Macroeconomics

The financial markets have not been a source of guidance in recent weeks. The US dollar has continued to weaken, while oil prices have risen to new record highs. 

In most Western countries the industrial output slowed down significantly in August and September. Many still worry as to whether this is just a seasonal factor, or if it is in indication of a general slowdown in global manufacturing. Looking at the industrial output in emerging markets such as India, South Korea or South America, it seems that the situation is due more to a general shift, as production in all of these countries has increased sharply.

High energy costs are starting to worry not only companies, but also the stock markets.  However, the financial markets seem to be waiting for the results of the United States’ presidential election, as no clear trend other than that of the burden of high oil prices can be seen at the moment.

Germany has been producing most of the exciting company news and has confirming its structural problems once again. GM has announced it is to cut 10-12,000 jobs in its Opel plants in Germany. Volkswagen is still being threatened with strikes because the unions are not willing to accept management’s cost cutting programme. Karstadt, one of the largest retailers in the country, is fighting off bankruptcy and needs a massive cost cutting operation to secure fresh capital and credit facilities. All of this will always have a negative influence on suppliers.

The US labour market also performed below analysts expectations and quite frankly it seems that none of the financial analysts has a clear picture for the global economy at present.

Market intelligence

In the past two weeks the market has entered much more into the normal seasonal pattern.  Despite negative reports, most of our sources confirm that, in general, trading activity has increased. This is not true across-the-board, but on the whole enquiries for and sales of raw materials have increased substantially.

There is no need to repeat the general problem of prices and calculations and the fact that the leather demand is not reflected in higher prices. Quite the opposite is actually true. Most markets had to reduce their asking price levels moderately and we would think that the price level in general has fallen by 2-5% over the period we are covering.

However, one has to realise that there is a tremendous imbalance in the market between the different grades and origins of the raw material. Medium and higher quality hides  - suitable for side leather production - enjoyed contrary to prediction quite good demand and prices have remained almost steady, at least if one does not compare them with the official price lists, but with the prices hides have really been trading at over the past four weeks or so.

In shoe and leathergoods leather the trend which we were meant to have already seen in spring seems to have finally materialised. Demand for better quality leathers is definitely rising and good quality, more natural, nappa leathers seem to be enjoying a solid trend at the moment. Lineapelle in Bologna at the end of this month will certainly give us a clearer picture about this.

The question many raise in regard to this is: How does this trend fit into the never ending discussion about prices? When shoe and bag producers look for better leathers, how can they expect that their continuing demand for lower prices can be satisfied? Could this already be a reverse trend, assuming that retailers and manufacturers feel that their customers are less and less satisfied with the offers they are making.

Well, it is most likely – as usual – a bit of everything. Shoppers with limited disposable income or with an extreme discount mentality will still wait for the cheapest offer around. However, when we look at the results of the luxury brand names then it is at least worth thinking about the fact that leathergoods continue to be an item of image and luxury and in those parts of the world where money is still easily spent, they are at present at the top of the shopping list.

We feel, however, that there is a market segment which is maybe being overlooked and underestimated. In many marketing companies the older consumers are being targeted more and more. Above average income, less fashion-oriented and quality conscious they buy more products than many realise. Contrary to the youngsters who are fashion, but not quality, conscious, they expect more from their product - it has to perform and it has to last. This is far from attractive to sales and marketing people and companies which expect double digit growth from season to season. However, such companies are there and we tend to believe that they are doing very well. We could not name one that is publicly listed and they don’t attract the masses with fancy sales campaigns.

In the ‘old economies’ we are seeing  more and more of the elder generation returning to their ‘values’ after a foray  into the glamour world of fashion and PR in the past few years. They want to be happy and comfortable with their shoes and want them to last more than one season.  With manufacturers following this market, taking care with the quality and product, being careful with designs and colours, and not having short term success in mind,  we realise that the business is doing well, profits are solid, creating the ‘happy few’ producers and customers.

We think there is potential to expand this market segment still and – who knows – why should it not become a larger trend. Question? Will there be companies whose management and workforce are capable of understanding this consumer and can accept that working in this market means hard work and little glamour?

The situation is different for the medium lower quality of hides predominantly used for the furniture industry. With the late arrival of any real market activity, many of the volume supplying markets were more and more affected by the absence of their buyers, as well as by the ongoing debates about falling leather and consumer product prices. From what we understand, South American suppliers in particular had to bite the bullet and lower their prices to attract the interest of any of their regular buyers. Interesting in this respect is the fact that more and more rumours are circulating about leather orders for furniture leather being pulled out of China again and it is either returning to Italy or the business is just staying in South America – for finished leathers rather than wet blues and crust. The same news was also delivered from the Highpoint fair which is finishing just as this report is being published. We hope to be able to supply more information about the results and the trends deriving from this event.

