in the market has yet to show any weakness.

The well heeled would appear to enjoy spending on ‘value for money’ luxury items more than ever, as well as on the most expensive products. We would even say that style is beating fashion at the moment. All top quality origins including calfskins remain in relatively limited supply but meeting steady demand. The most noticeable thing is that the downward pressure that has been seen in most other consumer markets does not yet appear to have impacted on that for high end luxury goods.

This is illustrated by the premium prices paid in recent weeks by high quality vegetable tanners for their preferred raw material (i.e. French bull hides). The manufacturers of premium quality automotive leathers are still enjoying very good demand from - in particular - the German manufacturers. The ‘big four’ (VW/Audi, BMW, Mercedes Benz and Porsche) have all grown their exports substantially, increasing their sales in the USA by high double-digit figures during August and September.

The average quality hides that are mainly used for volume productions saw marginal price erosions, reflecting the mounting downward price pressure in the leather pipeline. We would assume that the prices officially quoted - and which had already declined from their high points seen prior to the Shanghai fair by a couple of % - are presently being further reduced by some sellers by another few percent - but without being officially reported. We received this impression in conversations that we have recently had with leading producers and sellers.

There is a great deal of sense attached to them wanting to keep things quiet, since more and more businesses are concentrating on building partnerships with fewer but bigger customers, as part of an extended chain of supply. It is obviously not in the best interests of either the hide supplier or the tanner if the lower prices they have negotiated between themselves find their way out into the wider marketplace. This is because they would only serve to depress background prices still further.

This is something we have anticipated since we started the publication of Market Intelligence (MI). These big manufacturers, producers and retailers still enjoy good demand and are constantly growing their market share. In view of their interdependence, they have very little interest in making falling raw material prices public, as long as their suppliers are willing to grant them a discount on official price lists. Though the official price list might stipulate a 2% to 3% discount on large quantities, we suspect the real figure is in the region of 5-7 %.

The results are twofold. Not only is the market is at least temporarily protected against a steep fall in prices, but it is also giving the big and strong players the price advantage they claim for their size and importance.

The other side of the coin that for those smaller organisations not lucky enough to be part of this exclusive club, business is being doubly squeezed by higher purchasing prices and less market potential – a situation that could possibly lead to even higher production costs.

So much for the middle of the market. The low and economical price end meanwhile saw a relatively stable price period, with the shift in demand to lower priced hides failing to spark price rises, such has been the low levels of interest shown in this market.

Let us now take quick look into the world’s regions of leather production. The premium quality producers in Northern Europe would appear to be enjoying continued good demand - particularly in relation to the automotive market. In Southern Europe and the Mediterranean, the situation is, in our view, pretty much divided. While in countries like Spain and Italy few and larger groups and maybe also some split tanners are holding good orders, we are continuing to hear no good news back from medium sized average tanneries.

Furniture tanners complain about lack of orders and are in particular being beaten by the weak retail markets in continental Europe. Many have spoken about order reductions in the order of 20% - 40 % during September. Although traditionally the furniture business begins to pick up in October, these declines are much to steep to be ignored.

Shoe tanners in Italy and Spain competing in the mid and low price range are facing similarly tough times. Indeed, in our view the situation is much more serious here. This is because it is not only being caused by the weak retail environment, but also the massive ongoing shift of production to India, China and Eastern Europe. It remains a mystery how tanners who are facing such situation will manage their future without having a clear vision – and one that must be implemented soon.

In Asia, some of the optimism is starting to fade. Many still speak of good order books and a ‘need to buy’ situation – at least as far as business that is related to established and strong supply chains is concerned. A particular worry in relation to China however, is the increasing talk of deflation due to overcapacity and insufficient product quality. This may well lend itself to high levels of production but it is also leading to increased inventories due to insufficient product quality.

