Macroeconomics

In the last two weeks a number of figures have been released that are of general interest and importance to the leather pipeline.

Most of the general statistical data from the leading economies in the world are indicating that there are some clouds in the skies. Consumer confidence in the USA dropped on Friday (the Michigan Index fell for the second consecutive month from 95.5 to 94.2) and the producer price index rose by 0.3 %, which points towards the chance that inflation could rise. Although Mr. Greenspan confidently stated that consumer inflation is still under control, in his speeches this week,  more ‘experts’ share our opinion from last year that the evil spirit of inflation is slowly but surely preparing for its return.

Various sources are at last talking about the mounting price pressure in the supply chain due to: rising prices for steel, energy, chemicals, etc.; the weak US$; gains in productivity; massive competition; and a rapid shift to lower labour cost countries. The statistics on the industrial output of the emerging countries speak for themselves when one looks at the figures for countries like China and the rest of the Far East, India, Russia and also various countries in South and Central America. At the same time, many Western World countries are stagnating.

The economic figures presented for Germany last week speak for themselves. In Japan the recession is back, and the last quarter in 2004 was more than negative for Germany. Although polls report a feeling of optimism, one has to question if a turn for the better can really be achieved when one considers the high unemployment rate and the fact that there have been many positive forecasts in the past which never materialised in the end. Along with Germany, the Netherlands and Italy presented a weak performance with France and Spain being the only countries from larger European economies to present a slightly better picture. Britain offered good news for consumer spending with a 4.3 % rise in wages compared with a year ago, but this is another basis on which to believe that inflation levels are set to rise.

In general, most of the global growth, in 2005 too, has to be generated by the USA and the emerging markets. Europe will not add its share in the short term.

The US$ has started to erode again in the last few weeks and slowly but surely returned to a steady descent. Those who took the opportunity to protect, where needed, against short term declines were well-advised to do so. One interesting fact is that one can now hear the first voices on financial markets who are forecasting that the US$ could also behave contrary to all expectations and see a firmer trend in 2005. If US growth remains so much higher than that of Europe and the FED is forced to raise interest rates more quickly and to a larger extend over the coming months, the US$ could quickly regain popularity and see a firmer trend in the second quarter of 2005 rather than continue to fall to contend as forecast by those who see a weak dollar as the only solution to the deficit problem.

It seems that the next 6-8 weeks could offer us more background in order to lean towards one or the other position for the medium term.

Market intelligence

The assumption that the past two weeks would not deliver too much market news or activity proved to be correct and so we start almost exactly where we were two weeks ago. This also restricts the volume to report.

The currency market allowed one or two non-US$ suppliers a few sales for a reasonable return but in general the market was in holiday mood. In Asia in particular - mainly China - many people took a real holiday this year and many took their business phone off the hook, spent time with their families and took a proper break from the office. Some also went on their usual business/pleasure trips to Europe and the USA, but in general, it is fair to say that many were able to stop for a week or two and this is also proof, that order books and production needs were not as demanding this year.

So, the week before last was pretty idle with the ski/carnival break in many parts of Europe and the New Year festival in many parts of Asia. Business activity slowly resumed last week and many members of the trade confirmed that the second part of the week was more active, with more interest in general and more business finally booked.

As usual, the trade is still battling with the problem that market activity - or rather ‘sensed market activity’ - is being treated like the ‘windchill factor’ or ‘sensed temperature’ that comes today as an attachment to the daily weather forecast. As with this particular measurement and its dimensions, there is very little objective in it. And even if one could measure ‘senses’, the interpretation still remains completely subjective. Consequently, we are currently facing a distinct difference between the interpretation and the actual situation. However, one thing that they all have in common is that nobody is fully convinced of his own forecast, which is driven more than ever by hopes and needs rather then fundamental reasons.

We believe that it all has to do with the related industries (beef, hide trading and tanning industry to name the dominant ones) that are still finding it difficult, to accept that the prices for the raw materials have hardly moved at all (in US$ terms) for such a long time and since the first BSE case in the USA, no real trigger for sharp movement has been seen. The beef industry in the USA and Europe continues to focus on the declining kill and production of hides. While this was already happening in the USA in 2004, this argument has only now reached Europe with the declining kill being projected for the future. However, the rest of the trade has already known for a while that declining consumer prices and increasing availability from cheaper sources was compensating nicely; not only in terms of quantity as such, but also for the demand, which was for cheaper rather than more expensive hides anyway.

Hide processors and traders have also learnt their lesson in the last year – having always had the chance to give the market a push in their direction. Used to the fact that the market was always sensitive to rumours and changes on the supply side, there has always been a ‘market opportunity’ to convince the buyer to pay the ‘right price’. And if it was not for the sale of stocks and inventory that prices needed the ‘little push’, it served for a comfortable sold forward position. Quite the reverse has been true in the last year or so. Buyers stubbornly ignored any argument for a rise in raw material prices and so prices did not really move much, and looking at them from a non-US$ perspective they actually fell for most of the year.

