Macroeconomics

There is more and more of a holiday mood in the financial markets and activity is becoming thinner and thinner with transactions becoming more incidental rather than driven by any particular news. General activity will not resume until mid-August. So, there are fewer and fewer indications as to the general trend in the global economy.

The most interesting news from the past two weeks has definitely been the decision by the Chinese government to revalue the RNB. So as not to lose face or to give the world the impression that they bowed to pressure from the United States, China did not revalue to the extent that the Americans and others had requested, nor did it give any clear indication of how this small step may be extended in the future. So, control over its currency still remains firmly in the hands of the Chinese and they are still in a position to be able to surprise the global economy at any time they want to.

Oil prices remain stuck at the $60 mark and each time supply and demand allows price pressure to ease a little, it seems that panic buying or an accident quickly pushes prices higher again. (The death of King Fayed on August 1 pushed oil prices up to $62.20 a barrel).

Stock markets steady

Stock markets, in particular in Europe, remain either steady or are climbing constantly higher. This mainly applies to Germany where the economy has been in the doldrums for a long time and investors are now betting on a change after the elections in September. Equity prices in Germany appear low to international investors and therefore hedge-funds and other global investment companies are pouring a lot of money into this central European economy.

Although there are signs of a slowdown in the American economy, figures still remain positive with the growth rate close to 10%. House sales are surging and despite slower GNP growth rates, the economy remains quite robust and has a good chance of continuing to expand for the rest of the year.

In parallel with the rising stock markets the business outlook in Europe started to improve and the lame ducks of Germany, France and Italy have all reported rising confidence for the coming months. We do not place too much trust in these statistics though, because they have proved to be incorrect too many times in the past, where it has been more of a case of wishful thinking rather than a true reflection of reality. Maybe this time the situation in Europe could finally settle if not actually get fractionally better. However, it needs to spill into the employment market before it will really help the economy.

Anyway, the global economy is still on a solid path of expansion and if Europe starts to recover, too, we could enter another cycle of positive global development.

On the negative side, everyone should take into consideration that we are still suffering high energy costs, the world is still threatened by terrorism and the non-US$ regions still have to consider the risk of a falling dollar, which would definitely harm various economies.

Market intelligence

Since general business activity has come to a seasonal low and the summer holidays are presently more important in the northern hemisphere than anything else, we have time to think more about the general outlook for the second half of the year rather than the actual business activity as such. However, let’s start with a quick review of what we think has happened in the past two weeks. Trading was definitely not as low as we had expected; the sales figures coming from the United States, and reports from South America and Europe, did not give us the impression that market activity was as low as we had anticipated, at least as far as volume was concerned. There was not a lot of trading or market activity in general, but the number of sales between existing partners seemed to be quite high.

Our regular readers know very well that we have taken a pretty cautious view of the market for a long time. We have never been overly pessimistic but neither did we have a reason to get excited. The raw material markets, except for the low end, had been reasonably balanced and this was also the reason why prices did not move outside of a very narrow band. The key question is now whether we could see a change during the remainder of 2005.

Consumer confidence

We have, in our view, two conflicting power trends still determining the market. On the one hand, the massive pressure on retail prices which will not allow any surge in raw material levels. On the other hand, we are seeing a global economy that is in very robust condition and the World Leather Business Week is sponsored by: emerging markets, with a strong fundamental demand for basic consumer goods, are showing no signs of getting tired.This creates the impression that consumer demand is not going to slow down in the months to come. The same should apply to US consumers as long as interest rates or energy costs do not rise too fast. If the news that Japanese consumers are also starting to spend is really true, and the European economies start coming out of he recession in consumer spending, then the prospect for better sales and rising prices will definitely improve. We have also always held the opinion that better sales go hand-in-hand with increased inflation and here – in particular due to energy costs - we can also see signs of a rise.

However, the main reason for better sales and higher prices is still the balance between demand and supply.

