Macroeconomics

The global economy showed further signs of consolidation during the period under review (June 16-30) The stock markets showed gains too, recovering from their previous lows by 10-30 %.

The Fed cut interest rates again, this time by 0.25 %, bringing interest rates in the USA to their lowest levels for the past 50 years. Consumer confidence both in the US and  Germany also showed distinct signs of improvement.

After a seemingly endless period of bad news, the closely-watched German Research Institute (GfK) consumer confidence index rose two points to 4.0, leading some to dare to believe this could be the turnaround for private consumption in the country.  The US consumer confidence index declined by just a fraction from 83.6 in May to 83.5 in June.

A great surprise was the sharp increase seen in the sale of new homes in the USA. Sales went up by a whopping 12.5 % and seem to have benefited from the low interest sales.

The dollar also recovered pretty well from its temporary lows and is today 4 % higher vs. the € than a week ago.

Market Intelligence

The last two weeks have extremely exciting. Our previous edition of Market Intelligence had just been published when our repeated advice to our readers to think in terms of cycles rather than in market fluctuations was once again underlined.

In the USA, a sharp recovery in the hide market took place creating a classical bear trap. This saw traders attempting to cover their short term requirements as tanners tried to replenish their stocks at the attractive levels established. As these entered the market, they met sellers (packers) who had been quietly building a much better sales position than many had anticipated.

The consequence was that sellers were no longer tempted to accept bids lower than - or at - market levels. Prices rose daily in line with the sellers’ rising asking levels. Some suppliers even decided to refrain from making offerings. So prices went up 5-10 % in less then two weeks.  This was less the result of a general change in the supply/demand situation than the outcome of a market that had previously been run more on speculation and emotions rather than analysis of the hard facts.

As a result, the total need for raw material was not as poor as many believed while the price decline had more to do with cautious disposition of the trade due to the gloomy economic outlook (see previous edition of MI).

In North America, the impressive kill figures that have held sway in the US since mid May had to be balanced with the reduced numbers in Canada, so that the total availability from the continent was not much changed.

Europe was affected very little by the excitement in the hide market of America. Only some interest in dairy cows made its way across the Atlantic as regular sellers continued to report decent interest for this type of material. The rising dollar and support from the US market enabled prices to take off from their lows seen at the beginning of the period.

The situation in Europe itself remained quite depressed. Italian tanners did nothing to  help the situation by reducing their bids by the day. This prompted a response from nervous sellers in particular from the UK and Ireland, but at the end it was clear they had exaggerated and sellers finally refrained from accepting bids. This left those tanners that had still to cover small production holes in July to pay the asking levels for small volumes.

But then, buyers could be forgiven for making the very low bids for raw material that characterised the period.  The leather business in Europe and in particular for the traditional furniture tanners in Italy can best be described as disastrous. The substantial decline and constant lack of orders continues, and this is before we have reached the low season in consumer demand.  And this is outside the continuing structural shift in production to Asia.  Against this backdrop it is perhaps understandable why bidding has reached such a low point.

A not much better situation prevails in the rest of Europe, except maybe for some niche producers and tanners serving the automotive industry. These enterprises benefit from more regular customer demand but are still suffering from the price erosions for the finished product seen elsewhere

This, together with the fact that we are now just entering the holiday season, meant European prices failed to mirror the rebound seen elsewhere.

Not that the prospects for the coming weeks are much more positive. The very critical part of the equation is the continuing low kill in Europe. This will make price negotiations with the abattoirs in the coming months extremely difficult, especially as the low offers that are likely to be made will face massive resistance from the slaughter houses.

A frequently discussed related topic is whether or not the extremely low beef production in the first half of the year in Europe will be compensated by substantially higher kills in the second half.  The logic of production cycles points to this and indeed one can dare to predict significantly higher production for the months starting with September. But one should not fix one’s expectations too high as Europe is facing at present a big problem with one of its largest export markets, i.e. Russia. Import restrictions on EU beef and much more attractive price levels from South America have kept EU exports to Russia at a minimum. It will require strong political effort and most likely again subsidies to increase beef sales and consequently slaughter numbers. But European supply in the second half can still be expected to be substantially higher in the second half

The split market remained in its moderately undersupplied state, though here demand was  influenced by the upcoming summer holidays, as well as the low prices of hides. So prices did not increase any further while various customers pretended that they had been able to buy with smaller discounts. The good news in view of the low supply is that  the traditional huge summer stocks of collagen products seem to have been avoided. Gelatine and collagen producers continue to secure supplies and most of the summer production will likely be placed throughout the holiday season.

