Macroeconomics

On this occasion, we have decided not to cover the usual round of data relating to the period under review (December 15-January 12 2004). Most of you in any case will have had the time to catch up with the global economic situation over the Christmas break.

The reason for the departure is the one development that cannot be ignored right now, and that is the dollar/euro exchange rate. While the dollar has been in constant free fall, breaking new records as it goes, the reaction of the financial markets and politicians has been sadly predictable.  Whereas the Europeans are adamant that the dollar slide presents no danger to their economies and that the cheaper imports are compensating for more expensive exports, in the run up to the elections, the Bush administration appears quite happy to let the currency markets support the country’s exports.

We have long since warned of a dollar devaluation of the kind we are now seeing, maintaining that we do not feel it is good for Europe. Despite all the comments of the ‘experts’, the inescapable fact of the matter is that the current exchange rate of $1/Eur1.28 is harming the European leather business. As ever, this can only be seen with a time lag as export data released now is the business of some months ago. Looking at the figures, however, it can be seen we are in a classical economic war of attrition.  Devaluation is a sure sign of a country trying to muddle its way out of its internal economical problems.

In our view, the Bush administration continues to exhibit a high degree of short sightedness on the subject. The problem lies in Asia and its pegged currencies, as well as in the twin deficit.  Devaluating its currency at the rate the US is doing can only lead to massive problems for the world economy in general and the USA in particular. The day will come when the US fails to attract enough foreign investment to finance its deficit.  Meanwhile, betting on constant Japanese intervention in support of the Yen, which continues to account for a  large proportion of investment into US assets, continues to be a risky strategy.

The day will come when this is not enough and higher interest rates or some other attraction will be needed to keep investors interested in dollars. In the meantime, the stampede continues. It is simply too easy to make money just by selling dollars, even if this might last for a while in the run up to the elections. Sooner or later we will have to start to thinking about the action to be taken when the moment of reckoning arrives. If the dollar slide turns into an avalanche, recovery in the global economy will be placed in serious jeopardy. This is not an unrealistic scenario, and one which businesses of all sizes would do well to plan for now.

Market Intelligence

Taking a long break seemed a good idea in the run-up to the Christmas holidays. And so we decided to follow suit with Market Intelligence. Then came the first case of BSE in the United States.  For regular updates we recommend our news section on leatherbiz.com.

The BSE case has changed many plans and both the kill and market developments in the first month of 2004 have had to be rewritten. Being heavily reliant on US supplies, Asian tanners were the most badly affected.  They had been expecting lower prices and low market activity due to the holidays and were forced to react quickly.  By contrast, most Europeans were on holiday and in any case were not too worried given their limited exposure to the crisis.

The reaction was the classic one, being an almost exact rerun of that which occurred in Europe following its first case of BSE.  Suppliers withdrew all offers as buyers scrambled for alternatives and a great deal of stress was caused all round, bordering on panic in some cases.  It was so fortunate it all happened during the Christmas season since it gave people a few days to think before reacting.  But the outcome was still higher prices.  Though nobody could have predicted the problem, we had warned in previous editions of Market Intelligence that tanners in Asia were not sufficiently covered in terms of their raw material supplies for the first quarter of 2004.

The extremely high prices in the USA, as well as the insecurity now surrounding supplies from this origin, prompted tanners to take a much closer look at potential European sources. Consequently, the few suppliers in the old world who had their mobile phones switched on or who cared to check their e-mails had a busy season and a fair chance to close some business.  Various buyers from the Middle and Far East were also active.  While some were trying to avoid a bottleneck in supply caused by a potential shortfall of shipments from the USA, others were presumably trying to grab some cheap hides before the expected price rises took hold at the end of January.

Those who decided to buy did the right thing as slaughter fell in the United States and prices rose in line by an average of five to 10%.  Compared with now, not only did European hides have the advantage of lower prices to begin with over the Christmas and New Year period,  but they also had the benefit of a stronger dollar. 

Either way, the leather pipeline is now completely changed in comparison to the end of 2003, when market conditions were generally steady. 

Returning to the US, by shifting the media’s attention to an imported cow from Canada, the spin doctors did their government proud.  This had the effect of diverting attention away from the deficiencies of the country’s lamentable BSE testing procedures, where only 25,000 animals of an annual slaughter of 35 million head are tested, and even many of these were below the critical 24 month threshold.  The story disappeared from the headlines within days, helping to shield  the American beef industry from massive declines in domestic consumption.  It should also be borne in mind that the various import bans imposed on US beef account for no more than 10% of the total kill. Bad enough, but no real disaster either.  As in Europe, the main problem is a lack of rendering capacity to handle extra offal generated.

As regular readers will know, it is not the job of Market Intelligence to deal with the latest news.  Given the events of the past couple of weeks, however, we feel duty bound to give our readers a basis on which to make their decisions.  As ever, timing is the most important thing.