Supply and demand

For a very long time supply was exceeding demand, mainly because leather producers had to downgrade their raw material base in view of the massive price pressure on finished products. The general trend to reduce inventories throughout the supply chain squeezed volumes back to the initial source - either the hide processor or the packer himself. As both of these have limited resources to store, or at least in the case of the packer absolutely no interest in carrying excess stock, they were willing to reduce prices in order to move the quantities of raw material that they needed to find buyers for.

We are now starting to see a situation where the market and the suppliers are beginning to have a different attitude. Despite many negative reports that the volume of trading and the demand from leather producers has definitely increased, many suppliers in the main markets have, according to our information, reduced their stocks to minimum levels and are very comfortable about their present order book and prospects for sales in the months to come. This mainly applies to the key suppliers from North America but also in Europe. If these reports are true, customers are asking for quick shipments, and various traders around the world have not yet fully covered what they need to supply, the outlook in this market segment is pretty bright for the near future. It is also true that in difficult and bad times with reasonably low raw material prices, buyers tend to buy better quality product simply because they can get more for their money. This is traditionally the beginning of the cycle in the leather business, and when prices for these types of medium-higher quality hides and leathers increase, cheaper products tend to find their way back into the market for higher prices as well.

Higher grade raw material

Whilst most members of the trade are still quite pessimistic and draw attention to the large amount of stock available in the southern hemisphere, we can only recommend that you pay careful attention to the fact that in the medium-higher end of the raw material and finished leather market there is, in our opinion, a decent possibility that the balance between supply and demand will change later this year.

For a long time, manufacturers have been used to having raw material prices under their control as the option for higher levels had been faded out, and they thought that they could maintain this situation almost indefinitely.

We are definitely at the very early stages of this and we still have a number of potential obstacles to overcome, but at least long term planners should take into consideration that the risk potential for raw material and finished leather prices is definitely increasing. Since we are thinking within a time frame of six months and more, there might still be some buying opportunities in the short term, as we advised our readers at the beginning of this year and we now reiterate and even strengthen our opinion that this will be the case.

There is nothing that one can do about short term shocks which might come from the political (terrorism) side. Also countries such as China remain unpredictable factors for short term developments (currency, import controls, etc.), but on the basis of foreseeable effects, we believe that the number of arguments for a fundamental strengthening in the leather market has definitely increased over the last quarter.

Economical material still available

We still have some cheap and economical products available on the market and whoever has the creativity and courage to base production and sales on such material has a fair chance of taking a profitable chunk of the business for the rest of the year. Cheap calf and Kip which have been success stories in the recent past might be an example of this.

It will also be interesting to see if the cheap lamb and sheep which are still circulating, in particular in Europe, will attract other creative spirits. If anybody is still willing to take opportunities and if the large organisations are willing to act quickly and be more flexible, there’s still a lot of opportunity in the field of leather to produce quality products with a margin at an acceptable price.

Brighter outlook

So, our summary for the rest of the year is that there is a fair chance that the price structure could change. The medium-higher end has already climbed back into the higher or more expensive territory. However, there is plenty of raw material which can be used just as well that is comparatively cheap. Those items which are the preferred raw material for mass production might already be scarcer than many people like to admit. So, the focus will have to change to other more easily available commodities.

At the end of the day, everything depends on the flexibility of the tanner and manufacturer as we have stated many times before. The tanner is definitely willing and capable when the manufacturer or retailer allows.

For the coming summer holiday period and maybe well into September, we don’t envisage any particular risk of short term price hikes. Looking at the sales in the second quarter, considering the shipments and knowing that the speed of the cyclical production is only going to accelerate by mid-September, we believe that most tanners are reasonably well covered and/or need to run after more expensive hides for the moment. Consequently, there might be other buying opportunities for those who are interested in the next six to eight weeks.

Except for macroeconomic influences, we would be surprised if global prices leave their existing narrow price band this summer.