Market Intelligence features

The Leather Pipeline 22-03-04

Macroeconomics

The main event of the past weeks was not  business or finance related but the cruel, cowardly and disgusting terrorist attack in Madrid. As of today it is reasonable to assume that al Qaeda was behind the bombings and so the terror has finally arrived in Europe. It has shown that everyone, everywhere in the Western world is a target now.

After commiserating with the victims and their families, the world quickly returned to normal, at least at a superficial level.  Because beneath the surface some ripples could be seen as the dollar recovery was firmly stopped in its tracks and stock markets in Europe took a nosedive. In our view, however, this was just an exaggeration of a trend that had already begun. The optimism previously displayed by  political leaders, bankers and businessmen in relation to the EU economy has lost substantial ground. 

The stock markets, whose job it is to run ahead of  developments, were previously upbeat. Now they are taking a break, as if to evaluate whether that optimism is eventually going to be justified.

We continue to be much more cautious about the economic outlook in the EU, because the fundamental problems have still not been resolved and the results of the expansion of the community have yet to be seen. It could be that the new distribution of wealth will have more positive than negative effects. But if one looks at the forerunner of this process, the bringing together of East and West Germany in the late 1980s, the omens are not good. A once-strong economy has become larger but also weaker at the same time.  But the situation is not the same and so let’s think positively and hope that expansion of the EU will be more successful than that of the German economy.

Worrying is the trend in oil prices. Terrorism, speculation and the hunger of China for energy are the driving forces behind the jump that has been seen in oil prices. OPEC is fully capable of increasing production to keep the rise under control. If it does not turn out to be a temporary blip, the rise in oil prices could quickly become a burden on the global economy. Fortunately, we are heading towards the summer in Europe, the USA and Asia, so there should at least be a seasonal decline in demand.

Market Intelligence

The last weeks were again not really full of news and great excitement as the market developed mostly according to expectations, being slightly weaker in most grades in the USA and steady in Europe. The US was again fairly depressed with reports of limited activity and falling prices but, as in previous weeks, this did not really tally with the actual figures or the reality of the wider picture, as export sales in fact stayed high. How anyone can sell more than half a million hides in the space of a week and then complain about low levels activity is beyond the comprehension of this European observer. Maybe one day we will understand.

Nevertheless, the facts and figures speak for themselves. We dealt with the content of the various USDA reports in our previous issue and therefore have little to add.  Admittedly, the number of market players is shrinking but then the size of the deals being struck is also rising. In the past, it needed ten times the number of single contracts (customers) to shift the same quantity that is today taken by  a handful of clients.  And it is possibly because of this difference that we are now hearing so much about reduced levels of activity. We know we won’t make a lot of friends in the trade by saying it, but we believe that those who say business is down are giving quite the wrong impression. The actual volumes are the same as they have always been.  Regardless of who’s right or wrong, the future will tell us the truth.

Our European sources have delivered mostly satisfying results in terms of sales and levels of interest and for the first time in a long while, Italy is being mentioned positively in dispatches. It appears that finally, some of the larger tanners have had to replenish their inventories. Continental cow suppliers and UK and Irish suppliers have advised of more interest from Italy and this can be seen in the raw material price rises that have taken place in the country, which rose by several percent .

But while it is tempting to see this as the start of a firmer raw material market, we believe this is not the case. For some time now, there has been a large gap between prices. Not just in terms of  the same product in different markets (e.g. European dairy cows in Italy and Asia) but also between different products in the same markets (e.g. UK and Irish hides). What we are now seeing is a narrowing of these gaps. In previous editions of MI,  we explained how these differences came about in the first place. But we also showed that at the end of the day, the raw material market for hides and skins is a virtual closed circuit. Imbalances are always sorted out – sooner or later.  As ever, the best policy is to follow the real valuation of the hides, not the surrounding sentiment.

So, in the last weeks, what we have mainly seen is an adjustment in prices that has long been overdue.  It was not the start of a ‘bull’ market, triggered by some major improvement in demand or an upsurge in leather prices.

The key question that many people in the market are now asking is: ‘How is it that raw material prices are staying low or are even in a state of decline when all reliable sources indicate good sales with steady demand?’. In the past this was always a clear signal for raw material sellers to get greedy in their attempts to raise their prices. But not now. At the end of the day,  the market is neither firmer nor weaker. What is occurring in price terms is simply a reflection of the leather production.

