Macroeconomics

There is little evidence that the state of the global economy has changed significantly since our last review.

The FED interest rates were raised by another 0.25 % while last week the ECB decided to leave interest rates in the euro-zone unchanged. The assumption that the exchange rate could go up as a consequence of this proved to be correct, as the dollar broke the €1.30 mark. It had looked stronger for the last three weeks until last Friday when disappointing data on the US economy caused it once again to look vulnerable.

Oil prices had also reached record highs until they fell slightly last week, but levels as such are still well over US$50 per barrel. The average level is much higher than that of a year ago and the effect of this will be felt sooner or later. There is no reason to believe that oil demand will decline in the near future and so prices are expected to remain high. Our worries were underlined by a study made by Goldman Sachs stating that there is a real risk of oil prices breaking the US$100.00 level in the foreseeable future. We don’t think it is going to be that bad, but an average level of $50.00 is already enough to alter quite a few parameters in the global economy. At the end of the day, we have to assume that even in today’s prices, a fair proportion is just speculative and the actual prices are normally adjusted.

Following various forecasts, most analysts are predicting a slowdown in the global economy from nearly 4% in 2004 to a figure closer to 3% in 2005. Although this may be seen as a reason to be more pessimistic, we tend to believe that under present circumstances this would still mean a strong performance - strong enough, at least, to keep the positive foundations in place for the next 12-18 months. However, we believe that increases in the price of raw materials and energy are the biggest threat to the world’s economies as the effects of this is are always felt further down the line as businesses and consumers are only really affected by this some six to 12 months later. Until they are actually hit by this, it is merely an item in the news and nobody takes any real notice of it. When the effects are finally felt, there is a real possibility of an overreaction in the product pipeline.

In this respect, the direction of interest rates also has to be monitored. Although there does not seem to be a problem at the moment, there is a high level of liquidity around the globe and a short term surge in interest rates can be expected. Slowly but surely this global liquidity will be absorbed by higher interest rates.

Market intelligence

After the long Easter break most of the leather business directed its attention to leather show in Hong Kong. APLF offered the first chance for a large get together in 2005 where the whole pipeline from many countries has the chance to meet and discuss business and their impressions of the market.

With so much production having shifted to Asia in recent years, these kinds of events are becoming more and more important, despite the complaints made by people when having to book their flights and hotel rooms. In the meantime, it seems to have become the general fashion to complain about fairs and events of this kind. However, those complaining most loudly and pretending that they will not come to the next one or any other one are invariably first at the gate on the opening day. The reason for this is very simple: despite all of the available information, faster communications and an ever-increasing number of contacts, there is still no better chance to meet and talk to people face to face than at a trade show of this size.

All of the comments and predictions that the show in Hong Kong would quickly lose its importance and that the most important annual event in Asia would soon become the leather show in Shanghai must now be reconsidered. Most of the people attending now admit that to gain a true insight into the market and its developments in Asia – which concerns many more countries than just China - can only be obtained in Hong Kong, because it is only here that one can find so many countries represented. It is only by attending an event with a high concentration of those involved in the industry where face to face contact allows impressions, products and informal information to be compared and exchanged that one can gain a true picture of the situation. 

Most exhibitors are likely to disagree with this opinion, because they predominantly look for customers that are going to place orders and thus cover the costs of taking part in such an event. And this is indeed a crucial reason for holding such events. Exhibitors pay for the cost of organising such a fair through the fee they pay for having a stand.  If they feel that the event is less important from a sales perspective, and that fundamentally many people come to the event to discuss the market rather than buy, then the number of exhibitors will continue to decline and it could reach such a level that could put the event at risk of not taking place. This is nothing new, but we thought it needed to be mentioned again as we felt that the general opinion concerning the value and relevance of the fair had changed in comparison to the more negative mood we had noticed in previous years.

A more positive feel

Having said this, we did get the impression that many of the exhibitors themselves had a more positive feeling about the show. Many confirmed that the Hong Kong market place is their only chance to make contact with most of their Asian markets and international contacts. Consequently, the feeling concerning future participation, at present, has significantly improved.  One slightly disappointing element is that the chemical industry is less and less willing to exhibit at these events. While, on the one hand, this is understandable due to the cost of taking a stand in comparison with the questionable returns, on the other hand, the chemical industry remains a very strong catalyst at such a trade show and has always been a very important meeting point, especially for the technical people. Maybe there is a solution to this problem and a way to attract more companies to join in and play their part in ensuring that this important trade show continues to be successful in the future.

