The spectre of deflation loomed large during the period under review (May 5 -19) overshadowing other economic variables, which in any case did not offer much cause for optimism. 

In the EuroZone, the big economies continued to struggle with recession and the difficulties involved in balancing their budgets.  Germany again delivered the bleakest results where unemployment rose sharply to 10.7 %.  German GNP shrank by almost 1.0 % in the first quarter while consumer spending fell 4%.  An official report meanwhile saw tax revenues falling by Eur130 billion over the next three years. Even if nobody wants to talk about it, one cannot ignore the obvious parallels between the current state of the German economy and that of its Japanese counterpart in the 1990s.  One has to wonder how the decline will ever be reversed.

In France, the main problem of the moment  is a rising budget deficit, but other economic data coming out of the country at least look a bit better. The fact remains, however, that Europe’s  two largest economies are performing badly which means the prospect for recovery in Euroland are hardly bright. And with economies such as Italy’s continuing to suffer depressed growth, one can hardly expect the other economies to drag the region out of the mire.

In the US, sluggish retail sales continued to cloud the economic outlook while the trade deficit also rose to 47.1 billion, making a year-end figure of 500 billion entirely feasible.  Against this backdrop, it is perhaps unsurprising that not much is being done to support the dollar and as the financial markets continue to jump on the bandwagon, we not be surprised if the slide in the currency continued.

Over the past few weeks, the dollar has fallen constantly with only a small correction being seen last week before it slid back to a near-low of Eur1.16.  On the plus side State-side, however, there was a sharp rise in the US consumer confidence index, prompting some analysts to become slightly more optimistic while also allaying the fear of deflation.

The SARS situation in Asia in general and China in particular refuses to go away.  Despite the

fall-off seen in some areas, infection rates have remained stubborn in others the outbreak is increasingly seen as paralysing business activity in the region.  Witness today’s cancellation of APLF.  More and more travel and transport restrictions are being brought into effect while domestic consumption continues to disrupted. Apart from the direct effect on business, the psychological fall out from SARS can also be presumed to be considerable.  We feel the impact of this could be bigger than the direct impact of the virus itself.

If one were to go looking for a silver lining, one could argue that if SARS persists, then it could have a counter-deflationary effect as the downward pressure it is exerting on production levels and raw material prices starts to have a similar effect on end product prices.  However, we believe such a scenario unlikely.

Market Intelligence

There were one or two nasty shocks in the leather pipeline during the period under review, which started out with everyone waiting to see how things would go in Bologna, especially as the show was the first international level event for some time. As is so often the case where expectations are high, however, disappointment was bound to result.

Not that anyone was expecting a record turnout. As expected, talk of Italian government quarantine restrictions beforehand kept most Asian visitors away while fear of the SARS virus itself kept visitors from other parts of the world at bay.  The first and last days were reasonably quiet though the Wednesday was very busy with visitors crowding both the aisles and the stands.

To draw positive conclusions from the fair is not easy, but we are not about to join those who have called the results poor and disappointing. Rather, we think they are simply reflective of the wider sentiment of the industry,  which is hardly optimistic.

Furniture tanners are having a particularly difficult time. While the European consumer markets are simply stagnant (see section; Macroeconomics), the US market remains under massive price pressure as price calculations continue to suffer from the slide in the dollar and the effect of SARS in Asia.

Many furniture tanners at the show reported sharply lowered order income and few colour instructions being received for future seasons.  A number of businesses – several top names among them – reported order books of two weeks or even less.  The news was all the more alarming considering that many tanneries in Italy had already taken a break at the end of April due to national holidays.

The prospects for shoe and leathergoods tanners were more mixed. Despite the general downbeat mood, several were able to report full order books as far as the summer while admitting that they had benefited from recent fall in raw material prices. These were the more traditional tanners who sell to European customers producing traditional conservative products. The same was heard from tanners producing a higher quality calf leathers.

Either way , there was plenty of evidence to suggest that the top end of the market is being buffeted less severely by the winds of economic change than its less quality-orientated counterparts.  As explained in earlier editions of Market Intelligence, this would appear to be due to psyche of the main consumer of such products, (i.e. older, better-off Europeans) who buy not for reasons of fashion, but out of necessity.  This means that he or she will buy regardless of what is happening in the wider economy, as opposed to the younger, more fashion-orientated consumer who is more of an impulse buyer and therefore more likely to be swayed by issues of sentiment. The same model applies to the business community.

Although Lineapelle is not their  preferred fair – those automotive tanners present at the show were, by and large, able to report reasonably stable order books. Despite worries about falling car sales in the second half of the year, production continues to run at high volumes and the general decline in car sales is not seen as affecting the medium to high end of the market, at least for the time being. A raft of new models will be unveiled at September’s IAA car show in  Frankfurt, Germany, so we might see better second half than expected.

