Macroeconomics

The most important happening during the period under review (February 24 – March 10) was in our view the 3% decline seen in the dollar against the euro.

This latest fall means the dollar is now worth 20% less in relation to the euro than it was a year ago and 14% less than just three months ago. The greenback has also fallen 8 % against the yen, and even against currencies such as the Australian dollar (-13.5 %) and Brazilian real  (-12 %).

The Asian currencies did not generally fluctuate by more than 5 % in relation to the dollar.  This was largely due to the Hong Kong and Chinese currencies being pegged to the dollar and others such as the Thai Baht and Korean Won being more flexibly tied to the dollar.  This may also explain why their economies have fared so well recently.

The only currencies to have gained significantly in recent months have been the South African rand (+ 35 %) and the Argentine peso (+70 %), but if only because of the severity of the situations they were previously in.

Pound sterling also nosedived against the euro which means the former ‘sick patient’ of the international currency scene of a year ago is now looking a serious contender and a safe haven for the global investors. This is in spite of the continuing bleak outlook of the economies that make up the euro zone.  Although the Europeans complained about the weakness of their currency when it was introduced at a rate of 1.17 versus the dollar, it has arguably turned out to be the saviour of their export-oriented economies.

The economic news was no better on other fronts.  In the US, for instance, the closely watched Conference Board consumer confidence index for February 2003 slumped 15 points to 64 points, its lowest level since October 1993. Germany reported record unemployment levels and there appears little prospect for major reform.  The country is now waiting for next week’s speech by chancellor Schröder in parliament to see what the short to medium term holds for Europe’s largest economy. The bad news was compounded meanwhile by France’s declaration that it had so far in 2003 failed to hold to the strict Maastrich budget criteria.  In the UK, support for Mr Blair’s Iraq policy appears to be losing ground among both his ministers and the public, something which must certainly make his running of the country far from easy. Indeed, though strong now, the UK economy is showing every sign of slowing down. 

Market Intelligence

The market continues to be dominated by the global economic situation and the build up to war in Iraq – the ‘global economic situation’ being essentially the currency issues already discussed as well as the uncertain outlook for consumer spending in the US and Western Europe.  During the last two weeks most of the world’s hide and skin markets remained under a certain price pressure.  This was less related to actual demand than people’s fears for the future.  The slackening seen in hide prices primarily benefited the big companies which continued to run their businesses as usual.

Average hide prices eased within a narrow range of 2-4 % - depending on the market and grade - and without any significant decline in demand being seen. A clear sign of this weakness, as well as mounting concerns about the luxury markets, was seen in the 10% correction that occurred at last week’s Zurich auction. This was unsurprising given the prices of the high quality and preferred origins that are so characteristic of the auction.

What was a surprise, however, was that the luxury brands had allowed the bid prices to fall to such an extent in the first place.  Normally, one or other would have stepped in to prevent their precious supplies from falling into the hands of those lower down the pecking order.  The fact that they didn’t suggests to us that that the same deflationary forces that have been at work lower down in the market are now being felt at the top end.  This further reflected by the fact that many premium buyers are refusing to meet sellers at the moment.

But for us, the decline does not signal start of a wider market fluctuation, but rather a manifestation of higher priced material falling into line with the wider market.  Indeed, most of the declines seen in the market in recent times have in our view been corrections and adjustments in sympathy with the global economical outlook - including the Iraq situation - rather than the internal workings of the industry. It would appear that, given the present circumstances, sellers would prefer to have their order books reasonably well filled so as to secure their cash flows.  Tanners and manufacturers meanwhile are taking the opportunity to reduce their purchasing levels.

So, who is benefiting from the current situation?  Certainly, all those who operate value-added productions which include either cutting and sewing, or even the manufacture of the finished product. As we all know, the further along the chain you proceed, the less elastic prices become and the more one is able to benefit from reductions in the price of components and it is here we come to a very important point in our evaluation of the current situation.

Regular readers of our news section will have noticed recently that it is the time of the year when company results are published. Despite the world crisis, the difficult retail environment and all the complaints we have heard, many companies related to leather and leather products are publishing positive if not – under the present conditions – very positive results. HTL, Puma, adidas, Reebok, Ecco, Pittards and the Schaffer Group are just some which fall into this category. And it is not just the big names either, as during our regular talks with the industry, others which do not publish their results have also reported a good 2002. Significantly, however, most of these  have been either global automotive related brands or niche players. Most of the remainder of the industry found the year 2002 in general much harder and less profitable.