After these more general statements we would like to try to give our opinion about the results and directions this meeting of members of the leather pipeline delivered.

In our previous issues we had become quite cautious about the situation in the leather business. This was not purely because of the business prospects as such, but mainly because of the many structural changes taking place and different developments in different segments. These kinds of imbalances always tend to create tensions which need to be balanced out eventually.

To start with the bad news, we have not seen that these tensions are easing for the time being. The different market sectors are still developing at completely different speeds and what is good for one is probably not good for another.  This is also the impression one obtains when speaking to people about their feelings and evaluations of the situation. More than ever before opinions differ vastly and this is a reflection of the varied situations in the different markets. In our opinion APLF confirmed that there is a situation of differing trends which we have already seen in recent months. Tanners and manufacturers of shoes and leather goods for the low and medium consumer price market were quite happy with their order situation and their prospects for the rest of the year. Low selling prices and the cost of raw materials, chemicals and energy were the main complaints.  Profitability is falling and this is supporting, in particular, those manufacturers located in the so-called low cost countries that are not burdened by currency issues. These manufacturers account for a fair amount of the growth and have taken advantage of the generally positive development in this market section.

While in the last two years interest was almost entirely focused on China, the development in the last 12 months has definitely favoured other countries too and has spread far more. We got the impression that apart from the shooting star in shoe manufacturing, Vietnam, countries such as India, Pakistan, and Bangladesh have done their homework and were able to gain ground again, not to mention South America and Brazil, in particular, where the leather industry is also performing extremely well. When it comes to general growth and the question of where the centres of production are set to be located, it seems there are going to be three big areas, Brazil, India and China. These production centres are set to be the centre of the universe in the world of leather, with smaller satellites surrounding them. Italy also needs a mention due to its sheer size of production and this will definitely remain the European Centre. Know-how, fashion and the country’s incredible talent for flexibility will leave it with a good chance of continuing to be one of the global centres of leather production.  However, the introduction of EU regulations, the cost, the shift of leather manufacturing and the present disadvantage due to the currency situation does not seem to leave Italy with any kind of chance for growth and it looks more that it's going to be a question of by how much they have to downsize and restructure.

Apart from the location, another factor that is definitely related to the volume and the price level of the supply of raw materials is the size and the globalisation of the setup which has become a very important issue. The pipeline from raw materials to consumer products is undergoing another round of concentration regarding the number of businesses. For example, this starts with the concentration of the European beef industry and ends with the massive growth of global brand names and marketers. This change is still at an early stage of development and as this is still a very traditionally organised industry, the fundamental, structural effects of this are only going to become evident in years to come. It is probably a safe bet to predict that a number of well-known names might not be there in five years time.

As far as general business was concerned we saw every emotion. Satisfied people, disappointed people, hopeful people and people who were afraid. However, we tend to believe that there were more positive than negative opinions. This, of course, excludes those people burdened by the above-mentioned structural changes.

Most people involved in shoe leather reported a decent or even good order situation. Some even went as far as to believe that they could already be optimistic about the next production season which sees them looking forward to 2006. Products which fit into the price targets, and definitely that at the low end, of the big retailers and brand names are enjoying strong demand which goes hand-in-hand with the well-known price pressure. Consequently, the combining of low price raw materials and low labour costs is the winning formula today. At the same time top quality products in combination with a luxury image are also enjoying a strong performance and despite the complaints, price is still really a secondary issue. For the rest….. see above.

The upholstery segment

Another great topic of discussion was the upholstery segment. Overcapacity in Chinese production as well as in tanning, and cut and sew furniture production was the main topic of discussion. No matter what their stance, people agreed that overcapacity was 20, 30 or 40% which has reduced leather and product prices to almost unworkable levels. The underperforming car market in China has added to the problem as many of the production plants were built in expectation of the planned growth, which at least until today has not been achieved, as car sales have struggled since mid-2004. With more new tanneries and production plants scheduled to start production in 2005, the problem will definitely not be sorted out in the short term. A large amount of production capacity needs to be cleared out to bring the market back into balance.

