The financial markets started the new year reasonably quietly. Expectations that different economic regions across the world would develop differently have been confirmed. The publication of the Beige Book in the United States re-iterated that, for the present time at least, growth is evident in North America and consumers are continuing to open their wallets.

Inflation is slowly starting to return in the euro zone as well as is in the United States, with inflation rates reaching levels well above 2% again. Energy costs, in particular, are the driving force behind this development. Oil prices, which had already come down to almost $40 a barrel, have risen again due to the reasonably hard winter in the Northern hemisphere.

The most interesting development, however, was the fluctuation of the greenback. In our last issue we tried to explain that the descent of the US dollar would not be a one-way street. While every forecast predicted that the US dollar would fall further, in reality it rebounded sharply and has gained more than 4% against the euro compared with the levels seen at the end of 2004. For those who followed the advice in the last issue of market intelligence, there was a good chance to prosper from the situation.

Financial analysts are seeing the rebound of the US dollar as a result of anticipation of a short-term and extended rise in US interest rates. This could indeed be true, but we think that the underlying reason for this is not only to fight inflation, but also to secure the influx of money into the country in order to finance the deficits. Whatever the reasons, we don't see that the present firmer trend of the dollar as something long-term and it might be wise to use the present momentum to protect against any foreseeable currency risk.

The exciting question of 2005 is going to be whether the Chinese Government will let the Yuan float or revalue the currency. A lot of the evidence points towards a re-evalution in 2005, but the consequences of this will be extremely complex for the global financial markets

Market intelligence

It is not easy at the moment to find interesting subjects to discuss. The market situation has become extremely static and there are no indications, at present, of any significant changes or new trends in the market. The leather world has remained stuck in rut for quite some time.

The initial weeks of 2005 started reasonably slowly. The Asian markets have been preparing for their Lunar New Year holidays and the Europeans have been slowly returning to work after the seasonal break.

Raw material prices did not change very much, but the downward pressure was lifted.  While in America the main argument for this was the low kill, most other markets have been benefiting from the recovery of the US dollar. Most reports and people we have spoken to mention that any increase in demand for raw material has been moderate, if at all. Most of the buying is being called inventory replenishment and hardly anyone is of the opinion that the leather business has improved.

More and more people analysing and checking the global market realise that there is still insufficient demand to reduce the over-capacity that has been created over recent years.  An interesting question would be whether the capacities could ever be filled by the total supply of raw materials, if the sales and the market were there. This analysis is totally theoretical, because it would hardly be possible to evaluate the total tanning capacity in the world.

Nonetheless, a lot of the drums could be filled at present with the raw material inventories that are available around the globe. The raw material available might not be exactly what tanners are looking for today, but at the end of the day this inventory is looking for customers, while many tanners are looking for raw materials which fit their price calculations. But life is not that simple, and it must be said that quality and suitability for specific products do play a certain role.

The price pressure and the gap between today's raw material cost and the market price at which leather could be sold in volume needs to be closed. In the past we have already seen that the development of technology and the flexibility of tanners and finished product manufacturers has created a certain shift in demand from medium higher quality and price products to low price raw materials. For many tanneries and manufacturers it was not even conceivable some years ago to use raw material from origins which have today become the main base of volume production. The consequences of this trend can be felt, and is reported frequently, from traditional raw material supply bases such as the USA and Europe which, for a long time, were the only raw material resource for many standard productions.

With the ongoing price pressure and the technical advances offered by the chemical industry, more options have been opened up and Brazil, for example, has today become the main feed and driving force for global mass production of consumer products made from leather. As a consequence of this, American and also European suppliers are finding it more and more difficult to place their products on a regular basis. Many of the raw materials are simply too expensive for the mass market, yet of not high enough quality to qualify for the luxury top end market. Having said that, we have to exclude some of the American suppliers (big packers), because they have another asset which today is still reflected in the price paid by the buyer. This is volume and uniformity. King-size tanneries, located mainly in China or in isolated cases in other parts of the world, require consistent volumes for their production. In order to safeguard a consistent supply to cover two or even three month’s production, the manufacturers have no other option than to deal with the mega-suppliers and to accept that they not only ask but also get a significant premium for this. Some would even say that they don't get the benefit, it is just that the other, smaller suppliers, have to pay the penalty.

Many of the European standard suppliers are also paying this penalty as the structure of cattle breeding, beef production, and hide processing does not allow them to offer large volumes of single standard raw materials. Because of this most, if not all, of the suppliers do not qualify for any bonus based on supplying large and uniform raw materials.