Several factors explain this, namely;

·         The average price of hides in 2002 was higher than in the first quarter of 2003.

·         Global players tend to be far less susceptible to the effects of currency fluctuations and are better positioned to take advantage of lower cost areas of operation.

·         Added value chains and retailers tend to suffer significantly less from raw material fluctuations, but can take the full advantage of any price reductions that might occur.

Against this backdrop, one can see why things must be so difficult for the mainstream industry.

When one stops to consider that in the previous edition of MI we reported that most of the large conglomerates were anticipating further strong growth it 2003 it becomes even more apparent that in the competition stakes for raw materials, the individual local players will have an ever harder time. At the very least, they will need to think creatively if they are to defend their positions successfully.

But does this mean that raw materials prices can be expected to rise?  Not necessarily, as the past teaches us that all prices are relative to the outside world and that they are sometimes more influenced by currency fluctuations, rather than issues of supply and demand.

As has been clearly demonstrated in the ever changing relationship between bovine hides and the garment industry, fashion can make or break leather in the use of products. The functionality of competing materials has also caused a massive decline in the use of leather in traditional outdoor garments. At least this has made hides and leather available to meet rising demand from other segments without pushing prices too much.  As we have also seen in the short term market reaction during the European BSE and Foot and mouth disease epidemics, supply can also be  major factor.

Is there anything that could change the demand side in the near future? Many say it could be the war. But the biggest threat for the moment as far as we can see is the price of oil. More than anything else, it is this which cuts family budgets, increases production costs and consequently drives up end product prices.

But we don’t see the rising prices we are currently faced with becoming a trend. Every oil crisis in history has been short lived and we don’t see this as being any different.   However, the longer it takes for prices to cool down again, the more it will harm consumer spending in the meantime.  And it will affect everyone, regardless of where they live and how well other aspects of the economy might be performing.

What else has happened in the past few weeks? Split prices remained steady to firm for the most part, except for lower substance double butts and ex-lime split hides. Also here however we have to consider the currency effects. Prices may be rising in dollar terms, but once converted and compared with other currencies they are at best steady and prices in for example the euro are even tending toward decline.

As problematic as the situation was six month ago, demand for split by-products from the gelatine industry would appear to have stabilised.  So that at least this part of the split business in Europe is not burdening production.

The European sheep and lambskin business continues to recover, albeit slowly. Interest in lower priced nappa skins continues to be good, though the same cannot be said for higher priced materials, which is obviously bad news for premium tanning centres such as Italy’s Solofra. Double face tanners are desperately waiting for New Season lambs as the cold and long winter in most parts has resulted in skins coming in late and/or slow. As far as we are concerned, ideas for prices have yet to be established, let alone when the trade is going to start the season. At least the interest from tanners for the New Season continues to be good and shows no sign of slackening.

We are getting more and more reports of shipping companies trying to increase their rates from Europe to the Orient, citing rising fuel costs and the war - the average price rise being in the region of $200 to $300 per 20’ container. This may well be the case, meaning exporters will have to factor in these extra costs to their calculations for next six to eight weeks or so. However, we do not expect the situation to last, given the effect the declining dollar is likely to have on European imports, and the expected return to normality by oil prices.

What can we now expect from the coming weeks. Everything leads us believe that the green light will be given to military action in Iraq next week.  Whenever it arrives, we do not believe war will have too much of a short term impact on the market. The medium and long term effects we have already discussed above. For the moment, hide sales and demand seem to be quite strong despite the situation in the Middle East.

The next weeks will finally show how the retailers are going to replenish their inventories and how well the pipeline has been filled in preparation for this. We still think the market remains in fair balance and that as a consequence, prices will not break out of their present trading range. We would however not bet on significant declines and not at all be surprised if demand increased further.

With the continuing downward pressure on finished product prices, weak stock markets, rising energy costs and the stranglehold that the major buyers current have on the pipeline, we believe it is still too early to start talking about a return to rising prices.  At least not within the next two weeks.

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