European Perspective 26.01.04

During the period under review (January 12-26). the big picture was once again dominated by the currency markets. Within days of our previous edition, the European Central Bank intervened in the markets, just as we thought they ought to. 

It certainly had the desired effect, putting the speculators on edge and prompting many to abandon their positions.  The result was the 3-5 % reduction seen in the value of the Euro, which fell over the weekend to $1.22 against the previous high of almost $1.29.

The party was over by last Monday in any case, and those who took the chance were able to reposition some of their needs to buy or sell currency. Even as the dollar slumped to Eur1.28, it was clear that the markets were no longer betting on its continual decline.  This could be seen in the 2 % fall in the value of the Euro that occurred on Friday afternoon, closing at below the $1.26 mark. So in this respect at least, the European central bankers and politicians did what was expected of them.  Expect more volatility in the currency markets in the weeks to come.

On the other side of the Atlantic, the consumer confidence index of the University of Michigan rose by a whopping 10.6 points to 103.2, indicating that the malls will continue to be busy. There was good news too for the furniture industry in the 1.7 % rise seen in new housing starts, the highest for 25 years.   The strength of the emerging markets meanwhile could be seen in the 9.9% expansion of the Chinese economy during the last quarter of 2003 and the 13.9 % rise in Poland’s industrial output during the same period.

Market  Intelligence

Things didn’t turn out as bad as we feared as the rise in US prices slowed to a halt, and both sellers and buyers showed commendable restraint.

Sellers were quick to realise that buyers were in no mood to go along with any unrealistic attempt to capitalise on the situation by raising their prices to unrealistic levels. Besides, they knew it would only result in an overcorrection afterwards.   For their part the buyers - at least those needing product and coverage - were smart enough to buy quickly from those other origins offering attractive prices. These origins were willing to risk oversupplying the market with hides that could not be placed in their regular markets.

In this way, the forces of supply and demand were equalised, imbalances were ironed out and unnecessary tensions in the market eased.  For the first time in a long while, the hide, skin and leather business showed great sense, something which augers well for the future.  Barring any other unforeseen occurrences such as the US BSE case therefore, we are back to analysing the market’s fundamentals.

In the US, the kill may not be as high as the meat industry would like, but the 600,000 mark has at least been passed and that is not so bad. Further consolation is provided by the fact that domestic demand continues to hold up well.  Beef production is not being limited by any tailoff in domestic demand, but by the missing 10 % that goes to export and the limits of the country’s rendering capacity. So a problem that could have taken on an altogether bigger dimension would appear to have been successfully contained.

But the US authorities are by no means out of the woods,  especially with regard to restoring   consumer confidence.  While measures to increase the traceability of animals are now almost certain to be implemented,  confidence in export markets will not be so easily assured without extensive testing procedures being put into effect in the first place.

Without a European-style testing regime it will be impossible for the US authorities to know for certain whether or not the case in question was isolated, as they claim it was. The fact that the authorities’ attention has so far been focused on tracing the origins of the infected cow,  rather than on testing to find out how widespread the problem is, is itself a worrying sign.

It also serves to underline just how critical the situation remains. Although recovery in both domestic consumer confidence and the wider beef market has been swift, the chances of other cases coming to light remain high and will remain so for as long as the necessary controls remain absent.  But while any new case would not be so readily glossed over as the one we have just seen, neither do we believe that the situation is in danger of spiralling out of control.  There are simply too many powerful vested interests at stake. Either way, the US has had its first BSE case and the world has been changed forever.

So much for speculation.  Let us now deal with the facts in hand to see where we stand today.

We have already explained why we believe the risk of an immediate and sharp rise in raw material prices has successfully been averted.  The fact remains, however, that hides from most of the classic origins continue to be too expensive in dollar terms to be attractive or profitable for volume producers. So price increases on the back of tanners investing in more expensive  raw materials can easily be ruled out.

In fact, we think the opposite will occur as tanners become more flexible in their thinking and more accustomed to scanning the markets for cheaper alternatives.  The leather market is also becoming more transparent and volume-orientated.  As a result, we believe the average price of leather will continue to fall while the medium price market, which is already hurting, can be expected to contract further. The top end niche markets will maintain their momentum, but their share is too small to really boost average returns for leather.

There is one main weakness to this argument, however, and that is the growing number of integrated production operations, especially in South America.   Because there is no definitive market price for their output and any amount of value can be added to the basic product, they are able to subsidise the prices they pay for their raw materials in a way that conventional tanners cannot.  This can clearly be seen in South America where tanners producing wet blue only for export are increasingly having difficulty keeping up with the prices being paid by their integrated counterparts.  The effect of the automotive tanners should also be borne in mind.  The way this part of the industry is developing, these can hardly be called tanners any more.  They have evolved to become component suppliers who again are able to subsidise their raw material costs by adding value farther up the production process.

The Achilles heel of these integrated industries however is their inflexibility. To handle the big organisations, they have to be geared in the same way which means uniformity and volume are emphasised. As  result, they have a tendency to overvalue standard products and undervalue the  ‘non-standards’.

So nobody should be complaining, especially as it leaves the field open to others. There remain plenty of opportunities for those willing to discover and exploit them.  The trouble is that many of these are restricted by the various import and export restrictions that apply around the globe, the biggest culprit being China.

Though it is now a fully fledged WTO member, China continues to make the business of obtaining import licences for raw materials extremely difficult. Despite the EU’s uniform veterinarian policy, the Asian giant continues to distinguish between hides from different EU countries, with some being allowed in and others not.  This is reflected in the hide prices of those countries, with those having access to China exhibiting significantly higher prices than those that are not.   And while the trade has traditionally found ways and means of getting round these barriers, the progressive tightening of Chinese legislation means things are becoming more difficult by the day.

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