Macroeconomics

As regular readers will know, in the past six to eight weeks, we have not placed great emphasis on macroeconomic issues in terms of trends in raw material and leather markets.  But now all that has changed.

An important factor in day-to-day trade during the period under review (Monday February 29 – April 8) was the substantial strengthening of the dollar against the euro. In our previous issue we indicated  we were expecting a sharp correction in the greenback and so it came to pass as the currency gained 5 % on the euro. Other currencies were also sharply affected by the dollar’s new found firmness. However, the less than expected positive news from the US labour market on  Friday stopped the optimism, setting the dollar back by 2 %.  We think the high volatility of the currency market will last a while longer and therefore obviously needs close monitoring by those in the leather and raw materials markets.

The European Central Bank and the US Federal Bank left interest rates well alone and this begs the question what their next moves will be.  Most analysts recommended a hike in US interest rates and a lowering of them in Europe, moves we consider appropriate to the current economic conditions.

There was confirmation of sharp growth in the Asian economies. Despite the fact that the US, Europe and Japan still account for most of the world’s purchasing power, the substantial increase in consumer spending in the Eastern European economies should not be overlooked either. Germany delivered again disappointing news on the consumer front with a decline in private spending of  2.9 % in January. From a Western European viewpoint at least, it is becoming more difficult than ever to monitor and evaluate the influence of the global retail environment on our business.

Market  intelligence

The biggest development of the review period was the rise seen in US hide export sales.  Between February 26 and March 4, raw and wet blues together amounted to well over 1.5 Million units. As usual, the trade displayed its usual scepticism with regard to the figures.  While we  believe the figures were far from perfect, we nevertheless considered them accurate enough within the normal frame of statistical discrepancies to be credible reflection of the normal sales and flow of product from the United States.

But the fact remains that they were greatly at variance with US industry reports for the period.  These drew a picture of low activity and sales and sounded pretty pessimistic

There are three main problems with the daily reports as they are issued at present.

a)      Most of us need them.  It is impossible to follow everything that is happening on a day  to day basis in the market without them. The information they impart is absolutely essential for the decision-making process. So whatever deficiencies they may exhibit, we absolutely cannot do without them.

b)      Many reports are published by members of the trade. With all due respect, it is very difficult for them not to be influenced by self interest and their respective business situations. The potential for the creation of ‘self-fulfilling prophecies’ is also there.

c)      Those analysts who really are commercially independent are still dependent on external sources who might well be subconsciously swayed. It is certainly a better situation than that which applies in b), but still difficult for them to provide a truly impartial viewpoint, especially if they only make use of a limited range of sources. Not being an active member of the trade also makes verifying information in the short time frame of a daily publication extremely difficult before publication.

But this still doesn’t explain why there should be such a gulf between the statistics and the various sources that we have spoken to, especially since everyone would appear to have good reason to justify their standpoint.  

If  one’s starting point is rising prices = good market conditions and falling prices =  a bad market, then the pessimists who hold sway in the USA could be seen to be justified, the assumption being that falling prices are the outcome of reduced activity.  Others say it is the falling prices that have stimulated demand.  Both are agreed that business is not good and this is the reason why prices are falling.  But this would be to overlook the fact almost all of them base their findings on quoted prices. Since when have these ever been a reliable indicator of anything?  

Our view is that the dramatic fall we have seen in quoted prices is the outcome of traders successfully persuading their suppliers (packers) of a weak market, so as to cover their short positions at a good profit.  The actual prices paid are likely to have been higher, where agreements have been concluded. 

In earlier versions of the MI we discussed how the leather industry was moving from a ‘push’  model of  production to a pull scenario and how the power of the bigger retailers and brand names was rising. On top of this, we described the continuing consolidation of ownership within the industry and the cutting out of the middle man between the hide producers and the tanners, especially where large organisations were concerned.

This latter point would appear to have led to a better understanding and higher degree of trust between the two parties. In an attempt to move their output of hides, sellers have become much more understanding of the margin problems experienced by their clients and the exchange of information between the two has become much more open. Whether or not one supports this scenario, one side effect is that those traders who do not add value to their services will struggle to justify themselves in the new landscape. 

