Macroeconomics

As in the previous two weeks, there were few many meaningful macroeconomic indicators during the period under review (February 9-23).  While US industrial output grew 2.4%, in the last quarter of 2003 GDP in the Eurozone was found to have expanded by just 0.3%.

Germany remained Europe’s lame duck and the nation’s lack of confidence in its ability to dig itself out of its problems was confirmed by the fall of three index points seen in the ZEW Index to 69.9. The government is just not in the position to lead the country to renewed optimism and growth.

In Japan, the figures were much more encouraging, especially after the endless period of stagnation in the country.  GDP grew at 7.0 % in the last quarter of 2003, a level of expansion not seen for more than a decade.

The most important development came from the currency markets, where the dollar underwent yet another rollercoaster ride in relation to the Euro. After hitting a new low of 1.29 it rose sharply to break the 1.25 barrier late Friday – a variation that had obvious implications for the hide market.  However, it is not only the euro/US dollar exchange rate influencing our trade at present, but also the US/Australian dollar rate, especially as the Aussie dollar is also constantly hitting new highs against the Greenback. So, decision makers would be well advised to monitor the currency markets and continually assess their impact on their respective businesses. Changes of more than 3% in a week are easily outside the amplitude of fluctuations seen in the hides and skins market.

As far the US dollar is concerned, most experts are still expecting to see further falls. And as regular readers will know, we have been issuing warnings about the stability of the American currency for some time. The fundamentals of the US economy (the trade and budget deficits) are still extremely shaky and now there is the prospect of interest rate rises there.  However, one can’t overlook the fact that the Eurozone is not really recovering, despite all optimistic forecasts that have been made. The ‘big three’ of Germany, France and Italy are not producing the growth to put Europe back on track and the short term effect of the EU expansion this May cannot yet be accurately appraised.  But if US interest rates rise, the Greenback could well rebound in the medium to long term. This is just a guess and the actual scenario could be that the $ will fall further. But in the medium/long term the possibility of the dollar staging a strong comeback should not be discounted. 

Market  Intelligence

Analysis of the leather pipeline is not the world’s most exciting job at the moment. Why? Because most people like to read about exciting news and developments. Since we are not the ‘newshounds’  of leatherbiz.com, being concerned more with trends as opposed to day-to-day happenings, dramatic developments tend to be few and far between.  This is very much the case now, when the fast changing world of leather would appear to be taking a break, digesting and handling all of what has been instigated in the previous year.  If one takes a look at the present situation, it can be seen that we are in the midst of two major trends, overlaid by some lesser developments.

Major trend number one: The continuing shift of production – and consumption – to the East.

Major trend number two: The consolidation process.

Lesser developments: The shift from a traditional to an modern industrial model; the move from a ‘push’  production model to a ‘pull’ scenario; the homogeneity of fashion between different nations; the move away from the traditional models of supply and distribution; the increasing shift to integrated manufacturing.

All the above have already been discussed in earlier editions of Market Intelligence and whoever was able to draw conclusions for his own business from should have been prepared for their arrival.  But now that they are in full swing or are already rolling out, we are beginning to see the winners and the losers of the new situation.

This leads us to the present view on the leather pipeline which is one where the European industry continues to suffer.  Consumer demand is not what it should be and a lot of customers have left for new and cheaper destinations. The sharp fall in the dollar has also dramatically reduced the industry’s competitiveness in the international marketplace.  As a consequence, market potential is shrinking and overcapacity is rising. In that a market never shrinks to zero, however, the industry is now faced with one of two options; either downsize or specialise and upgrade. And while some businesses have successfully adopted one or other of the above two approaches, others have done neither and fallen by the wayside.  They will not be the first.

Consequently the flow of raw materials is changing and the process of change accelerating. The hope for a recovery in the main European tanning centres has all but faded and the move that is taking place is irreversible.

For those raw material suppliers who have monitored all global markets therefore, the shift Eastward has come neither been a surprise nor a problem. They have aligned their sales and deliveries to current levels of demand, built customer relations early and gained experience organically. Those who chose to hang on to the old ways and remained focused on the old neighbourhood (i.e. Europe) , ignored the long term trends and are now struggling to live with the new world order.

For a long time, the European hide business was supported by three main factors:  

a)      Chilled hide business for cost reasons

b)      Overseas import and export restrictions imposed import licences and health certificate restrictions

c)      The laziness of suppliers to follow markets that offered better long term prospects.

In recent years, the chilled hide business for many hide suppliers has been the only one to offer real potential for growth. Its low labour requirement, quick turnover, and fewer environmental considerations permitted small operations to increase their market share without the need for large amount of capital expenditure or investment in large storage facilities.  This is  the antithesis of  the curing and exporting processes which are labour intensive and require high levels of  capital investment.  The also demand serious storage facilities, especially if the Asian markets are involved, as well as marketing and sales skills, plus administration to handle logistics and the associated financial issues.

