Automotive industry and consumer confidence drive markets
Macroeconomics
The last two weeks have delivered general information to guide one through the jungle of economics. However, the information did not deliver any clear signs as to which direction to go in, and arguments in favour of all directions were plentiful.
Leading brand and luxury names delivered very positive results. Adidas, Nike, Yue Yuen, Gucci, and Prada were just some of the names delivering positive figures regarding turnover and profits. Whilst these results reflect what has already happened, the forecast for the last quarter of the year is also quite promising.
Estimates for the growth of the global economy are working on an increase of 5% for 2004 and around 4% for 2005. The
Oil prices stayed around the $50 mark and the currency market saw a slowly weakening US dollar.
Consumer confidence declined by 1.9 points from August to September in the
Stock markets fared quite well through the traditionally difficult month of
September and many forecasters see a good chance of a firmer period in the last quarter, despite the high oil prices which could weigh on company profits.
Although the presidential election in the USA is getting closer, there is still no clear indication on how the financial markets will react and who they are favouring. The polls still see Mr. Bush in front while Mr. Kerry made up ground after their first TV encounter.
Market intelligence
The last two weeks delivered a weaker market trend we than expected in our last issue of Market Intelligence. Prices in most markets continued their decline, which is not illustrated accurately in the official price lists which are circulating today.
Sellers are trying to defend their price levels until the very last moment, because they realise that merely lowering the asking prices would not stimulate demand at the moment. Tanners who needed to buy, did make purchases, but this was definitely not enough to satisfy the wishes of the sellers. However, it was pretty obvious that the leather pipeline was still waiting for a clearer picture about orders and prices before making any final decisions on how to replenish and to plan purchasing for the coming weeks.
So, we believe that the volume of trade was much less than one would expect for this time of the year. We have already been suspicious in the past, that the production cycle for the winter semester is starting a little later every year. In 2004 we have additional reasons as to why the industry is still reluctant to make final decisions. The high oil prices and the uncertainty about the prospects for the global economy are making decisions even more difficult than before.
However we feel that the mist in the crystal ball is now starting to clear.
We believe there are two trends which also tend to slightly alter our view. First of all we think that the outlook for the automotive industry has become gloomier. Everyone following media reports is already informed that the markets and manufacturers have been affected by the difficult times car sales have had in the leading markets like the USA and in parts of Europe. One thing that is clear is that the industry is fighting over-capacity and even the increased use of leather cannot compensate for the inventories of cars that have already been produced.
Despite many new models, and the success of some brand names which traditionally consume a lot of leather in the production of their cars, insufficient sales have forced many carmakers to cut production. Large and reputable automotive leather manufacturers in Europe have significantly cut production in response to lower orders and indications from their customers. The same applies for the USA.
The rising star, China, has also not performed as expected in the last quarter. The tightening of credit policy by the Chinese government has reduced spending on new cars and the reduction of prices has added to the slowdown in car sales. Buyers feel that they are now well advised to bargain and to wait for further discounts to come. Consequently, the number of unsold new cars continues to rise, although forecasts expected a substantial growth for the running year.
As a result hides sales for automotive leather production have also slowed significantly after having been a strong sector for European and American shippers in the first half of 2004.
The second trend we see is the widening gap between the prices for consumer products in necessity production and the luxury end. We have dealt with this phenomenon before, but it seems that the erosion of the medium price and quality segment is far from being over and has in fact accelerated again. Some will definitely claim that this market segment had already been totally destroyed and that it is just a price reduction in the volume of business as such. At the end of the day it makes no difference who was right as the result is the same - falling prices for leather and consequently less power to demand today's asking prices for raw materials. Rising oil prices add another problem to the situation.
Tanners’ only option is to get their calculations right and this means lowering the cost of raw material which accounts roughly for about 50% of the finished leather cost. Energy prices and chemical prices already have or will also have to rise.
The situation would be more complicated, if there was a shortage of raw material available around the globe. Many argue that this has happened with the decline in slaughter in the United States. Since this is the only raw material market in the world which delivers reliable weekly statistical data, many watch this without realising that other supplies have easily compensated for the US reduction. South America is easily filling the shortfall. Supply is balanced out, as the reduction in production in Europe has also created more availability for the rising production capacities in the East - at least for the moment.
