Macroeconomics

The past fortnight has placed the development of oil prices and the eventual consequences for global inflation very high on the agenda. Mr Greenspan indicated to the financial markets that the Fed would take immediate action if the sharp increase in inflation was recognised.

The strong performance of the Japanese economy continued, and resulted in an increase in the value of the Yen.  The US dollar also saw a rise in value, and the current trading range was widened from 1.18-1.24 against the EURO. The market has yet to identify which direction the greenback will take over the summer season, but the final outcome is likely to depend on whether the sound performance of the American economy is more influential than the negative effect of the lingering threat of terrorism.

China has given a clear indication that its government is slowly starting to restrict financial resources in order to cool the overheated economy. This applies mainly to investments in the heavy industries, but it is becoming more evident that agricultural commodities have been affected, and now a large number of exporters have confirmed Chinese customers are looking for extended payment terms. At this stage, the immediate influences on the global raw material markets are not visible, but China’s financial situation is being closely monitored. With the light industries mainly producing for local demand and investments, they are definitely feeling less of the pressure at the moment.

Market Intelligence

With the arrival of summer, so the raw material markets have entered their seasonal decline in advance of the holiday period in all parts of the world, with the exception of Asia.

Following the high volumes of raw materials purchased between mid April and mid May, raw material asking prices have been edging up in the past two weeks.  But this has met with little response from the tanners who are comfortable with the position they are holding. Any purchases made have generally been to fill production holes or to cover incoming orders that have not yet been drafted into the regular production schedule.

The Americans are facing a period of high-season reductions but have managed to protect themselves with the large sales made over the past eight to 10 weeks.  In other parts of the world, particularly in Europe, the summer season has made sellers act cautiously and the volume of supplies has reduced.

With the almost perfect equilibrium that now exists between demand and supply, the raw material hide market has found a very solid base. As a result, prices of the main standard items have not altered significantly, with any movements that have occurred being caused by day to day developments. The global balance between supply and demand is more even now than it has been for a long time and as a result, buyers or sellers attempting to push prices in their own direction meet with little success.

Imbalance

The previous version of Market Intelligence highlighted that the long decline of American prices has not been a reflection of a global imbalance, but is merely an indicator that prices are returning to a level warranted by the value of the hide. The present price level should be convenient for all players in the market, and people are being advised to do everything they can to keep the current market conditions in place for as long as possible – or at least until the balance between supply and demand is determined and justified.

The oil market has been the latest example to highlight the ways economy and business can be influenced by speculation and emotions. Oil is reaching price levels of more than US dollars 40 per barrel, and with supply and demand never justifying this increase there has been much debate heard. Similar situations have happened in the hide and skin market, and on most occasion the outcomes have been negative.

After describing the dreamland of the past, it’s time to look to the future again.  Firstly, let’s evaluate the problems we can expect in the near future, and assess whether tanners and leather buyers are taking too big a risk with their purchasing prices.

In general, the global economy is in quite a healthy state with American and Asian consumers maintaining their healthy spending levels. The slightly improving performance levels of central continental Europe has also been an encouraging sign, and this has been further enhanced by the successes experienced by some of the emerging markets including Russia. The figures given by some of the leading brand names relating to the leather industry have shown an increase of sales and in the majority of cases are complemented by healthy profits. On a global scale it seems there are no major issues affecting consumer demand, but with the threat of terrorism constantly hanging over us it could change very quickly.

The ‘China Effect’

The supply side is fairly steady, and there is no reason to believe global slaughter should alter any more then the normal annual variations seen for the past few years.  Any changes implemented at all are likely to move in a positive direction, largely due to the rising population figures that are placing an increased demand on the production levels of cattle. Whatever happens, it is unlikely the changes will be standard across the globe. For instance, the EU policy could reduce the killing figures in some of the member states and then compensate by increasing production in Russia, South America, Africa and China. But with tanners gaining increased flexibility over the supplies they are using, any general worries people have about raw material supplies are unjustified. Issues are beginning to surface for those tanners and leather users’ dependant on a specific type of raw material as they are facing uncertainties about the availability of their product in the medium to long term market. Similarly, users’ of raw materials are also being advised to start investigating whether there can be any changes in the production structure of beef, or if the marketing of the by-product could influence their access to preferred origin and supply. There’s no need for people to panic, but it is worth analysing how their product, cost and location fit in to the supply chain.

At the moment, the markets are quite steady but that could change at the end of the summer or in the autumn. This is likely to be a positive move because once the economy sees a trend for cheaper consumer products, the prices tend to stay in place for a long time. The falling prices for most consumer products have generally been caused by either an increase in productivity, the relocation of production to a country with cheaper labour costs or an improvement in the management of supply and logistics chain. Most companies taking such measures have done so as a result of the massive price pressures the retail giants have put on their suppliers. A lot of the price reductions and the general descend of consumer prices have not derived from falling raw material prices. They are actually more the result of lower production costs, currency factors, and the general overcapacity of production all over the world. Some people call it the ‘China effect’.

We believe the majority of the price cutting has finally come to a halt. This could result in the industry suffering another season of depressed finished product prices, but this doesn’t necessarily translate into weaker raw material prices. As long as terrorist attacks do not destroy the positive outlook for the global economy and the energy prices do not continue to rise, the outlook of the leather industry looks promising.

Inventories

Inventories in the shoe and furniture leather pipelines remained quite low, which has mainly been a result of just-in-time deliveries, the attempt to keep stocks as low as possible and a majority clearance from the last season. This may not apply to industry as a whole, but as a general statement it can be accepted.

As ever, the main determinants of current raw material prices are levels of consumer demand, inventories and the level of demand for competing products. If demand exceeds inventory levels it is likely we will see price levels increase to the benefit of competing product markets. Balanced against this however is the fact that these are likely to be hit hard by rising oil prices. All things considered, we can expect raw materials to rise in the long term, even if it is upset by short term market fluctuations along the way.

One of these ‘blips’ could be the EU policy for agricultural subsidies. Within the next few months, we will finally know exactly what the decisions will be. If we get the results we are expecting – that is a change to subsidies on land rather than on production - we have to expect an extra kill will take place between September 2004 and March 2005. This would increase the supply for a short period of time and allow more time for the prices to stabilise. 

Taking this away, all other parameters are supporting the chances for a more solid trend in the longer term. A rise in demand and inventories has allowed the price levels to increase, but this has not been a standard issue across the board, and has affected some markets more than others. Some categories, such as cows, are already on the higher side, but the lower quality materials have room for improvement. Within six to 12 months it is likely the risks will be worth taking, and any buying opportunities that occur will be a strong protection for the business.

Other fields have been fairly quiet. The split market continues to sidestep, with lower quality splits struggling to find homes at the right price while better quality splits still receive adequate interest. Sellers looking to achieve better prices levels have found stiff resistance, and as a result the market has remained tight.

Concern

Skins have had some mixed observations over the fortnight. While some reported a steady flow of interest at the lower prices, others complained about a lack of interest from the traditional market. It seems this is merely a pricing issue. As the production season approaches over the next few months, the demand for skins should stay at a stable to good level. Double face skins have managed to find their levels, but the price of nappa leather is still causing some concern.

Over the coming weeks, we expect buyers and sellers to be equally relaxed. Tanners all over Europe are hoping the prices of raw materials will be lowered to compensate for the low consumer prices. This could happen over the next few weeks, when the summer season starts to see a slow down in activity. A reduction in the demand for raw materials should see the prices lowered slightly, but the industry should not expect anything too dramatic as the inventories are not high enough and the leather business is good enough to keep the product flow intact.

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