Now the classic ‘export trader’ which limited its activities to the buying and selling of salted hides, looks set to become a temporary survivor of the European hide supply sector.  With hardly any business left in Europe, some were able to maintain their operations with overseas exports over the past years. However, with the firm dollar keeping many hides in Europe, there was very little trade left for them to transact and many struggled to survive. But they worked at their new markets, going to where the ‘producers’ (processors, abattoirs) did not want to go because it was too much hassle.  Now they are reaping the rewards as business in Asia continues to expand rapidly.

So the world for a trader in Europe is almost perfect right now, for the following reasons.  

-         markets are not fully transparent and therefore harder for newcomers to penetrate.

-         the number of potential clients is much bigger than the number of suppliers.

-         the knowledge about markets and products is still limited on both sides, the supplier in Europe, and the client in Asia

-         non-tariff barriers in the form of health certificates and import licences continue to prevent direct supplies from all regions of Europe to the new markets.  Thus, the markets are being classically ‘managed’ by traders.

So while most other regions have already gone through the above process due to limited local market potential, Europe is just at the outset of it. Some producers have now realised the error of their ways and begun selling hides to the traders while allowing themselves an appropriate margin for their know-how. Many of the producers don’t mind this situation, at least for the time being, because they assume it will be short-lived and their hides will easily find their way to their new customers.

And the Asian tanners and traders are much more adept at finding the right sources than their  suppliers in finding the right customers. A good example is the purchase of the old Van Buren facility in Holland by the Chinese, as is the extensive travelling currently being done by Asians in Europe.

For the suppliers however, this is short-sighted. Not to know the market conditions of your customers and the products they are manufacturing is hardly a recipe for successful business relationships and all it does is support the position of the export trader.  It will not last for ever, however, but for the coming month or years the situation can be seen as being favourable to those involved.  As long as the non-tariff barriers remain in place, the longer the situation will be on their side.  Apart from the better know-how, they can also take continuously advantage of the price difference between the various European supply markets.

Let us now take a brief look at the trading situation of the past two weeks and as we expected, the market continued to trade in very narrow ranges. The US hide market continued its slide correcting the excesses of the BSE period. This was nothing really abnormal, just the expected  reaction of the market.  We must admit to being surprised how quickly customers were willing and able to change to new supply origins, however.  This was done to prevent their dominating supply source from getting ahead of itself price-wise and a lot of demand shifted to Europe. Great luck for their suppliers in that area who were struggling with their local customer base, as well as the traders who effected their transference. In this way,  a lot of the hides unwanted by the domestic tanning sector quickly found new homes and the European market was able to hold its own.  Only the weaker trend of the US dollar and the psychology of the weaker US market exerted a downward pressure on the market.

This was at variance to reports that business was not as active as the market would need to hold its levels.  And the same time, almost all sellers were admitting that they were being requested to immediately ship everything that they were selling.  We would venture that this signals a major change in trading activities.  In a previous issue of MI, we alluded to the reduced levels of speculation taking place, suggesting that was also the reason why people were feeling that there was less demand.

Now, however, we believe that the downturn in trade has been much more to do with the fact that buyers are buying exactly the volume of raw material they need. Most people in the trade will agree that sales in the past were often more a letter-of-intent rather than a binding sale.  And when the market was going in the right direction the consignment was as good as shipped when it was sold.  But when things were less rosy, the chances of sale being translated into a delivery were much less certain.  The best that one could hope for under these circumstance was that the delivery would eventually be made, but that the price would have been renegotiated downwards in the meantime . So, the contract books and export statistics were far from being an accurate guide to the amount of hides actually being delivered.  We believe that today’s figures are much more in line with reality.  Conversely, we believe that people’s impression of trading activity continues to be wide of the mark.

Let's now take our customer brief view of the skins market and here it can be seen that almost all origins reported very good interest in large economical skins from China.  Where the skins carried a lot of wool, trading levels were even better.  Larger sales were concluded while many sellers reported that they were reasonably forward sold. Strong interest was also noted in better double face material.  However, we were unable to verify this interest for ourselves. But that is not to say that something positive was not going on in the background, so we would concur that the skins business is in better shape than it has been for some time.

Most reports concerning the split business were also positive with demand and sales being quite strong.  We consider this to be related to the increase prices for finished grain leather.  This keeps splits in fashion while keeping average prices low. When we look at the prices for splits, we still feel that many of them are overvalued and could be easy be substituted by low price hides.

For the coming weeks we have no reason to change our erstwhile opinion of price developments.  Raw materials are in most cases adequately priced and we can't find anything in our analysis to suggest that a new price trend will be established some time soon.  The more positive global economy and growing sales of consumer products in the last few months would justify a rally in raw material prices, but the massive downward pressure on finished product prices and the purchasing power of the big buyers continues to make this extremely unlikely.  This is the result of extremely low price inflation worldwide.