The furniture fair in Coburg in Germany - which used to be one of the most important trendsetters - has become smaller and is no longer a very important event on the calendar. It is now a local fair with only limited influence on global market trends. However, in line with the terrible retail environment in Germany at present, most visitors reported that disappointed manufacturers were just talking about the ongoing price war with the big retail chains or purchasing cooperatives. Leather prices of just above €1 per square foot were frequently mentioned. This is further confirmation that the German retail market at present is from most sellers’ standpoints just the place to lose money—if not on price then with the high risk of not getting paid on time. We must not forget that the problems of Salamander, Garant-Schuh and Karstadt only confirm the problems of this particular market.

In the furniture business we can find very little of what we mentioned for the shoe and leathergoods market. Although some quality suppliers are still doing quite well, the price gap between mass produced and ‘quality’ goods is too wide. So, the top can be better called the luxury segment and more than ever before the medium market segment is missing these days.

Pretty poor news was delivered from the automotive industry. Despite some market research institutes still offering a positive outlook for leather as an interior product in cars, at present the situation is not particularly good. Car sales are not meeting expectations and even the one piece of good news about stronger sales from the USA has to be understood as being due to the sale of stocks rather then new orders coming in. The sales that were made had to be supported by discounts, zero finance programmes or other incentives to attract the buyers.  Having sold cars means that there are fewer buyers around for the cars that are to be manufactured in the months ahead.

Despite the general problem of sales we also discern substantial price pressure on the established manufacturers of automotive leather in Europe. Many of the larger and well-known companies report not only fewer orders, but also massive competition from market newcomers which are cheaper. For some of the global players the situation is less problematic because they own low cost production plants themselves. They will be in a much better position to fight against cheaper offers, but those who mainly operate from one European location will have a difficult time. According to recent reports the German automotive industry - where GM intends to cut about 10,000 jobs and the threat of a strike looms at Volkswagen - it is pretty obvious that for medium and low price cars Germany can no longer be the preferred location.  Looking at where automotive manufacturers are building their plants in the next few years, a trend towards the east is very clear.  It is logical that this will also pull suppliers’ business in the same direction.  This will definitely include leather. The fact that more automotive leather production is also going to move to the Far East is also very well known and again illustrates that Western European automotive leather producers will face tougher times in the near future.

For the moment we are seeing cuts in the European automotive leather production and if this temporary slowdown is not settled soon, we could see quite significant effects on the types of hide used in this particular market section for many, many years to come.

So, the summary of the bovine leather market in October 2004 is really a bit mixed.  While we can definitely see some positive signs in shoe and leather goods production, we have to be cautious about upholstery in general. The normal cycle of production should have already started and the dynamics should be much bigger than they actually are. The massive price gap between low price levels and high price levels in furniture does not make the analysis of the markets any easier. The present slowdown in car manufacturing cannot be compensated for by higher penetration of leather in cars. We believe this is the case for the first time in many years.

The split market seems to be a victim of the change in fashion. If the trend in the shoe business is confirmed – in Bologna - to be moving in the direction of better quality leathers, splits will definitely suffer. In the furniture industry the price pressure should basically support splits again. For the time being the massive price pressure on split prices which started with the bankruptcy of an Italian split dealer still persists, but we believe that split prices are also going to settle down in the next month or so.  With the decline of automotive leather production in Europe it may be that splits of a certain quality will be produced. With mass production still being very price sensitive, splits must come back into the focus of interest pretty soon. Since prices have already eroded, some further reductions might be possible in the range of 10-15%. Lower levels of supply should lead to a change in leather demand and should, therefore, change the market sentiment again.

The skin business has not fulfilled any of the positive expectations we had. Everybody is talking about good orders for leather garments, but we fail to see any interest from tanners looking to buy raw materials.  While Turkey remains quiet because it is still suffering from transport restrictions to Russia, China is not converting a positive mood into any larger raw material orders. We would like to wait for another two weeks to make a final decision as to what we really think. However, in general we are leaning more to the positive than to the negative side when considering whether we expect business to pick up in the weeks to come.

For the coming weeks the focus is going to be on the Lineapelle fair in Italy. In addition many will be looking at the results of the furniture fair in Highpoint, USA. Contrary to many others, we think that the inventories of furniture tanners in Asia are not very good and if they have been able to harvest some orders they will need to buy and to cover.  This does not necessarily mean that the raw material prices are going to increase again.  Basically we are still trading in the range we have seen for almost a year now, so everything is in order.  Even in the worst case scenario - that average leather prices come down and production costs go up - we believe that the maximum market risk would be about 10-15% from today's level. This may seem a lot to many, but it is not a catastrophe, as it would still leave prices in a completely normal fluctuation range.  And, we believe this is a worst case scenario, not what is really going to happen. 

On the whole, we are still following our advice strategy, despite a lot of negative news it might not be a bad idea to use market opportunities and to buy when bargains are around in the coming weeks.

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