Macroeconomics

During the period under review (April 7-21, 2003), the impact of the Iraq war and the SARS virus lessened its grip on the world economy. 

As far as military operations were concerned the war has almost ended, however the battle over Iraq is not yet finished. Protestors are demonstrating across the country, proving that the appeasement of Iraq and the region will be a long process, if it can ever be achieved.

The war is no longer dominating the global economy and financial markets. Oil prices have fallen again and the stock markets have generated solid and continuing gains over the past few weeks. These are positive factors which are stabilising general economical conditions.

The SARS epidemic is still a burden in Asia, however, and has caused a decline in local retail sales. In Hong Kong sales of apparel and footwear have fallen between 30% and 50%. Hong Kong is a very important shopping centre, but from a global perspective it has minimal influence. Large Asian footwear and garment manufacturers are not too concerned by the epidemic and have not yet lowered their production forecasts for 2003. It also seems that fears over travel restrictions interrupting the supply chain have also been exaggerated.

Reported cases of SARS are still increasing and revised figures for China show that the epidemic has already spread significantly across the country. Consequently, it is necessary to anticipate what the real consequences of the epidemic will be. Scientists estimate the loss to businesses at $30 billion, yet it is currently too early to predict the full extent of the outbreak. SARS may be used as an excuse by those suffering from other business problems and could also be blamed for missing orders or cancellations which were not caused by the epidemic.

Market Intelligence

The market has continued in the same way it has done so for approximately the past six months.  Prices have continued to fall as a result of general price deflations, rather than a lack of demand and large companies are continuing to increase their market share. The fragmentation of the leather industry is now in decline; it is one of the last traditional industries and is developing fast.

We can see from the results published by large companies, such as Puma and Wolverine, that their global sales remain strong. Puma is expecting profits to surge between 20% and 30% in 2003, confirming once again that successful companies are increasing their profits. This is the result of the falling costs of raw materials, better branding, better control of finished product prices and rising margins generated by integrated manufacturing.

Many will remember one of the first Market Intelligence features, which suggested that tanners and manufacturers should consider their position in the pipeline and decide where they want to go - it now seems it may be too late for such decisions.

The automotive industry – at least in Europe – has continued to report better than expected global sales and exports are running strong and are compensating for declining European sales. Renault has even reported that it has a satisfying order book for the coming months. The leather industry is benefiting from a wide range of changes being made in the models of cars available. Analysts predict that the Chinese automotive industry will expand between 20% and 30% per annum until 2010. Consequently, more manufacturers are starting production soon and BMW and Toyota have announced plans to open new plants in China. On the other hand, smaller and traditional companies are becoming increasingly dissatisfied. For example, the furniture industry is already feeling the effects of the approaching low season in Europe, its orders have declined significantly and delays in colour instructions and inspection dates are frequent.

The situation in the footwear and leather goods industry however remains divided.  The luxury goods division is performing well, for example, Louis Vuitton Möet Hennessy posted strong earnings for 2002 and Q1, 2003. The manufacturers of heavy weight, top quality calf leathers are also enjoying steady orders as high quality leather goods and top quality men’s shoes remain relatively untouched by the global problems of demand and price. The demand for bovine leather, however, has declined by the greatest margin. Korean and Chinese tanners are also suffering due to the low season and the rapid fall in the use of bovine leather in garment production. Korean garment tanners have almost given up and the rest have moved into China where business is slightly better.

Increased purchases of dairy cows in January and February triggered a short lived rally in the cow market and pushed prices well over the $50 mark. A decline in orders and a lack of support from the furniture production industry has now made prices fall back to between $45 and $50 - such prices have always been profitable to tanneries. Over the past 4-6 weeks, problems have also occurred in the bear market for cows, triggered by a decline in prices and reductions in demand. Cancellations, claims and contract renegotiations are still standard and it is also sometimes common practice to deliver goods which are not up to standard when prices are high. Interestingly, buyers purchasing at current price levels have returned to the market and many sellers have reported a sudden increase in orders from new customers and Asian automotive tanners for cheaper female hides. This confirms the rising production of car upholstery in Asia, which could compensate for the decline in leather garment production.

