Macroeconomics

The global economic forecast for the next 12 months, published by The Economist, looks reasonably good. The USA is expected to report growth of more than 3%, while the Euro Zone and Japan are expected to remain in the region of about 1.5-2.0%. With emerging markets, including countries such as Brazil as well China and India, set to report strong growth, the outlook for the global economy is quite positive.

In our opinion, however, a question mark still hangs over oil prices. The price per barrel continues breaking record upon record and other commodities are also climbing. Steel prices, as well as energy, are one of the strongest worries at present. This could eventually cause a rise in inflation. We have the anticipated increase in interest rates in the USA next week, and although this would combat inflation in the long term, in the short term it would lead to an increase in cost and prices.

The US$ oscillated up and down showing no clear direction, but still remains well above 1.30 against the euro. There might be a slight change in the currency ratio in the medium term.

With a new agreement on the stability pact, the EU governments have basically given the green light for a further increase in national budget deficits in the Euro Zone. If the FED in the USA is going to raise interest rates (an expected 0.25 %) next week, the greenback could see support and this could even turn the trend against the euro despite the unresolved deficit problems in the USA.

Although the trade deficit hit new records last week, it would only require a few positive figures in the coming weeks or months to change the sentiment of the currency market.

At the moment the market is definitely walking on a razor’s edge and one can sense that although the players are looking for a new trend, they still haven’t decided which way to jump. However, we believe that one would be well-advised to go against the common opinion at the moment.

Market intelligence

The market in the past few weeks has been similarly uneventful as in the preceding weeks. Everyone is still expecting a new direction to become clear; however, as yet this has not happened.

In most of the world markets things have turned pretty sour.  The only bright spot remains the shoe upper market where fashion and the general global demand for footwear is keeping things moving. The big brand names and the big shoe manufacturers are, on the whole, reporting good sales and profits as natural growth is keeping them on track.

Most of the other leather segments remain in the doldrums.  It seems our fears have proved to be true as the global demand for leather products in furniture and garments is insufficient. We have to conclude that sales for this kind of product have fallen even despite the fact that the world economy is generally in good shape. 

We should not forget that we are coming to the end of the season. The low season for garment and upholstery leathers runs from April to October and we are fast approaching this period. Some activity is still sometimes seen around the fair in Hong Kong, but even this does not seem to be triggering anything this year.

So, only the market niches and the specialists can defend themselves against this trend and maybe some of the well-established global leather manufacturing organisations. The traditional medium-size local tanning operation is finding it increasingly difficult to maintain its position and to run a profitable business.

This might sound pretty pessimistic and we have to admit that we are now more cautious than we have been at any time over the past six months. It is hard to accept that there is so little positive news to find at the moment, but almost all of the concerns that we had about leather as a product in the consumer section seem to be materialising at the moment and this season, at least,  seems to have been lost for many producers.

Having spoken to many producers and manufacturers of fashion products, a fair number of them confirmed that leather is only playing a role in high end fashion where some level of prestige has been maintained. The rest of the consumer market has downgraded the image of leather as a material. Consumers are no longer attracted by leather as a material as they were in the past. This applies particularly to the medium and lower end mass production of consumer products.

Although many still argue that this is not true and will find examples to prove it, we believe it makes very little sense to ignore the facts. One good thing about the situation is that leather has always been a cyclical product and there's no reason why it should continue to be.

It is simply tough because the general downturn in the appeal of leather has happened simultaneously with the massive expansion of production capacity. We have known about the price consequences of this for a long time, and the consequences on image are now becoming clear. Leather is probably one of the few products that has lost a lot of its value due to the shift of production to low cost countries.

As long as leather was identified as being an artisan product, made predominantly in the fashion centres such as Italy, Spain, Turkey, and the beauty of fashion and of the product were recognised by the consumer. However, with a move to mass production in other countries and the ensuing price wars, the reputation of leather was definitely damaged.

The big question we have to ask now is whether leather can regain its position as a manufacturing product and if it can once again be integrated as a valuable consumer product. If not, what could replace leather - not only as a material, but also at as a high value product?

The main problem, in our view, is the fact that in many cases the raw material prices at present do not reflect the situation in the finished leather market. The gap between the very limited top end, luxury market and the volume of production has become too wide. The increasing specialisation of the tanning industry is making the use of the material produced more and more difficult. Yes, there is a market for different selections, but the returns achieved and the consumption of the materials produced is no longer guaranteed.

This has led to far more inventory than we expected. Over the last six months there has been strong demand for so-called ‘cheap products’. This has left the impression that lower priced raw materials were easy to sell in the volumes produced. However, talking to a number of people, we discovered that the endless pressure on finished leather prices have made even the very cheap leather facilities unprofitable and that many tanneries across the world are now trying to break into the medium or high price sector.  This has led to an increase in the surplus of low quality material, not due to a lack of demand, but simply because production was unprofitable.

Since the price achieved for the lower quality material is weighing so heavily on revenues, the superior return of the better selections can no longer compensate for this. This is a new situation. Furthermore, the lower quality material can no longer be sold in the total volume produced. This means that what many tanners and producers of semi-finished material considered to be a safe situation has in fact a burden become over the last months. Until a while ago it was just a question of how much one was able to obtain for the lower end of the selection and not if everything could be moved. Having the sale and the price for the lower selection sewn up, the basis for the higher end was laid and calculations were easy. Price was the determining factor and demand was for the cheaper material.

Well, price is still the determining factor, but as already discussed in a previous issue of MI, the ever falling price level for leather and consumer products has seen leather prices spiral downwards. The consequence of this is that lower prices are no longer stimulating demand and low selections start to pile up.

An increasing number of sources report a higher volume of offers from the so-called ‘cheaper’ regions such as the CIS, South and Central America and not to forget Africa. Those who were so confident that their product would be absorbed in the endless market of China in its search for low cost raw material, are today in search of new clients and markets to take their product.

If this theory is correct, the interesting question would be whether there might be a renaissance in medium quality selections which were neglected for so long for the same obvious reason as stated above. However, if there is no strong rebound in the middle section, current raw material prices are no longer reflecting market reality and could be called too high.

The top end also remains untouched, because the luxury market segment is still in good health and may even be growing.

We find this a very interesting situation and it might be the start of something which could be called a new trend.

The split market was pretty quiet in most parts of the world and prices remained at best steady, although prices in Europe were weak. This trend would underline the above theory that the falling price trend for leather has also disqualified splits as well as a lack of support from fashion. Looking at the absolute prices for cheap full substance hides, splits look expensive however you view it. We have no reason to believe that there is any hope for a short term change in this situation and trend. Unless leather fashion begins to support splits again, a significant recovery of split prices cannot be expected.

The skin market can – at least in our opinion – be called a nightmare. The poor state of the garment tanners in particular in Turkey and in China and the very bad sales in Russia are weighing massively on the market. We also sense that there are much higher stocks and inventories in this market than many might admit. The financial problems of tanners and traders are an open secret and various businesses have already had to cease operations.

All hopes are now pinned on the new season’s material in Europe. However, we fail to see any short term improvement of the situation and things are more likely to deteriorate further.

Our general outlook for the future is consequently less confident now. However, the next week will not bring much of a change. Sellers and buyers will use the Easter break and also the Hong Kong leather fair to justify their individual resistance for any major move as far as prices are concerned. We also believe that both parties – but maybe sellers more than buyers – will try to find agreement before the fair rather than on or after the show. Consequently, we expect little change in the official price lists. Currency issues may once again be the main factor in prices in the non US$ regions rather than anything else.

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