So what is our main reading of the market as it stands? First, we feel justified in our view that the leather business globally remains on a sound footing. Second, the massive price pressure on finished products is preventing speculative purchasing of raw materials so their prices will remain low. This is becoming more like the relationship that exists between the leather and beef industries.  Here, the leather producers have been successful in convincing their suppliers that the disposal of their most important by-product can only be safeguarded in the necessary volumes, if the prices they pay meet their calculation targets.

The BSE case in the United States, followed by significantly reduced slaughter tempted gave some sellers reason to believe that the shortage of raw material could be translated into higher prices and in the past this would have been true.  In those days, speculation was more readily triggered by smaller units and the influence of the trade. Prices would be raised without a realistic chance of them being translated into higher leather prices.  This time however -  and this is the main point to be made -  the leather industry has acted in a much more mature fashion,  resisting the temptation to hike prices while taking appropriate action to keep its suppliers under control.

Two years ago we complained about inflexibility of the leather industry in using different raw materials, something that we said would allow them to exploit the big price differentials that occasionally arise around the globe. This time around they did, as evidenced by the fact that demand was quickly switched from the US to Europe. Tanners also stuck to their minimum requirements, making it clear that they were unwilling to bear losses from a situation with no clear outcome.

This has not only led to new era of technical flexibility, but also accelerated the trend toward declining inventories. What started in 2003 as a move to save capital and other costs was intensified by the leather industry’s cautious handling of the low kills in the United States. With the arrival of more steady business even a positive outlook for the remainder of 2004, however, the leather industry has at last been forced to act.  The beef industry has had no option but follow suit in order secure the shipments of its products.

The results can be seen in the large volumes traded over the past weeks, not only from the United States, but also in Europe.  With the deep crisis engulfing the European tanning industry, the Asian buyers were able to take full advantage of the new situation, convincing their suppliers to accept the realistic price offers made, so as to secure their shipments in the near future. The split market continued on the same course as before.  Prices were steady to firmer and demand in particular from Asia continued to be strong. Splits remain popular as a cost-saving alternative to leather, although we still consider them overvalued. However, the trend continues and we can't find any argument as to why split prices should change or fall in the foreseeable future.

The demand for lamb and sheepskins continued to be good and the shortage of material in Australia and New Zealand is now showing through in the rest of the world.  Turkey and China are showing good interest but are resisting the higher prices.  Apart from the record price levels being attained in Australia, other supplying markets have had little success in increasing their prices on the back of the shortage. If the demand for leather continues to be as good as it appears for the moment,  however, there is a fair chance that sooner or later other origins will benefit from the situation.

What do we expect for the coming weeks? Well, we don't have any reason to change our outlook. While hide prices are on very safe ground, leather demand remains good despite all the complaints one hears from around the globe.  One part of the world may well be doing better than the other, but all the fundamentals are much better than they were a year ago.  For all the reasons mentioned above therefore, we believe that for the moment at least, the leather industry has  good control of the market.  Declining kills in Europe are easily being compensated for by higher kills in the United States and, despite the fact that the second quarter of the year traditionally sees a bit of slowdown of production, we remain very positive about leather demand in general.  We believe this should be enough to prevent from sharp rises in the raw materials market.  Looking at the market from all different perspectives we still find very few reasons why raw material prices should leave the trading range they have occupied for some time. We are just a bit worried that inventories might  not be sufficient to meet leather demand in the short term.

Traders and also tanners may well be reporting variations of up to 10% and there’s no denying these are big movements. But if the hide market can be held steady for another three months in the same price range as now, we will see a lot more stability then we are used to.  In other words, we are getting very close to achieving one of the main items on  tanning industry’s wish list, which is long-term price stability.

The markets outside the US dollar region might see more changes due to the currency influence. In that there is very little that can be done about this, however, we can only repeat our recommendation to take great care in this regard.

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