The issue of overcapacity is certainly something that must be watched closely. All in all, the shoe business seems to be reasonably intact. What we need to watch carefully are the garment and furniture sectors as these are much more vulnerable to the slowdown in global demand for consumer products. This could lead to a deflationary situation and a production bubble. It is very hard to make a safe judgement on the situation because one can easily keep track of what is happening with the top producers. However, the massive number of the smaller and medium sized enterprises spread around Asia can never be consolidated in reliable numbers.

In South America - and in particular Argentina - the leather pipeline is burdened by a catastrophic economic situation. Poverty is on the rise and as a result, the consumption of beef is declining. So too is the kill and the availability of raw material. The weak currencies are at the same time increasing the competitiveness of their producers. So can some of the supply problems in this part of the world be compensated by raw material imports? With most finished products being re-exported they are able to obtain enough foreign currency on their import invoices and thrive on their low production costs in local currenies. However everybody knows that this is only a temporary advantage in countries of devaluating currencies.

The split market continues to be tightly supplied and prices remain relatively strong. But prices are rising only moderately here because in most instances, split leather is used as a cheaper substitute for grain leather. Split tanners are also not in the position to benefit from rising finished product prices. What we have seen now is again a classical cycle. Grain is running ahead and split follows.

In the sheep and lamb skin markets we saw a very peculiar situation prevail. While economical nappa skins were either very well sold or at least still in steady demand, we saw an abrupt end to the enthusiasm for double face. Turkish tanners, who are the main players in this market, abruptly stopped their buying activity and have yet to re-start. With many of the Turkish sales people for finished products travelling in Russia, it seems that their trips have not been very successful. The new Russian tax regulations for imports which hinder the suitcase trade and ‘trading tourism’ can be assumed to have had another negative impact.

So what do we make of the present situation? Our regular readers will know that for quite some time, we have been extremely cautious in our outlook, based on the mounting problems previously described. The market is being continuously driven from the supply side. Virtually only North America is maintaining a high level cattle slaughter while in most other areas with the possible exception of Brazil, the numbers have been at best steady, but in many cases lower. We have only one segment in world leather production that is constantly rising and that is automotive leather.

The European car manufacturers are enjoying very good demand and increasing their global market share. Car sales in the main markets may not reach record levels in 2002, but they will still be high. The expansion of car production in Asia (Thailand, China) is increasing demand for this type of leather as well. The Paris Auto Show saw most manufacturers optimistic about the coming season. The model year 2003 is expecting more than 100 new models and types and many of them are the upmarket marques – the majority equipped with leather. How quickly these cars find a buyer in the first year is of limited interest because the initial round of production is already planned and programmed. So, for the coming 3-6 months it is impossible to expect any decline in automotive leather production and the increase in the global market share of leather production will most likely continue on its upward curve.

Looking at the data from retailers and the outlook for the coming months, shoe leather production can best be described as steady. Optimistic forecasts are meanwhile limited as we enter the furniture retail season while the consensus in the garment sector is that the season is already over and nothing better can be expected until next year.

What does this now all mean? We believe that under the current world situation of limited supplies and stable demand, prices will continue to trade 5-10 % either side of present levels. Price pressure from retailers, deflation and a negative outlook for retail businesses should keep raw material prices fairly well under control. Rising production costs including the high average price for oil should also exert a downward pressure on prices, so that the high end of the possible price range is for us at present not an option. Rather, we envisage that the full range on the downside (i.e. –5%) might well come to pass. Certainly, the correction that we expected at the end of August beginning September is now in process.

Should anything drastic happen, we would see this weighing on the downside of prices rather than on the up. It would be a fool who ignores the destruction of wealth by the falling stock prices as well the problems that will likely arise from military action in the Middle East. We don’t need to explain the consequences of further rising energy costs and the insecurity which could spread easily from the Middle East over to the world.

In the very short term, the dock strike in the USA could also severely interrupt the product flow in the leather pipeline and damage the system for some time.

Let’s hope that all the pessimism is unjustified and we enter into a very strong Christmas sales period what will clean up inventories, keep production running and the product in leather pipeline flowing.

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