Tanners have finally noticed that hide prices – despite all arguments – are still not a true reflection of the leather business and/or prices. However, tanners had the chance this time to act by moving into other more adequate and financially beneficial supply markets. One example of this was a huge shift by Chinese upholstery tanners from US and European hides to South American ones.

In a way, many tanners were lucky because the upholstery market, in particular, was so price oriented that for the sake of bringing prices down, retailers and manufacturers were willing to accept lower quality or –to put it another way – less natural types of leather. In an attempt to keep volumes up by lowering the price, it cost leather its image in the mass markets of furniture. But we have discussed this already in previous editions. So, one always has to come back to the question of whether this trend is now passing and we could eventually return to better quality again.

Well, despite all theories – including our own  - that we have seen in the recent past, it does not seem that we have overcome the price problem yet. But there are many arguments as to why one should watch the situation with great interest.

We are currently seeing an increasing fragmentation of the leather market.

The mass markets dominated by the large retailers and no-name producers will continue their fight and there is little reason why producers, in the short term at least, could win this price battle. They have – in our opinion - only one chance. Along with other prices going up due to the rise in raw material costs (specifically energy, chemicals and metal), a small window could open up in negotiations. Leather has also been under so much price pressure, because other consumer products (such as textiles, electronics) had much more room to fall. So, the situation should eventually come around, although to what extent is anyone’s guess.

Besides the mass markets, which definitely play the most important role, following extensive research and analysis, we have come to the conclusion  that there are more market segments for leather products opening up and on top of this one should not underestimate the impact of the increase in wealth that is now growing quickly in the emerging markets. The new segments and markets opening are not in the low price bands, but are also not just delivered to the doorstep. The markets are new, distribution and taste are different and so the business that is developing has probably not even been recognised as yet.

When it comes to the simple and global fashion for shoes in general, then there are a lot of indications to support the opinion that the fashion and also taste of the next seasons will favour leather, of a good quality and style, particular in ladies shoes, which is good news. 

So, it might be that the opportunities for better business, prices and sales will not be triggered by traditional markets and customer bases so much as by a hidden and less recognisable source which would require more attention and needs to be developed.

Despite all of the structural problems that we are still facing in the leather pipeline we feel more optimistic again for 2005, after the tremendous challenge of 2004. It might still take a bit of time and those who have hardly been touched by the structural changes will not agree, but, however, this is not an individual outlook to forecast everyone’s future.

The split market remained difficult. Interest in general tended towards the end of the period and splits suitable for higher quality garment suede and specialty products such as high substance are still finding homes. The bread and butter business is still suffering from fashion and price. Splits from the US$ origins have had a better time over the last few months, while the European tanners have had to accept a downward trend in prices which still has not been turned around. We continue to believe that prices for splits from the US regions will remain steady, while EU splits will continue to have a tough time to find enough buyers at the right prices.

The skin market in general also remained in the doldrums. Skin prices did not move by much and the focus of interest remained on large skins with good wool revenue and that were cheap. The increased supply due to the Muslim festivals and the holidays did not support business either. Basically, skin prices are extremely attractive now and this should tempt designers and fashion retailers to consider leather garments again. It would be logical and it would be good, but there is no other argument than fashion these days to use leather in garments, and as to whether this is enough has yet to be seen. Another hope could be the shoe and leathergoods market. From the standpoint of calculations and value for money, it would just need a bit of technical and design creativity to create a certain renaissance for skins in these markets as well.

For the coming weeks, we continue to believe that the present price band will remain intact. However, we finally feel that tensions will start to increase, depending on the activity from Asia - and in particular from the Chinese market after the holidays. Next week business will return to normal and over the next two weeks the leather industry has to pull up its socks and really see what the demand and business outlook is going to be until the summer. We are quite optimistic for the shoe business. Fashion and the natural growth of shoe sales will support the business and selected specialty items – in particular light weights – will in our view benefit.

In upholstery things will remain difficult. Most of the prices are fixed and orders have been placed until the summer which does not leave much room for change at this time of the year. However, the coming weeks will be decisive. There is a fair chance that tanners in China have been too pessimistic and have reduced their stock too much based on price forecasts and the outlook. If this theory has got some foundation, a round of sales and shipments could support the market in the coming weeks, to the surprise of many. If business remains as sluggish as it was between November and January, then the season will be lost and a bit of market speculation towards the Hong Kong Fair could be the only reason to support upholstery related hides.

We feel more optimistic than pessimistic for the rest of the first quarter this time.

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