The first thing to bear in mind is that it is only the supply of hides from the United States that are affected.  All the other fundamentals are the same as they were on December 23^rd.  Regular readers will recall that we predicted steady to slightly firmer market conditions for the beginning of 2004.  This was because we considered the general leather business to be better than the false impressions being deliberately created by some tanners.  Since leather production was not particularly profitable in November and December and US prices nearly always dip at the end of the year, many tanners reduced their purchasing activity in the expectation that raw material prices would fall after the holidays.  In our view their mistake was to underestimate the total volume of leather orders available and placed, hence our predication of steady or even slightly firmer market conditions.

But now approximately 100,000 hides per week have gone missing from the equation and with no large inventories around, neither in the hands of the sellers nor in the warehouses of the buyers, there is precious little buffer to absorb any shortfall in US beef production.  In that the balance will have to come from other origins, the question then becomes “Will these origins be able to make up the difference?”

While we think the answer is an unequivocal ‘Yes’, we believe tanners will have to be more flexible in their thinking in terms of the kinds of raw materials they use.  We have mentioned for quite some time the large price differential that exists between European and American hides. We have also alluded to the massive structural problems faced by the European tanning industry, in Italian and Spain especially.  In short, we believe that declining European output will liberate enough hides to satisfy the short-term needs of their competitors in the Orient.  Not particular nice news for the European tanners, admittedly, but we fail to see how the Europeans can match the prices currently being paid by their Asian counterparts.  

There is another reason why we think that the short-term reduction of supply will be balanced out of Europe, and that is most European tanners have had disappointing orders this season.  This is especially the case where cowhides and maybe heifers are concerned,  but not so much for the classical European bull.  In that many will have bought their usual volume of raw material at the end of 2003, attracted by the strength of the Euro and in anticipation of rising prices in the first quarter, it can be assumed that their inventories are well stocked, again leaving more in reserve for the Asians.

In describing the current situation, therefore, it is clear we are seeing a seller’s market.  Looking ahead to the second quarter, potentially things become even more interesting.  Prices can be expected to rise in line with sellers’ expectations and we have absolutely no idea how far the situation will run.  As usual, however, the pendulum will probably swing too far.  As stated, the present supply buffer is not particularly large but then again US beef exports will likely be made up from other origins, most likely South America or Australia.  So the total number of hides available globally will not significantly change. 

Against this backdrop, we would not be altogether surprised if, two months from now,  the pendulum was well on its way to the other extreme. By then, the US kill is likely to have started its recovery, precisely at the time when hide prices have peaked and leather production has already gone into its seasonal decline.  It should be remembered that regardless of whether the mood of the leather industry is up or down, animals continue to be born at more or less at the same rate and their by-products still need to be processed when they are slaughtered.

Spurred by lower beef and cattle prices, consumer interest in beef is likely to return quickly and with it, a rise in consumption levels. While nobody can say exactly when this will be, the period between mid March and the end of April would be a reasonable assumption.  The result: an avalanche of hides arriving in the marketplace. As we all know, contracts negotiated in periods of high emotion and at very high prices, as the are being now, are seldom advantageous to the buyer.

It should be borne in mind also that the price of leather is very finely tuned price-wise, as is the demand for leather. At present tanners just have to cover their existing contracts, but when it comes negotiating for new contracts they will likely ask for substantial higher prices from their customers.  On the back of this, demand as usual will nosedive as manufacturers look for alternatives. Anyone budgeting for the next six months therefore will need to carefully balance their production needs and should not be tempted to capitalise on whatever the ‘scare of the moment’ happens to be.

The sheep and lambs skin business remained reasonably quiet, being unaffected by the situation in the bovine sector.  The double face season is almost over and the demand for lambskins remains very quiet.  Sheepskins continue to generate good interest, especially from China.  For those selling in US dollars, the market remains steady to firm while those calculating in Euros continue to be burdened by the strength of that currency. With the high prices now being paid for dairy cows, interest in nappa leather made from ovine skins can be expected to build, thereby supporting the market for this material over the next few weeks.

The split market was also reasonably quiet, though rising prices for hides and sensibly priced finished products can be expected to support prices of this commodity before too long. Against the current low inventory levels, it does not take much foresight to see a steady to firmer split market in USD terms for the weeks to come.

In looking at the hide market in the weeks to come, how can anyone expect anything other than a steady and firmer market? Sellers will try to push their asking prices higher by the day and we have the gut feeling that there are many tanners in Asia who do not have the raw materials coverage that they should. And since this is against existing orders, not futures, they will have very little option but to pay the going rate.  Neither do we agree with those who are predicting to upcoming holidays in Asia will ease the situation. This break has already been factored into calculations and will not help.

However, this would be to ignore the difficult situation in the European market. We believe will be much more influential, placing more hides at the disposal of the market in the coming weeks than most buyers probably realise. For the moment, other than analysing the alternatives at their disposal, there is little anyone can do but go with the flow. In the medium term, however, we would not be surprised if rapidly improving supplies coincide with a declining seasonal demand, prompting a new round a rapid price cutting.

The message is: In the absence of other bad news, don’t believe the hype!

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