Those selling hides suitable for furniture in the medium-lower price segment are finding demand pretty good and consequently have a positive viewpoint of the marketplace. Sales are strong and in some cases, demand is even outstripping supply. However, those selling hides to the medium higher sector, both in terms of shoes and some parts of the furniture business, are facing massive price pressure. The sales potential and purchasing power of their customers has become strong to the extent that they have been able to squeeze prices step by step. One simply has to look to the financial results of a company like Nike, (profits up by 61 %) and their sub-suppliers to understand what is happening. Suppliers to the automotive tanners are  being similarly pressured. This explains why for example dairy cows and dairy steers are holding their levels and the classical medium/higher ox are facing so much pressure and difficulty.

One consequence of this is that hides are once again increasingly being priced in terms of sq ft. of raw material. This is exactly the reverse of what we reported upon three years ago. At that time, easy spending and the boom in the ‘new economy’ meant sellers of high quality hides could command virtually any price they liked and, as a result, the spread of hides prices was massively expanded. Now, the cycle is returning to where it started from.  And so it goes.

While raw hide traders and processors have understood the new market environment for some time, beef producers have been slower on the uptake and have yet to realise that their ability to ‘make’ markets is on the wane. It may return one day, but this is unlikely in the short term.

So what does the market need to see a return of higher raw material price levels? Many in the leather business will not like what we say in the next paragraph, but it needs to be aired. In our opinion two main market developments would make it happen.

The first is simple. Demand for hides continues to rise, physical inventories are absorbed, options to substitute leather with other products or obtain more raw stock resources are exhausted and the gap between supply and demand widens.  In this scenario, to meet higher level of demand, producers have little option but to raise their prices for raw materials. But this is conditional on what happens with inflation.  If inflation stays low, then consumer prices will remain under massive pressure and leather products and their related raw materials will have little opportunity to break out of the weaker to steady trend that has been in place for some time now, even if there are some spikes in prices along the way.

The second scenario is a bit more complicated. Although leather has lost none of its beauty, it has lost some of its prestige becoming ‘just a material' in some sectors. The strict boundary that once existed between leather and fabric or other materials is crumbling and its status as a premium product is only intact within the high-end luxury segment, which of course has a very limited influence in the wider scheme of things. The trend started with garments, with shoes following together with furniture. None of these segments are inclined anymore to offer leather at a premium and the material has been sacrificed on the altar of price, particularly by the global brands and retailers. The emergence of the mega productions in Asia has only served to speed up the process. With the automotive industry now following this trend, the last line of exclusivity is now being eroded.

The business world sees this is an irreversible trend. Well, this might be true for the moment. However, the day inflation returns and consumer spending starts to grow in the Western world, there will be new opportunities for fashion. Fashion will once again become the driving force, allowing prices for leather and raw materials to return to higher levels again.

Inflation and the price of leather substitutions are also highly correlated to the price of oil. With the sharp increase that has been seen in oil prices recently, it would be advisable to keep an eye on this variable, even if its short term effects are limited. 

A brief look into the other markets shows a steady demand for splits and steady prices. However, we are hearing more and more that split prices could face some downward pressure. While we think there are good reasons for this, for the moment we consider that splits will remain within the trading ranges that have been in place for some time, along with hides.

The lamb and sheepskin markets have started to show some signs of life. At least in Turkey where the new production season has started and the ‘scouts’ have been dispatched to source material, preferably of the ‘New Season’ variety.  This has created much better interest and all the signs are that skin prices will soon start their seasonal climb. The firm wool market is also taking on a more important role and the calculation of the wool return is becoming more important by the day. We wouldn’t be surprised to see rising prices for skins over the next few weeks and emotions will determine how far the trend will go. As far as finished product prices are concerned, however, the potential remains limited.

For the coming weeks we are extremely cautious in our outlook. Anything can happen and in our view and tensions are rising. If buyers and sellers have already made their commitments prior to APLF, than we should see a relaxed and uneventful fortnight ahead of us and to be quite frank, this is what we would prefer. Raw material prices have in most cases found a basis the trade and industry can handle and the gaps and spreads have normalised.  But if European prices were to be pushed higher by some enthusiast, we are quite sure they would quickly run out of steam and sales would become difficult. US prices have come down and the premiums they unjustifiably realised for so long have almost been eroded.

If, however buyers are in a ‘need to buy’ position and the feedback from trips and the show in Hong Kong are positive, asking prices could rise quickly. For the reasons stated above, we would then see dark clouds gather for the leather business. We don’t see any opportunity for leather prices and finished products to rise in 2004 and so any move toward higher raw material prices would simply end in the usual market turbulence, with no benefits except maybe for some speculators.  All things considered, we think Option One has more chance of becoming a reality.   As the leather industry would appear to be becoming more responsible in its pricing actions, we  hope this is not just wishful thinking.

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