Macroeconomics

As far as general economic data was concerned, there was little of interest during the period under review (May 18-June 1 2004). All the larger economies produced slightly better results with Germany, France, Italy and the Netherlands posting moderate expansion in their economies while Japan continued its moderate growth. Oil prices remained high and are likely to rise further after last week’s terrorist attack in Saudi Arabia. Worries about high oil prices have reached the general media and the minds of politicians and economists.  OPEC is starting to talk about the long term effect of an exaggerated price for oil.

The fear of inflation is rising too. Many manufacturers are already preparing their markets for what they expect will come. Prices for energy and steel are already sharply higher. Prices for plastic will follow soon, as will many products which are related to these basic materials. It will take some time, however, because prices need to filter through the supply chain, but under present conditions, it is inevitable. Examples include household goods, home appliances, while cars face massive problems, not just for their content of plastic and steel – but also their consumption of energy.

Market Intelligence

The hide market continued its orderly readjustment.  The long term decline in US steer prices ended as asking prices rebounded. Sales and exports remained at very high levels, meanwhile, underlining our view that leather business continues to be good. In Europe, the business was mainly determined by tanners filling production holes created by the speculative activities of some of the bigger players, on the back of falling raw material prices. But they waited too long, making the classic mistake of not believing that raw material always find its way to interested buyers, and no-one ever buys on the basis of doing someone else a favour. This, combined with some very low kills, temporarily gave European sellers control of the market. Prices were steady and, in the case of some specialty products, firmer.

Central Europe apart, consumer product sales in the latest season have been strong, which means inventories will be comparatively low and expectations reasonably positive. This applies at least to the markets for shoes, furniture, leathergoods and maybe even garments. A question mark hangs over car sales, however. While the Asian market is still strong, more and more clouds are gathering in the US and Europe. Manufacturers have positive expectations, talking about export possibilities and aging fleets. Market analysts are much more concerned, however, citing higher fuel prices, rising interest rates and reduced family budgets. In the US, unsold cars have already reached a worrying 80 days of stock and this cannot be ignored.  Rising fuel costs are also a worry, as are increasing interest rates.  Both are likely to drive down the demand for cars.

Dominance

This can already be seen in the price of classical hides for automotive use, in the US HNS and in Europe, where comparatively cheap bull hides are beginning to experience firmer demand from other segments of the leather industry. The demand for hides and leather in automotive applications is not showing the dynamism that might have been expected. The mounting pressure on leather prices in the automotive industry is also becoming apparent.

The rise in the price of preferred raw hides in Europe is not just explained by the low kill, however. Bull hides, for example, are becoming more affordable for the makers of vegetable and higher quality shoe leather.

This might also be one of the mega trends for the near future. The dominance of auto tanners across many raw material grades is fading. These are the guys who in recent years have had first pick of the most select raw materials, not least because their selling prices always allowed them to outbid every competitor. The available evidence suggests that the medium/lower end-and this where the big volumes in automobiles are to be found–are no longer delivering substantially better revenues than their shoe and furniture leather counterparts. Normal competition is gathering momentum, a factor which in turn means specific premiums for standard hides should not be expected in the foreseeable future.

Our main issue for this MI is however the fascinating development surrounding US steer prices which have returned to the trading range of $60-65. In our view, this controlled retreat to economically sound price levels-without allowing speculators to take control-is a masterpiece of control by the big players in the market.

While most of our readers will object to this view, the fact remains that, for the moment at least, there is no central market control by any one individual or organisation. Consequently, nothing except the relationship between supply and demand is dictating the price trend of the market.

Transparent

As we have stated in previous editions of MI, most parts of the market can afford standard raw material as it is exactly within this price range. Better on the lower side, but life isn’t perfect. On the other hand, packers do not operate within price bands. In their attempt to optimise the revenue of the by-product, they understandably try to get the best prices they can at all times. However, apart from the short term price target, producers of hides also have to ensure that their sales and-even more importantly–their shipments, are as regular and steady as they can be. With the increasing capacity of their clients, the markets are becoming more transparent and, with more and more company results being made public, suppliers today have a better feel for adequate, sustainable price levels that guarantee a steady outflow of their production.

Looking at the results of leather retailers, particularly the brand names, it can be seen that the rise in their profits over the past year has been remarkable. They have taken full advantage of the lower raw material/leather prices and the shift to lower production cost areas. When competition in the leather production field declines as a result of the concentration process and rising raw material prices, they will be the target of higher prices rather than pressure building on raw material prices.

Returning to the price range for hides, we believe that the large producers of hides in the USA have woken up to the fact that selling their hides is conditional upon a) an adequate price and as a result b) reduced market volatility. Since contact between the major players is today more direct, market information and analysis is adequately available and the relationship between equals in size terms is at the moment leading to more co-operation and communication. We see a more planned price rather than the classic raw material volatility of the past. Tanners are creating more of their own raw material mix between the cheaper and/or more expensive raw material origins to optimise their average hide price. This applies only in periods where we have an adequate balance between supply and demand – something which we have now had for quite some time.

Calm

We believe that market players would be well advised to preserve this period of relative calm for as long as they can. It will need tremendous discipline to keep the speculators and greed out of the market. So it wouldn’t be easy, and would very likely be unsustainable for a longer period of time. At present, however, the market is still being guided by the general pressure on leather prices and only a general trend towards higher prices (inflation) could, in our view, break this control.

As already mentioned in our macroeconomic section, however, inflation is lurking around the corner and this will have a double-edged effect on hides, skins and leather. On the one hand, inflation absorbs purchasing power, as is the case now when energy is a major factor in higher prices.  At the same time, however, the remaining disposable income can be spent more readily on products with a smaller price tag. This supports the demand for ‘value for money’ and longer lasting products. This poses a massive threat to the present discount mentality which does so much to support the ‘throwaway’ mindset of many consumers.

If our scenario is right, this would mean in the medium term a strong support for ‘good quality’, ‘well made’ timeless products that you can make so nicely with leather and the manufacture of shoes, bags, accessories and furniture.

After this philosophical excursion we return to the hard facts in the lamb and sheepskin market. As far as we are concerned, there were not too many changes and reports remain pretty mixed. However, interest from China was reported while demand from Turkey started to slow with many tanners stating that they couldn’t afford the prices for new season lambs. In summary, the market is pretty steady with spot deals determining the prices levels.

Resistance

The split market did not provide much excitement either. While splits are still finding buyers, the business is becoming more selective and only good quality splits, well flayed with adequate substance are still being readily absorbed. The lower, thinner end is facing increasing resistance from buyers and we would not be surprised if prices started to ease. Having said this however, we are just looking into the leather segment. Lime splits for gelatine supply will enter into shorter supply towards the summer. Despite the attempts of the gelatine industry to regain control of prices, shortages could quickly support the market for lower quality again and one will have to watch the next weeks carefully to get a feel for who is going to win the battle. At present, the gelatine producers would seem to have the upper hand, but we will have to wait until mid July for a clearer picture to emerge.

The coming weeks will be interesting. For the moment, sellers have regained control of the market and will try to push their prices higher. As long as prices stay within the certain frame we are not worried as prices are never fully static anyway. However, we don’t think it is the time yet to challenge the market too much. It is not yet ready for a new and higher level and attempts to push prices up would definitely reduce demand, starting the whole thing over again.

In our view, most parties are aware of this danger and therefore see little opportunity for a sharp upward move. Prices can therefore be expected to remain on the firm side of steady, which is probably the best that can happen to the market prior to the summer slowdown.  This will help avoid the need for renegotiating sales booked in the past months and which will need to be shipped in the near future.

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