The lamb and sheep skin market continued to enjoy steady demand. The supply of good quality double face lambs from Europe is falling behind demand, with the result that customers predominantly from Turkey and China are clamouring to secure what they can, from whatever source. The strengthening of the dollar also helped in many sellers’ calculations, as most of the finished product is headed  for Russia, where invoices are made out in the US currency. Prices remained steady or advanced slightly. Top quality materials from Spain and Italy have in the meantime already returned to the almost record price levels seen previously.

What can we expect in the coming two weeks? We do not believe that the present rally in the American raw material market is more than a natural reaction to the downward speculation previously seen. As regular readers know, we have never been as pessimistic as the raw materials market in assessing the supply and demand situation, and the events of the past two weeks were in line with our expectations. However, although levels of  raw material supply and demand are getting back to a more orderly situation, it is too early to tell yet whether a constant recovery of raw material prices has set in. Global deflation and the uncertain macroeconomic outlook still justify a cautious forecast for the months to October. But without doubt, things look more promising today than we dared hope three months ago. The fundamentals have improved. So there is a fair reason for hope.

But we should also not overlook the influence of the bleaker parts of the market. In particular we would mention global furniture sales which we consider to be one of the least promising businesses unless markets such as Russia and China are going to compensate for the sales slump seen in the US and Europe. Whether or not the steady but slowing growth in the use of leather in the car industry will also compensate has also to be seen in the coming periods.

Another big question mark hangs over whether the attempts of the Western markets to stimulate consumer demand by tax and interest rate cuts will be successful.  Knowing that consumer perceptions and reality are two different things, these actions taken might not be the solution. In America the consumer is overspent and lower interest rates may help as well as the tax cuts, but clearly this does not resolve the problem of the imbalance between long term disposable incomes and the need for increased spending. One should not forget that more than 50 % of the US economy is dependent on consumer spending, as opposed to industrial and commercial purchases.

In Europe (excepting the UK and some other smaller economies) we could even be facing a Japanese-style deflationary situation. Against the current backdrop of uncertainty and falling consumer prices, consumers may well decide to save their money after all rather than spend it.  If this happens, it will then become even more difficult for demand to be stimulated and for the main economies to get  back on track. Reducing unemployment and rebuilding the consumer’s faith in the future are the most important objectives for the main euro economies, but ones which unfortunately they now seem further away from than ever.

So, we believe the summer will not be the time to decide whether the coming leather season will be good or bad. The opportunities would appear to outweigh the risks, so there is no reason to be particularly pessimistic.

We are optimistic too about the consumption of shoes and leathergoods on a global scale. Fashion and the growth in demand in Asia and Eastern bloc should provide a solid base while car upholstery can at least be expected to remain stable. While the US and European markets might become more difficult in the second half,  there should be increasing growth in the other markets (Asia). This should ensure a stable if not increasing production situation. Furniture remains the most problematic market, not least because is still extremely dependent on the Western markets.  Furniture is also one of the items that consumers can easily postpone or avoid purchasing altogether. We might be too pessimistic considering the booming housing market in the USA (see Macroeconomics), especially if the sale of new houses is followed by the purchase of new sofas. This would be a strong sign and underline even more our moderately positive outlook for the coming months

Assuming that the price of leather in relation to its substitutions does not increase,  we see little risk of another reduction in demand for leather products in total.  In terms of the raw material market,  we will continue to watch the supply side with interest. Kills in the Americas will soon peak while in Europe the seasonal kill will not start before the autumn. Our sources meanwhile indicate that the key sellers and producers are  well sold and will therefore not have any reason to lower prices by much –  except to follow minor market fluctuations or move into production sidelines. 

So, for the coming weeks and maybe the next two months, with limited trading activity, raw material prices can be expected to fluctuate in a band of 5-7 %. The next clear trends should be established after the second half of August. Keeping a tight reign on one’s raw material requirements should remain priority in the meantime, however, as surprises in the currency markets and Asia are never too far away!

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