Macroeconomics
Except for its final day (Friday October 3), the review period covered by this Market Intelligence (September 27-October 3) was characterised by negative headline economic news. The financial markets likewise offered little cause for celebration as stocks fell continuously for a number of days, helping to melt away the previous positive forecasts and sentiments.
At the same time, the dollar, which had been falling against the € and the Yen took a moment to reflect on the situation, the result being the small rebound that was seen. Whether this marks the low point of that last two weeks events remains to be seen. We still believe the world economy to be on a knife-edge and that the ongoing unrest in the Middle East is not only threatening individual governments, but also posing wider dangers for the world economy.
Away from the headlines, however, there was still some positive news to be found. First, there was last Friday’s US unemployment figures which delivered better than expected results, prompting some recovery in the stock markets. The Japanese economy also continued to show signs of recovery as the national Business Confidence Index rose again and unemployment continued to fall. The closely-monitored US Purchasing Managing Index for September also gave some cause for cheer as 2003 remained on course to become the third or fourth best year ever for auto sales. Even if the fortunes of individual makers continue to vary wildly, with only General Motors managing a reasonably positive outlook. There has been no let up in the onslaught of Asian imports into the US market, from which both Ford and DaimlerChrysler have been badly hit.
In Europe, several countries continue to suffer from heavy budget deficits with Germany, France and Italy all posting deteriorating figures. Their social systems also continued to struggle, threatening their wider economies with something more than just the normal cycles of good/bad. The war in Iraq also continued to burden the economies of the USA and the UK and it is clear that the whole Western world is facing difficult times ahead, despite all the positive forecasts of the analysts. There’s no getting away from the fact that, in order to spend money, you need to make it first.
Market Intelligence
Once again, we appear to have had a lucky run as our market judgements of the previous edition were proved well founded. We say this not to praise ourselves, but merely to underline the value of objective evaluation in an unpredictable world. So, while there is no such thing as 100% accuracy, we will continue to try to get as close as possible.
The US and European markets were both headed in the same direction during the period under review – and that was South. But while the US market embarked on a moderate retreat, the European market ended up paying dearly for the wrong roads it had taken at the beginning of September. Everything went against them as far the prevailing market conditions were concerned, with by far the biggest factors being the weak dollar and the seasonal increase in slaughter. On top of this, and the factors mentioned in our previous issue, were the stocks some European hide processors had intentionally carried from the summer. All this created a situation of rising concern and fear - pretty much the same that was seen during May, the only difference being that in May, people were concerned about the state of their sales during the upcoming holidays. This time around they found themselves being squeezed by the large supplies they had to place in the market.
The other fundamentals were unchanged with all the same tanneries having full orders and working at almost full capacity while others continued to suffer from insufficient order books, but without the excuse of the summer holidays. It should be clear to all by now that this situation is less of an issue of demand and more of structure, as production has largely relocated Eastwards over the past few years.
At the same time, it begs the question of how the reduced demand for leather in Europe will be distributed in the future. In furniture and shoe leather, the largest shifts have already taken place while in furniture the Italian dominance in the low end market has long since faded. The value they were able to add to relatively cheap hides of limited quality is no longer enough to compete with the total added value chain and the cheap production costs of their Asian counterparts. This leaves them with the market of smaller volumes and quicker deliveries, which is certainly not enough to keep the Arzignano Triangle busy. Only manufacturers that are part of a global network or integrated in some other production chain can expect to get out of the present mess in one piece.
What about the others in Italy which, let it not be forgotten, remains the world centre for excellence in design, development, fashion and quality. For them, it is difficult to have a qualified reply. It is not that there is no demand for their output, or even that they are lacking a market. Their main customer base consists of the so called “well offs” who appreciate good quality and these people are still mainly to be found in Europe and in the USA. But the Europeans are at present keeping their hands firmly in their pockets.
Even those with good sized disposable incomes are scared by the present job market conditions and they have not too much confidence in their social systems. Even if the economy does recover, given that furniture is something it is easy to put off buying, it is hard to believe they will start purchasing again before the end of 2004. .
