Macroeconomics

The main focus of the macroeconomic world over the past few weeks has been on interest rates, oil prices and the risk of the asset bubble bursting in many markets such as the commodities and real estate markets, where it has been inflated in several countries.

Analysts and experts are scratching their heads, because a variety of economic tools and laws do not seem to fit with the current trend. The main problem the experts are having to deal with is the conflicting trends in interest rates. Whilst in the short term, interest rates in the USA are rising, long term rates are continuing to fall to new record lows. Inflation remains under control because of the overcapacity in production and the liberalisation of the world markets is keeping price competition extremely high.  There are too few investment opportunities for excess liquidity and consequently the old theory that an excess money supply drives consumer prices up, does not seem valid anymore.

We have also been proved wrong, for the moment at least, with our assumption that rising energy and other commodity prices would push inflation up.

The only question that still needs to be answered is whether this was just a short-term error and will eventually lead to a delayed, but even sharper reaction in the markets. Well, as long as excessive production continues in most consumer product sectors across the globe, it seems unlikely that there is a realistic chance of any short term inflation rise.  However, we have to watch whether the trend for rapid increase in production capacity in Asia and the closure of plants in other parts of the world persists.

In the meantime, oil prices increased to levels well above $60 per barrel before falling back slightly to settle just below the new record.

The larger than expected increase in the American purchasing manager index on Friday indicated that the expansion of the American economy is still continuing and this positive mood was also confirmed by interest rate hikes. The FED increased US interest rates by another quarter of a per cent, just as the financial markets had anticipated.

As a consequence, the US$ extended its gains against the euro and the yen and easily broke the €1.20 and ¥110 marks which leaves the door open for further potential for the American currency to extend its gains in the short term.

Market intelligence

The leather pipeline confirmed the controversial analysis of our last report.

There is still no clear direction where the markets are heading, but the assumption that higher quality material is on a very solid footing and low quality material faces substantial problems from the markets proved to be fairly true.

Lightweights find demand

The only exception that was made in low quality material was for lightweights. There is a substantial demand for very economic hides between five and 20 kg and this is coming from all over the world. The driving forces are definitely Italy, India and China. The key question that we still cannot answer is whether this is the end of the previous season or if demand is being carried over to the next. Since production is higher in the second half of the year than in the spring and summer, it would be somewhat of a surprise if the same quantities continue to be produced as those we have seen in the last six months.

However, it could well be that we will just not see the demand from the shoe industry, or it could also be that the handbag fashion for artificial prints and strongly corrected grains might push the demand seen for this material.

What is worrying is the fact that on the other hand a lot of cheap materials are looking for homes around the world, and in Brazil, in particular, sellers are struggling to find customers for their hides. The kill is constantly rising and so is the supply of cattle hides, due to the success of cheap Brazilian beef around the world.  They are now sold cheaply as wet blue, and it is difficult to understand why people are still chasing other origins which are definitely not cheaper.

Manufacturers become inflexible

Speaking to some of the insiders in the business they believe that most manufacturers have become more and more inflexible in their selection of raw materials because of the stipulations laid down by customers.  If we look back to 2003 and 2004, the weight ranges of between five and 20 kg found hardly any interest at all,  except maybe for the top quality range, but most piled up in large inventories all over the world.

It was the traditional story that all of a sudden designers and leather buyers discovered a new fashion and attractively priced raw material. They then set technical standards and specifications which allowed only particular hides of a particular size to be used.  This limits the leather producers so that they become completely inflexible and alternatives cannot be used.  The only ones who can avoid this problem or can even take advantage of it, are integrated manufacturing units where leather production and the manufacturing of goods go hand in hand. However, even here you now find that more and more of the businesses are managed by controllers or by production managers who do not come from the leather field and for these people, specifications are more important than the potential savings though being flexible in the use of potential alternatives of raw materials.

This is another example of how our industry is continuing to shift quickly from artisan fragmented production to industrial conglomerates.

Packers achieve decent premiums 

We think this also explains what we are seeing presently in the raw material markets. Large producers that are able to generate and deliver standard hides are achieving a decent premium at the moment, above what we would consider to be a fair value of their hides. A good example of this can be seen in big packer material from the United States. While three months ago, most of the market reports were very conservative with regard to the outlook and the price development for this kind of material, the opposite is now true.

High sales and rising prices have occurred and the only explanation for this can be that the mega producers around the globe are in need of a constant and large volume of standard hides that the production plants are used to. Under these circumstances discussions about prices and calculations are squeezed into the background and the production managers take the easy way out by forcing purchasing departments to buy product they know and is the easiest to handle.

We feel that there are a lot of unjustified price discrepancies between exchangeable raw materials which are related to this particular problem.

With the trend to larger and more industrialised producers, the market and price forecast also becomes more and more problematical. We don't have a free market place anymore in the world, where buyers from around the globe can meet and in most cases follow a flexible economic decision. A rising part of the raw material market is now controlled by fewer and fewer players and consequently the standard items of raw material are no longer even accessible to the others.

Consequently, there is no longer any realistic daily or weekly trading on many raw materials. Fewer sellers are dealing with fewer buyers and we would consider that most of the price reports today are more political statements, which suit either or both parties, rather than a fair reflection of dynamic trading activity.

Split market 

The split market saw a bit more interest with some of the shoe and side leather business, which is also related to the fact that fewer splits of the required quality are now produced. The demand for good quality suede splits remains quite reasonable and prices are solid if not becoming firmer. For the rest of the market, price remains the key issue and China, in particular, is looking for very cheap material. Splits which are predominantly suitable only for PU production are only really finding interest at insufficient price levels.

Skin market

The skin market for volume and lower end garment production remains in the doldrums. Most of the market players are now waiting for the outcome of the fashion fairs in Russia. There is not too much optimism for the leather market in the second half of the year. Anyway, many prices for skins, mainly in Europe, have fallen so much that they have become a particularly attractive raw material for any kind of leather production. Price levels of $5 or even lower per skin for a good quality lamb are no longer prohibitive for any kind of use in the leather field. Considering that bovine materials between five and 20 kg are becoming pretty scarce, it would not come as a surprise to see some leather articles being switched to lamb instead of kip. While reports several weeks ago about speculative purchasing of lamb and sheep turned out to be false or wishful thinking, present information about tanners and traders sniffing around for bargains seem to be more genuine. However, the prices they are quoting are so low that some sellers called it waste management rather than interest in a valuable raw material.

For the coming weeks we would not be surprised if the present trends extend further. This means that good quality standard products might be able to extend their gains as far as prices are concerned, while the continued surplus of low grade material, in particular for the garment and upholstery industry, will still weigh heavily on revenues.  However, we have not lost faith in economic theory, and it would not come as a surprise to us if the price trend on the high side could lose some of its dynamic going into the summer, while the abundant supply of cheap, standard hides, in particular from the southern hemisphere, could gain more interest again.  For a turnaround in the price trend it is, in our opinion, still too early to say.

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