Since the hype of the Chinese leather industry was over by mid 2004, many European traders and suppliers have come back down to Earth and have had to return to their old customer base. The endless demand from China, which made it possible for everyone to dump all kinds of European hides into Chinese drums, has come to an abrupt end and with negative reports about leather demand, in particular for upholstery leather, for the coming months, there is not too much hope that this will return in the near future.

So, supply and demand of raw material for the leather industry has still not found an adequate balance between the different style and sizes of the companies. The process of a proper adjustment was interrupted by the short-lived explosion in demand from China last year. We now know that this was not a constant trend, just an interim period in a long-term process of adjustment.

We believe that 2005 is going to deliver many of the changes that we have talked about frequently and for which the trade has been waiting for quite some time. The European tanning industry is suffering at present from the low value of the US dollar and from the increasing cost of effluent and other environmental charges, not to mention the bureaucracy which has become one of the main obstacles in the lives of European tanners today. Consequently, anything else other than further shutdowns and/or relocations would be a surprise, because very little has happened so far. At the same time, due to the existing capacities in China, there is a need for more production, or better said, more customers and market. Since any real market growth cannot be expected, we have to either expect shutdowns over there or more production moving from other parts of the world to China.

Frankly speaking, we do not think that many of the production facilitiies which could eventually close in Europe can be replaced by increasing production in China. This can only happen if the uniformity of the leather products is going to increase further. The scale of production in Europe and the style of their products and manufacturing is definitely not the same as that in Chinese tanneries. A transfer of production from Europe is also questionable as the philosophy and the style cannot be relocated in the same way as the production lines.

We have already aired our doubts, in previous issues of the

Market Intelligence, over whether mass production of leather products in China could actually do anything to stimulate leather demand. It may work for shoes and shoe leather, because for this product leather is still essential to a certain degree. Fashion is important, but in general blacks and browns are still dominating the greater part of the entire market. However, for upholstery ‘uniformity’ seems to kill the spirit and we have to repeat that nobody really needs leather in a sofa. So, the only interesting question is if the natural growth in shoe production and consumption is going to dominate leather demand and production in the coming years. If this is the case, then there will be very little room for big manufacturers of furniture leather and furniture, while we could see a return and the growing success of more flexible and individual, smaller producers again.

We believe that we are going to see a settlement of the large production facilities in Asia, as we don't think that there is any growth potential for this type of manufacturing except in shoes. Flexible and smaller facilities might still have a bright future in Europe and definitely in the former eastern bloc countries. Good management, efficient logistics, transfer of management and nearby manufacturing facilities of finished products could become the basis for success. For western Europe and the traditional suppliers it seems that there will only be space for very sophisticated, efficient, high quality producers.

We will definitely know more about these trends in the coming year.

The split market seems to have come out of the doldrums a bit. A month of cheaper products, combined with less soaking in recent months has supported the market situation and eventually created a steady demand that is not covered easily by adequate supply at the moment. In some cases, shipping programmes can't be met and various buyers are returning to some of their old suppliers to make sure that enough raw material is going to arrive at the factories. This has not yet led to a sharp rebound in prices, but, as with hides, the downward trend has at least been stopped and the market can definitely be called steady. We would not be surprised if split prices saw a moderate increase in the weeks to come.

The sheep and lamb skin business remains very difficult. There is a steady and constant demand for cheaper raw skins, or skins which deliver an adequate return through the recovery of wool etc. However, the demand for garment leather is far below normal levels. This was reflected at the fair in Istanbul last week that did not deliver any particularly good results. The Moslem holidays with their sacrificial slaughter this weekend will increase the supply and the availability of skins over the coming weeks, so while supplies should be abundant, we have no reason to believe that the demand will increase in the near future. Consequently we think that skin prices will stay under a certain amount of pressure in the coming weeks.

We cannot see any particular reason why the general position of the market and the situation in the leather pipeline should change in the weeks to come. At best we can see some continuing replenishment of inventories and if things go really well then we might see some impetus from the leather fairs being held at present. Although we have not covered the automotive industry in this report in particular, this important sector of the industry has not performed particularly well, so there's little chance of any positive market development that could lead to more activity or higher prices. At the same time, lower kills and the firmer US dollar seem to have cushioned the market reasonably well. So, as boring as it may be, we can see very little sign of any major variation in the market for the weeks ahead. Tanners should view this as positive, seeing as stability is what they want and need.