This leads to another development which can now be seen much more clearly than in the first half of the year. We were always suspicious as to whether the growth of production capacity in China was covered by demand. It is becoming more and more obvious that factories have been built without having a solid market base for their products. This means that although the drums and capacity were filled in the first six months of the year, this was not covered by a solid client base. The expectations for market growth, in particular in furniture, have been too high and now leather producers are struggling to find enough consistent buyers. Consequently, finished leather prices are coming under even more pressure, if sellers can find any buyers at all.
The only bright spot one can find in the market at the moment is the leather goods sector. Handbags are the main attraction with ladies and this applies, in particular, to the medium and higher end of the range. Global brand names are all reporting solid growth and good profits. This is good news for those who have the right hides for this purpose. However, it is only a small part of the industry and consequently has no general influence on market development.
The conclusion is that despite adequate demand for finished leather products, the global pressure on finished product prices continues to weigh heavily on raw material prices. Rising oil prices, and the uncertainty about the outlook for the global economy has resulted in shrinking margins and has made buyers more cautious and more price sensitive than ever before. The growing demand for luxury products cannot compensate for this trend.
For the moment tanners have moved towards cheaper raw material origins. As long as these are in sufficient supply, other supply origins will have to deal with the need to adjust their price levels. Unless there is a price incentive, tanners will not risk replenishing their inventories above their current needs.
Nobody should get us wrong. We still believe that the demand for leather products is quite good and we have a fair chance of a good round of consumer selling in the coming season. However, prices are decided for the moment, and for the time being the buyers - that means consumers and retailers - still have the upper hand in the fierce competition between producers, giving them every chance of winning the battle. Our concern that rising inflation could eventually also lead to higher prices for raw hides and skins as well as higher prices for finished leather can be ruled out for the next quarter. The problem has definitely not been solved, but most likely only postponed.
A brief look at the other markets gives us a similar impression.
The split market is also seeing much more pressure on prices and this was definitely triggered by the bankruptcy of an Italian split merchant. We had already considered split prices to be overvalued for quite some time but obviously a clear signal to the market was needed to force a readjustment in price levels. Prices came off in the range of five to 10%, but we believe that the situation is close to settling down now.
In the skin markets a lot of interest in cheap skins is being shown. The main problem is that tanners can't find many skins at the price level they are looking for. The double face business is heavily burdened by the air cargo restrictions imposed by the Russian government. This is weighing massively on the Turkish industry that depends so highly on the small trade into Russia. Not only is the “suitcase” business affected, but the large producers are also struggling to ship their product on time for the start of the new season, due to the restrictions.
For the next two weeks we remain cautiously pessimistic as far as price development is concerned. The medium price hides from Europe and the USA will struggle most to hold their levels. Even though many of the sellers are complaining about this, they should not forget that we are still in the price range which we have seen for the year as a whole. Even a decline of another five to 10% would be nothing extraordinary as many hides are reaching levels which we saw year ago.
We should remember that last year in November and December, the market was also facing a lot of price pressure due to the competition and the price problems retailers pretended to have. Only the BSE crisis in the USA changed the market pattern and allowed prices to trade at the upper end of the price range for quite some time. Assuming that we are now in a similar situation and we don't expect any similar reduction in supply, it does not take a lot of courage to predict that hide prices could see a further adjustment.
Having said that we would like to repeat our opinion of previous issues of Market Intelligence. When hide prices decline it has always been wise to lock the margin in and not to gamble and speculate further gains. Last year illustrated how quickly the supply situation can change through adjustments of external influences and this means that it is far better not to take the chances.
From the demand side we have a lot of positive indications. Global growth continues to increase, house sales in the United States continue to be at a very high level, shoes and leather goods are the classical small ticket items which normally sell better when times are quite uncertain.
So, we continue to believe that the present pessimism is temporary and that the general business environment will brighten up from now until the end of the year. All this will, however, be hypothetical if the terrorists in this world are successful in really scaring the global society again.
