European prices come back down to earth with a bang
Macroeconomics
The inflow of statistics during the two weeks under review (September 9-22) was normal for the time of year, but it failed to signal a clear direction.
As before, prospects for growth in the global economy were generally positive, with the two lame ducks of Germany and Japan showing some hope for the coming year. While the data relating to Germany and France had more to do with confidence in the future, in Japan they expressed tangible progress. And while Germany’s Index for Business confidence rose again in September - the ninth month in row – the economy is by no means back on track. That is something that can only be confirmed by a reduction in unemployment and growth in the economy. Whether this can be achieved without a complete restructuring of the economy is a different matter.
Aside from the build up to the next year’s elections, in the USA public concern about the country’s future would appear to be rising. Dissent on the issue of
Exchange rates – our main concern – all but wiped away the competitiveness of European supplies. The dollar fell to almost 1.14 euros and 113 Yen, seemingly confirming our prediction that the dollar rebound would not last. An interesting question is how long the Bank of Japan will allow the rebound of the Yen to run. If it gets its timing wrong, it could present a massive threat to the fledgling recovery in that economy.
Market Intelligence
Most of the prediction we made in the previous edition of MI were borne out as the hide market failed to sustain the positive expectations that were established in August. Only our positive outlook for splits was a bit wide of the mark as the news from the European tanners was generally not good. The split tanners, which had been performing reasonably well, also ran out of steam.
All in all, the market was the victim of timing. As on previous occasions, many of the main market players didn’t have the patience to wait for the fog to lift before acting. And so market decisions were made without the benefit of hard facts. No wonder September has so far proved a disappointment. It will take a while until the volatility created from the current situation settles.
While it depends on your perspective, generally speaking many of the hopes and budgets made for September failed with currency exchange rates again being the main villain of the piece.
While the USA market seemed superficially very solid, European raw material suppliers had no choice but to accept that the easy times were over for the time being. Where previously tanners’ resistance to the price increases was easily compensated for, or even outweighed, by the strong recovery of the dollar during the summer, now the pendulum is swinging back the other way. The revenues and plans made during those halcyon days can be seen to be melting like ice cream in the European summer sun.
American packers played it much better, even if the official export sales and shipments data for the summer does not correspond with the views of the big players. In short, we think they completely changed their strategy. Under normal circumstances, the trade would have been expected to support the market by inflating the sales numbers. Now the opposite would appear to be true as actual shipments tend to be much higher than the sales reported over the summer months. With the kill being both higher and longer in duration than before, it would be reasonable to assume a significant inventory of hides had been amassed in the hands of the producers. On closer analysis, however, we believe this to be wishful thinking by many in the trade (both tanners and traders alike) and that if this build up it did occur, it was only in a few isolated areas.
The optimists would point to the fact that packers were pushing for sales and shipments. This may well be the case, but we think it is more symptomatic of the normal practice among packers, which is to moderately oversell, so that their inventories are kept to a minimum and their books and warehouses are kept as clean as possible.
Against this background, we would say that the US packers have done an excellent job in managing their volumes since the spring. After the sharp price adjustment in May brought about by the poor outlook and the SARS-induced slowdown in
Of course,say the naysayers, you can also do this if there is sufficient demand. However, we believe that they protected the market conditions through a lot of deals which where neither published, or transacted at the prices mentioned in the official lists. They were therefore able to stay well sold without endangering the stability of the market. Many will of course complain they were never given the opportunity to take advantage of these ‘secret’ deals. Well, that is why they are secret. In times of uncertainty, it is only reasonable that sellers should look after their best and safest clientele.
The upshot of all this is that prices in the US market are probably now too high to be sustained and are now in need of adjustment. This may well be true, but at least sellers managed to get through the period of high kill without destabilising the market. We have deliberately extended our excursion into the US market situation because many readers will have their own views and they can compare notes on the subject.
In Europe, the situation developed in a different manner. With the low kill in the summer, the strong demand for female hides from Asia in July and August was fuelled by the stronger dollar. On top of this was the expectation of better demand after the holiday, the result being the explosive mixture of price rises that was seen. But not once did anyone stop to consider how much of the frenzy was the result of currency exchange windfalls. So, by the middle of this month, many had already taken a hit as their expectations failed to materialise. It all served to underline that whether in terms of hides, tanning or leather manufacturing, the market conditions that prevail in Europe are completely different from those that exist in the rest of the world.
In the absence of sufficient local demand for hides and leather, export business has become the driving force in Europe, with almost all materials being invoiced in dollars on the export side. In the days when there was a specific European market with sufficient demand for raw hides and certain leather types, Europe was able to detach itself from the global market when things suited it, at least for a while to give it a breathing space. Now, with the miserable retail business in Europe and the homogeneity in fashion brought about by the rise of the international mass market brands, the individual styles that once marked out the people of individual countries are fast disappearing. The knock on effect of this is that the smaller local apparel manufacturers who manufactured these styles are fast disappearing too, being unable to compete with the economies of scale enjoyed by the big brands. Like everything else, style is fast becoming globalised.
