Macroeconomics

The financial world is - as every year around Christmas – playing the ‘guessing game’.

This means everyone – whether they are asked or not - is telling the world what they think is going to happen in the coming year. This includes subjects such as currency exchange rates, stock market levels, interest rates. We’re not sure why they don’t include the weather or the lottery numbers in their predictions as the precision of forecast for these would be as reliable as for the others. However, the media is full of it and –this is also true – everyone likes to read or listen to it, because it is always forgotten in January and nobody expects the information to be more than gossip in the press and everyone is well advised not to pay too much attention to it.

Well, the forecasters feel much more comfortable this year as the self-fulfilling prophecy game has worked so nicely on the value of the US$ in the last three months. With the permission of the US government, a money-making machine has been created, called hedge-funds which sell their own currency short, depress its value and make money from it, and all with official government support. What a game. So in the afternoon US time, when the rest of the trading world is on its way home or in bed, in the USA it was selling time! So far, so good and our readers will remember that we warned a while ago  that something was going to happen due to the deficits in America. However, there is a tremendous difference between a necessary fundamental adjustment of currency value and a speculative bonanza. And what seemed funny and logical at the beginning is now getting more and more out of control and – if it can’t be limited in its extent and speed – will eventually destabilise the global economy. Consequences – unknown, but not good!

In the meantime US officials and the US$ have achieved a ‘banana republic’. Or is there any real difference at the moment between the reputation of the Turkish lira, the Argentinian peso, the South African rand or the statements of some years ago or their leaders and the ‘strong US$’ policy the US officials are claiming? Yes, there is one. No inflation yet. And this is why most in the game do not think it is dangerous and believe it to be under control. We don’t believe this, and there is no reason why inflation has to increase before a currency value drop and not the other way around.

Since Americans are not very bothered about the value of their currency, it will still be a while until the consequences for the normal citizen are felt, and in the meantime it is only a question of time as to whether the situation will become a ‘prestige’ matter for the US. We at least expect a fantastic rollercoaster ride when it gets into full swing so fasten your seat belts and wait for the unexpected.

Apart from this subject, the most interesting fact in all the data submitted was the 15% drop in car production in China in November. While production for the year is still up by roughly 6%, one can see how sharp the drop is towards the end of the year. This is another nice example of the value of market forecasts, considering the hype about the Chinese car market just a few months ago. This situation will force manufacturers to push exports of cars out of China even sooner, which is not good news for the workers in other countries in the year(s) to come.

Good news came again from the US consumer. Consumer confidence rose sharply in December to 102.3 after a rise of roughly 92 in November and a four month fall before that.

Market intelligence

As far as the leather pipeline was concerned not much happened and it was what everyone expected. Companies were busy exchanging their best wishes for the season and there were no surprises toward the year’s end. Only buyers could have initiated some activity and they didn’t.

So, we end 2004 on a very quiet note and this is what we have been seeing for quite some time now. As already mentioned in our last edition, this is mostly related to the poor state of garment and upholstery production with a more than poor performance in the second half of 2004.

In our final round of discussions with our people in the trade, we again realised how many are questioning the reasons for this, when - in general - the global economy had one of the best years in a long time. Consequently, everyone should have expected normal or average results with steady raw material and finished product prices; even more so considering that other commodity prices rose sharply if only because of the the weak US$.

How could raw hides and skins, and their finished products not benefit and remain under price pressure and is there any chance that this trend is going to reverse in the next year?

Most of our readers will claim that most possible arguments have already been put forward on this subject. This is true, but with the dominating importance of raw material price in the calculation, one has to return to this point again to debate if the time is right for a change in direction and cycles, or can one just sit back and let the market slide?

The reasons for the fall in prices in the second half of this year may just be recapped:

1. Leather demand for garment, upholstery and car upholstery leather did not meet the expanded production capacities. So, production was cut. Inventories were too high, and overcapacity and oversupply led to a price war with declining prices and falling demand.
2. Leather as a manufacturing product is not essential for garment or upholstery. The lack of quality and the falling prices did not stimulate demand as everyone would have expected. Quite the opposite. The consumer found it less exciting to buy leather products due to its fading image.
3. For garment leathers in particular, Russian import restrictions had a very negative effect on demand and due to a lack of alternative markets (specific fashion, and design etc.) many manufacturers were suddenly stuck with the production and stocks.
4. For non-US$ markets the sharp devaluation of the greenback resulted in a natural reduction of product values and has left the impression of falling prices in real terms.
5. Although demand and production in shoe and bag leathers was strong and the global brand names all reported sharp gains in sales and profits, it was not enough to offset the decline in other sectors.

Other fundamental differences such as sharply increased supply (slaughter) etc. have not taken place and destabilised the supply and demand equation.

Returning to the question of whether the last six months can just be transmitted into 2005 and whether tanners and manufacturers can count on a sustained fall in prices to keep the competition alive? 

We believe not and having made this provocative statement we would like to remind our readers that this is not a price forecast for the next days or weeks, but should describe a general trend for the coming months in the year 2005.

What are the reasons for this opinion now and why have we been recommending for some time that one should grab the chances for securing material at present price levels?

While the last months were just focussed on negative news many have forgotten that we also have a lot positive news for the year 2005. Talking to the leading shoe manufacturers and retailers, almost all of them are going into 2005 in extremely positive moods and this is based on full order books and very positive forecasts from the sales and marketing departments. No surprise, considering the growth rates in the emerging markets, the much higher leverage effect of rising incomes on the consumption of basic products (we consider shoes to be one) and the fact that fashion in the next season(s) will support leather shoes. Don’t forget, that still 50-60% of the global leather production is used for shoes or related products.

We also believe that the precautionary effects related to the problems of the upholstery sectors are rolling out. Inventories have been substantially reduced and will need replenishing over the next 6-12 weeks. Business never comes to a complete standstill and even considering the first six moths of 2004 a ‘capacity bubble’ production will not fall to less than before and this means, that after the consumption of the excess stock, normality will return – and this is more than we have seen in the last few weeks.

This also leads to a general statement. Market psychology also supports our opinion. With the constant decline of prices, market players tend to reduce their stock and delay purchasing, in the hope of further declining prices. This mainly applies for tanners. As far as leather buyers are concerned, the situation was even more pronounced by the fierce competition between tanners. Buyers not only got the impression that raw material prices were constantly falling, but also that supply at lower prices is constantly guaranteed through competition between suppliers. Why should this change then? Because many tanners have operated below profitability in the last year and have now decided it is better to cut production or even to close rather than continue to drain the assets in their companies.

Another – even more unpopular – opinion is that we don’t believe that the fall of the US$ will continue throughout 2005. The speculative bonanza is not over yet and we can still expect one or two other surprises, but with the whole financial community (polls are showing over 60% of the experts are predicting a further fall by about 10-20), we think that the need for adjustment which we always alluded to will be fulfilled and the focus of interest in 2005 will be on the revaluation of the Chinese Yuan that will eventually support the US$ as well. Even without this, the US currency needs a better ‘image’ to attract enough investment to pay their bills. So, in 2005 one is again well-advised to watch the currency markets carefully and to consider, in detail, the effects of changes.

The split and skin market we will leave out in this issue as very little has happened and nothing exciting that it warrants a mention. A lot that applies for the hides market can also be said for these two segments of the leather industry.

The weeks will give us a slow start into 2005 and the only interesting fact will be to see if the Asian buyers find the time to come and replenish their stocks and to start a round of purchasing for their return after the New Year festivals. We think this could still take until mid or end of January.

We wish all our readers a Very Happy New Year!

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