An interesting fact is that the production overcapacity is no longer inflating raw material prices. This has happened many times in the past and we now know that the steady or strong performance of the raw material market in the first half of 2004 was, in a great part, related to the production capacity that needed to be filled, but failed to find buyers. With strong pressure on finished product prices, the fierce competition, and the purchasing power of the distributors and retailers, producers have decided not to fight for a market that simply doesn't exist. The global demand for leather furniture, at present, is simply at present not as big as the production capacity.

Not to be too negative regarding upholstery, it must also be mentioned that those tanneries and manufacturers that did not simply try to increase production, but focused on the needs and requirements of the customer, have proved to be a reliable and consistent source. Combined with their ability to improve product quality, in these limited number of upholstery tanners and manufacturers in China, business is good and they are working at full capacity and even admit that they are making a profit. There will be more important fairs related to furniture upholstery the rest of this month and the main ones in Highpoint, North Carolina and Cologne, Germany might give us a bit more insight into any improvement can be expected for leather furniture for the rest of 2005. At the end of the day the industry needs it.

Raw material prices did not change very much during the Hong Kong leather fair. For most people it was pretty obvious that there is no significant imbalance between raw material supply and demand. We realised some time ago that price trends are essentially demand driven and this is also reflected in the trend of raw material prices. Also the situation in some small isolated sectors, such as European heavy hides and high quality calf skins, for example, does not conflict with this statement. Due to their exclusivity, they might be supply driven in the short term or even generally be influenced by the top end of the market, but they represent a very small l percentage of the market and can definitely not be used as a reference.

Consequently, raw material prices have not moved very much. Sellers realised very quickly that tanners have no desperate need to search for suppliers and pay more for their raw material. For most of them there are plenty of options and an abundant supply on a global scale. So, prices remained mostly unchanged and for mainstream products, some marginal price erosion may have been reported. For the leather industry as a whole, light weight materials, hides suitable for average quality shoe production, and top quality products found homes without too much of a struggle over price. The classical product for upholstery manufacturing required more complicated discussions and when it came to sales one or two lower bids had to be taken.

The market for splits remained difficult. The demand was there, but splits remain a cheaper product and so sales were only generated if the price target of the clients was met. This did not please the producers and sellers of splits very much. We couldn't see any signs of a major renaissance of splits in leather fashion for the time being and this might, should and would please the market for next season.

Skin business remained extremely difficult. Double face had a disastrous season last year and is not doing much better now. There is at least hope for the near future. With a sharp drop in raw material prices over the last few months, many voiced opinions that the present level of lamb and sheep nappa could become an interesting product for the fashion industry next season. Also, with pigskins being in such short supply, a shift to a better quality product and an acceptable price level would not come as a surprise. However, at this stage it is definitely far too early to make a solid judgment, but the discussions about the possibility are already giving some hope and an indication that we might be over the worst. With most decisions about next season being made in the next few months, we might have a clearer picture later in the spring.

An overall view on price

What facts have we gained from this important week in Asia for the forecasts of the markets? There is still no indication as to why we should not believe the established price bands will continue in the near future. Raw material supply, at least for the vast proportion of production, is still sufficient. There might be some shortages in light materials which could mean that sellers attempt to raise prices. If the show in Bologna at the end of this month again confirms that the demand for leather in this particular segment remains strong, then we have a fair chance that insufficient supply will have an effect and prices could be pushed higher. However, buyers will give sellers a very hard time achieving this. The only other market which could see tensions could be the heavy weight bull market in Europe. If slaughter doesn’t improve, supply could take command and prices might move upwards. Again how far tanners are willing to follow and what their decision will be, just in case this happens, needs to be seen in the terms of how willing they are to switch from the particular raw material.

The rest of the markets – and this still reflects the mainstream and volume products – have no supply problems so far and we fail to find an argument as to why prices should move much. Sellers will not give much way and neither will buyers. Neither is so constrained at present that they have to change their position much. Maybe later in spring a change of supply could alter their positions, but for the coming weeks we fail to see any major market fluctuation.