To return again to the SARS virus, there are worries that the epidemic could have an intense effect on the leather industry and production. If SARS spreads throughout China it will influence retail footfall and as Chinese consumer spending is strong, SARS could have an even more significant influence. If there is a similar reaction in Hong Kong private consumption could also be reduced massively. Some production sites may need relocating temporarily. Footwear, leather goods and furniture industries could be moved to a ‘safe territory’ and support the suffering productions in Europe. However, the many beneficiaries will probably be producers in South America and India.

The split hides market has remained firm as far as good quality splits from wet blue split hides are concerned. Demand has continued to be strong and our expectation that the split market would run out of steam earlier than later has been proved wrong. For the coming weeks it is unlikely to change very much, but we remain very attentive about this market. Taking into account the recent reports in sales volumes supply is likely to remain relatively tight until the summer.

The quick progress of the war in Iraq has helped Turkish tanners out, but the late start of the production of new season lambs has delayed activity. Last week many producers in Europe reported that they have had high levels of inquiries, but no business as yet.  They must decide how they are going to handle the next season. The nappa business destined mainly for the spring and summer season has almost been lost. We will only see in the next weeks if Turkey’s industry can recover from the Iraq war. This will depend on whether a large amount of late bookings are made for the summer season. As the mood and situation in Turkey is improving, this should support the market and at least increase demand if not prices.

In addition, Russia’s tax and Customs situation remains unclear. Rumours are mounting regarding the increased production of skins in the country. Production is not focused solely on garments, but also on shoe linings and other areas, which seem to move closer to the main markets of consumption every year. Sooner rather than later, Russia will increase its importance as a potential buyer for lamb and sheepskins.

Will the downward trend in hide prices continue? The majority of traders say “Yes” and their arguments are indeed strong. The second quarter has barely ever brought better leather business and higher prices, except during the BSE crisis. Many of the larger countries which produce hides normally increase slaughterings during the second quarter. At the same time, demand in the Northern Hemisphere is declining. Deflation is still a strong factor in the world and the dominance of the larger companies in the market is leaving them more and more control of the pricing levels. SARS is still an unresolved problem and could eventually heavily reduce consumer spending – at least in China and/or Asia. All these are overwhelming arguments for a further decline in the price of raw materials. And for the coming weeks, we suggest that bargain hunters will continue to have it their way.

Looking ahead, the following circumstances should be considered. The market is – despite the problems of the past months – still relatively balanced. Oil prices have fallen back to normal levels and stock markets have gained ground. The last statistical figures delivered from the US are also not as negative as expected. The kill – neither in the US nor in Europe - has so far not reached the levels one expected for this time of the year. Due to the high uncertainty of the last months everyone in the trade has tried to keep stocks at the minimum.

In summary, all these factors have led to ‘range trading,’ as most standard hide categories are trading within fixed price ranges. If it was not unrealistic one could think that the ranges are already set by the main players. Considering that the accuracy of the statistics for volumes and prices have become questionable, it may be worth believing that the figures follow intentions and keep the markets within the frames set by the largest producers and consumers. This can potentially only work in markets which are in, or are close to, their balance. In this respect we have to also state and admit that the inflexibility of tanners has faded and global players are also indeed more flexible than before.

Various producers in South America and Europe are reacting quickly to local price tensions and are not letting local prices run out of control. This demonstrates that the hide market is under relatively poor conditions and is presently reflecting more currency fluctuations rather than imbalances of supply and demand. In dollar terms one can determine a very stable price band for various types of hides for a very long time. This is unusual for this raw material market and demonstrates how sensible the market must be against a minor variation in the fundamentals.

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