In the US, the picture is slightly less gloomy in that the Americans are still buying and building a lot of new homes, offering at least the chance for the sale of leather furniture. And since these consumers are much quicker reacting to changes in the economy, there is at least the possibility that their purchasing activity is going to start earlier. On the downside, being a more price-driven market, it offers fewer opportunities for higher quality suppliers. It is questionable if the potential pick up in good and higher quality leather demand will arrive in time to rescue all European tanners from oblivion.
In shoes and leather goods the “special forces” in the Tuscany area face similar pressures and may even be facing an even more uncertain future. Since their customer base - the manufacturing - has moved away almost in its entirety and the fashion houses (e.g. Gucci, Prada) are increasingly investing in their own tanning facilities, their prospects are looking far from favourable. It will need a quick and strong recovery in consumer spending on fashion items for them to secure their future.
In the meantime, at least they have the benefit of a market where fashion is the main driver and where it therefore easier to stimulate short term demand through the constant introduction of new styles. The fact that the price of the finished article is that much lower compared with furniture also helps. The end of the leather production in the Tuscany area has been forecast many times over but, with their never-ending output of spectacular new products, the Italian masters continue to keep the Grim Reaper at bay. It will certainly be interesting to see what they will be showing at this month’s Lineapelle.
The Italian situation may explain why the European raw material market received such a beating in the last two weeks. It should also serve to underline importance to the raw material suppliers of doing their homework in terms of the markets and products their hides are used for.
And so we come to the ‘Great White Hope’ of the world’s raw materials and leather suppliers, Asia. Here, interest and activity slowed after the hype seen in the second half of August. Analysing US sales and talking to European suppliers who are fairly well positioned in the Orient, it is clear that levels of demand have simply returned to normality with nobody complaining of sharply reduced interest from, or sales to, that destination. And while there was some talk of slowdowns in shipments, the product flow continued uninterrupted. This leads us to believe that demand for leather products globally has not declined to any significant extent. As ever, it was emotional and seasonal factors that dictated the industry's sentiment.
One thing that is patently clear is that there is absolutely no room left for price increases in leather destined for volume productions. The price range stipulated for finished products, leather or raw materials during the early summer remains valid, with the rises seen four weeks ago being just a temporary aberration. Prices have corrected, returning to the levels that make economic sense.
The split market did not slow as much as we expected, however. After a short period of absence, interest woke up again, leaving limited scope for any fluctuations in price. From what we hear, there is little reason why this should change in the near future. Splits are still scheduled in many productions and many sellers are decently covered into their next months’ productions. Turning to the sheep and lamb skin markets, interest in double-face products continued to hold steady but with most taking the form of dollar-invoiced finished jackets into Russia, the weaker greenback hit producers’ prices badly, especially as most had bought their skins in euros. So, despite the good demand, many producers were kept occupied trying to find better offers, or trying to convince their suppliers to sell at lower prices. As far as we understand, due to a lack of supply, they have not had too much success. So prices remained steady in the main. Some interest for cheaper priced nappa leather is also starting to come through, with many suppliers confirming their interest in economical skins suitable for nappa leathers. We expect double face materials to hold their levels towards the end of the season and would not be surprised if the cheaper nappa skins did the same.
We see no reason to alter the predictions we made in the previous Market Intelligence. However, we consider the speed and extent of raw material price reductions will now begin to slow. There may be room for another couple of dollars off in the US, where leather manufacturing is now becoming profitable again. It should also be borne in mind that the period of ‘super-supply’ is also over. This prepares a very solid base for prices in the medium term.
We would not be surprised if the descent seen in the market begins to turn as tanners start buying for arrivals after the New Year celebrations. In Europe the situation is a bit different. Here, the high kills and continuing focus on local customers for many grades and products leaves room for further declines. Knowing the great volatility of some regional supply markets, sharp price reductions in the short term cannot be ruled out. But we think this will be a short-lived phenomenon and that the price declines will reassert themselves, bottoming out around the middle of next month. To anyone who has got a fair and safe idea about their leather business into the next year, our advice would be to take advantage of the attractive price levels while they last.