It would be no exaggeration to say the hide market has turned sour in the past few weeks. We have been especially supply-oriented in our observations over the past months and, as far as Europe is concerned, our scepticism surrounding abundant supplies would now appear justified.

Quite the opposite situation currently prevails in the USA where kills of 700,000 head per week are being sustained. However, the combined effect of SARS and the slowdown in the Chinese consumer market means Asia is at present unable to absorb these quantities. As a consequence, US sellers are now looking to Europe where their willingness to sell cheap coupled with the weak dollar now makes their offerings extremely competitive.

Unfortunately for these suppliers, the European summer break is now almost upon us while most tanners have already satisfied their needs until the holidays.  There is also the situation increasingly being experienced within the upholstery tanning sector, where orders are in decline or being called off by customers at a much slower pace than anticipated.  As a result, most tanners are now finding themselves well covered to September, at the very earliest.

Not that the low kill in Europe this year has done much to counter falling prices.  In such a depressed environment, rumours about contract cancellations are quickly spread among hide suppliers and readily believed by buyers and sellers, with the result that a spiral of pessimism quickly sets in.  Falls in prices become self-fulfilling prophecies as the cycle gains momentum and spread outwards to other parts of the world. Against this backdrop, it is to be expected new lows will be reached in the weeks to come but that a commensurate correction will also follow.

One market that continues to defy the down trend, however, is splits.  Due to decisions taken by various operators a year ago to bring average raw material prices down, splits are now in use across many areas of production. Garment, shoe and automotive productions continue to make use of the product which as a result continues to find a steady stream of takers. However, even this part of the market has shown itself susceptible to the combined effects of the weaker dollar and SARs, which means the potential for correction is rapidly increasing, especially since many hides are now significantly cheaper than premium splits. From various sources, we hear that many suppliers and producers of splits are fully aware of the situation and therefore desperately trying to keep their inventories at zero levels and – if possible – build forward positions.  Add to this the current lowering of demand for splits in Europe - both because of difficult business conditions and the large number of holidays seen in the past few weeks -  and it becomes easy to see everyone should exercise caution with regard to these materials.

The sheep and lambskin market is continuing to experience improved levels of interest from Turkey and the ‘new season’ kill is being comfortably absorbed by tanners. Orders from Russia appear good while premium qualities have already surpassed the €10,00 per skin mark. Demand for nappa skins however remains low - again because of SARS in China - plus the fact the tourist season for most Turkish tanners has already passed. As a result, prices for nappa skins are holding just about steady, albeit at low levels, while the spread between nappa and double face has widened. The  weeks ahead will show if demand for double face from Turkey can be sustained or if it is just the traditional early season hype.

For the coming weeks the markets will remain extremely volatile as fluctuations in the currency markets and dollar continue to be the centre of interest.   Compared with the Euro, the dollar can be expected to fluctuate between the Eur1.15 currently and Eur1.20. £ Sterling meanwhile can be expected to fluctuate in sympathy with the Greenback and, so long as the Japanese government continues to exercise care, the relationship between the yen and the dollar can be expected to  remain stable. Either way, with the Japanese tanning industry losing ground the way it is, this relationship is likely to be of marginal interest.  

In the next few weeks, it will be seen whether or not the raw material market can protect itself against further steep falls in demand.  At present, it all hinges around whether the Asian tanners will return to the market in volume, both in terms of buying and receiving goods. Further cancellations or delays in issuing of letters of credit would not be well received in the market.

As we have already said, most tanners have covered most if not all of their needs until the summer holidays and even if some decide that price level are attractive and buy, shipments would not arrive before the beginning of September. So, in the short term, the outlook remains pretty bleak for the supply sector.   Looking slightly further ahead, hide prices can be expected to return to attractive levels and even now they are reaching the point where tanners can again begin to operate profitably. Against the backdrop of the current uncertainty and SARS there has indeed been a slowing in demand, giving rise to a slight excess in supplies.  But it should be borne in mind and that normal circumstances will soon reapply themselves and that the market will return to its natural state of undersupply. So, for those who are confident of their future orders and production levels, the coming weeks could be a very attractive period to prepare for the rest of the year.

Likewise, companies with steady order books can be expected to continue widening their margins. Assuming that the world is not falling into a deep hole because SARS and that deflation does not take hold,  the sharp rise in consumer confidence in the USA could be taken as a real turn for the better.  Now more than ever, it is important to remember the trade is more heavily influenced by cycles than by anything else.  In other words, focusing on the here and now is likely to be of limited value to your business.

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