So, after the USA, Europe is now losing its production, labour force and also national style tastes. Where this has not yet fully happened, then producers are fighting an endless battle against weak retail conditions and the discount prices of imported goods. Only by invoking the highest levels of quality and image have a few been able to successfully defend their positions. All this is mentioned to explain why the optimism surrounding Europe had to fail in line with the falling value of the dollar. Only with dairy cows and some ox/heifers, together with some premium qualities have they been able to make some inroads into the Asian markets. In that they compete in dollar terms with substitutes from other areas of the world, their prices in Euros must fluctuate in line with dollar exchange rates.
The other hides – the European specials – and here we are talking mainly about the heavy male hides that have always fetched premium prices, have struggled to defend their positions. Demand from the traditional European tanning industry for these materials has reduced in line with the decline in demand for middle and higher quality leathers.
We mentioned this about a year ago when we said that in the non-discount and non-luxury markets, you needed the buy-in of the ‘new rich’ to sustain the leather prices. Now that this class of buyer has disappeared in the US and Europe, and a middle or upper class buyer has yet to be established in Asia, European hides and leather can be expected to continue to have difficulties in fitting into the full luxury or discount environments. And there is almost nothing to indicate a change from this in the near future.
As a result, the market in the € zone continues to struggle. And it is not just tanneries with their frequently-mentioned problems. The hide producers and sellers can also expect a bumpy road ahead. In the absence of strong demand for the middle and higher segment products, they will have no choice but to accept the fact that cows will continue to fluctuate with the price levels of their US/AUS counterparts. Bulls could enter a new situation where they become relatively cheap compared to other origins, simply for the reason that they haven’t yet successfully entered the Asian market. The remaining European tanners will need the prices for their raw materials to come down, so as to compensate for their higher costs and discounted leather prices.
If this scenario materialises then many of the ‘old rules’ will disappear and common valuations will fade if they haven’t already done so. The trend is already evident in the prices for European bulls and American steers seen over the last year. The split market, despite still decent demand, shows signs of being also a bit tired, with the European hype now seemingly coming to an end. Various suppliers report that demand is slowing down from European customers.
Before the holidays, while every shipment was desperately awaited, now the first requests for delays are being heard. Payments are coming in later and higher prices for new offers are no longer being entertained.
Various reputable names in split tanning report that they are increasingly having to contend with low offers of grain leather. This is not a surprise as we have expected this for some time. Asia continued to show interest in splits but also here a similar story prevails. The heat is off for the time being. While it is certainly too early to make a final judgement, it would appear that the normal rules of economics are slowly returning to the marketplace and an end to the period of the overvaluation of splits could now be in sight. In the sheep and lambskin business there was very little news. While double face skins found ready homes at the high and steady prices of the previous few weeks, the season can be expected to run for some more weeks more before slowing down again. Demand for nappa skins remained quiet as sheepskins with a high wool return found interested buyers in China. The rest of the market is now awaiting new directions from the fashion world and the spring and summer collections for 2004, with hopefully some impulse for nappa garments.
The coming weeks – we believe - will not be particularly exciting. Those who are in the trade will likely disagree because general levels of business stress look likely to rise. But as far as results are concerned, we don’t think much will transpire. As with the wider business world, the leather scene is presently living in the land of hope, (i.e. everybody believes that business is turning to the better). Whether in terms of the world’s largest auto show in Frankfurt or the shoe fair in Düsseldorf, everywhere people are talking about the improvement of the business later this year and in 2004.
While we don’t dispute that a wider upturn in the economy is on the way, we don’t think it will mean a lot to the market. As stated, the structure of the European leather business is changing and this is by far the most influential factor. As far as price trends are concerned, we believe that the situations in the two main markets of the USA and Europe will continue to diverge. While the kill in the USA is likely to decline, the kill in Europe will increase. And whereas in the US, hide producers will be able to continue to count on the Asians to absorbs stocks across the board, in Europe there is a much greater dependence on local markets.
In the US, inventories are reasonable well cleared, but in Europe stocks – if not in raw, but in wet blue - continue to weigh heavily on the market. Against this backdrop, we expect the US market to trade in a very narrow range in the weeks to come. There is enough demand for the hides and with some small exceptions, they can be reasonably be expected to be sold.
Life will be more exciting in Europe. In many countries, the abattoir buying season is now just around the corner. Kills are rising all over and in the UK and Ireland, annual highs can be expected. Many of the hides to likely wait for European tanners to buy them, as the tanners are still waiting for the leather orders. We believe that hide prices in Europe have a fair chance to returning close to the levels they reached before the holidays, before the market once more bottoms out. Once this has occurred, a very solid base for demand and business can be expected. We would therefore not be surprised if after mid/end October, things in this part of the world become much more solid again with good outlook - but with fewer players.
