Macroeconomics

The financial markets have delivered a number of conflicting indications over the past two weeks. And, as a consequence, most analysts cannot agree on a common opinion as to how the global economy is going to develop for the rest of the year.

At the end of the day everything boils down to whether the high oil prices are going to eventually have an effect or not. In addition to this, Mr. Greenspan also added to the confusion by warning that the American housing market boom could burst in a similar way to the Internet boom some years ago. Both situations will have a very strong effect on the global economy. Most pundits agree that real estate prices might already be overvalued in some countries. When it comes to the question of oil prices, in view of the recent rises, almost everyone is predicting a continued rise in prices for this material.

We will just have to watch the situation carefully as speculation might be higher than many would like to see. We would not be surprised to see a one-way street for oil prices, higher volatility and maybe one day a sharp correction that nobody is expecting at the moment. However, as we’ve said many times before, the average price for crude oil has risen substantially and we believe that the effect on the global pricing of products is going to be more pronounced than most people would have us believe. It might not be comparable to the oil crises in the past, but if you consider transportation costs and general energy costs for companies, it is hard to believe that the tripling of prices will not have an effect on companies or consumer prices. The rise in consumer prices in the United States, from 2.5 % to 3.2 %, may already be an indication of this.

Mixed reports

Statistics from the main economies around the world were mixed and on the whole most gave conflicting pictures of the situation. In the United States we saw that the housing market was quite strong with new house sales rising with more than 6% and residential construction was once again higher in July; but at the same time new orders for durable goods fell and industrial output declined.

In Europe, the German monthly consumer confidence survey rose by a whopping 13 points to 50 points which has left the optimists with the idea that Europe’s largest economy might be through the worst. However, it could well be that this figure has been affected by the expectations of a change in government to the more business friendly conservative party. The elections will take place on September 18 and it seems that these could trigger a direction for the general feeling in continental Europe.

The currency market did not deliver any substantial new trends. Most analysts are still predicting a steep fall in the US$, but so far every attempt to break through the level of 1.24 against the euro has been in vain and so the trading range remains between 1.21 and 1.23. As a matter of fact it seems that the big speculators are paralyzing each other and so, as a result, no clear new trend has yet been set. The fact remains that while the brain might be saying the dollar will fall, the stomach can find many reasons why it could go the other way. It could be wise not to take too much risk this year and to bet on it going either way and cover as soon as it is necessary.

Market intelligence

The last two weeks saw the leather pipeline still strongly affected by the holiday season. Reading most reports, hardly anyone is reporting any kind of a regular type of business. On the other hand, nobody was really reporting that business had completely dried up. Just looking at the export sales from the United States and speaking to people who were already back at their desks everyone admitted that although business was definitely not normal, it was at least on a better level than one normally expects at this time of the year.

Almost everyone is now trying to position the business for the remaining four months of 2005. As usual the last third of the year plays quite an important role if budgets for the year are to be met.

Footwear sales flourish

Even though the summer did not deliver too much new information about the business as such, a lot of companies reported financial results and this confirmed what we had sensed so far for 2005. The major shoe companies and retailers are all reporting business to be substantially up versus a year ago. Just looking at the headlines in the Leatherbiz.com news section on the whole we are seeing double digit increases for sales and profits for the current year. Add to this the brand names in the handbag business and the luxury brands and we find only happy faces and very satisfying business results.

So, this market segment has taken full advantage of the basically positive global economy in the past two years. Rising income in the emerging markets, decent consumer spending in the United States and at least some kind of a steady business in Japan was good enough to push sales and production to the levels reported. There was also a stronger fashion trend in ladies fashion, by no means a mega trend, but a stronger trend was seen. Sports companies like Puma have reinvented the sport shoe as a fashion sneaker and the different colours and slightly changed designs have given women a lot of opportunity to shop. As a complementary fashion trend, boots, high heels and sandals gave the ladies another reason to extend their shoe collections. This, in combination with belts and handbags, offered tremendous opportunities to sell products different in the market and there was no case of one model fits all.

From the information we were able to collect, we have no reason to believe that in the short term there is going to be any break in this positive situation. The only possible threat is from the macroeconomic side, due to high energy costs which could weigh on the willingness to spend in general. However, history tells us that fashion is generally much stronger than rational, economic individual decisions and there is a good possibility that if the consumer continues to like what is on offer he might save in other parts of his life rather than on shoes and apparel.

Quite the reverse remains the situation in the garment sector. We consider that fashion is the biggest problem in this section. There is no attraction to buy leather garments and since they have lost their premium position as far as functionality is concerned, there is little reason to buy leather garments at present.

The only way out of this situation is if we see a change in fashion which could come from the fashion designers. So we have to watch the fashion show in the near future to see if there is a revival of leather on the catwalks.

Upholstery market remains uncertain

As for the large segment of leather upholstery, and this means the furniture and automotive market, we do not feel that we are in a position to make any reasonable forecast. We have dealt with the macroeconomic risks which may be on the horizon. If higher oil prices and, as a consequence, inflation, become the dominating factors for the next year, we have to be very cautious about the prospect for these products. With rising energy costs and the potential risk for the real estate markets, these factors could be very dangerous for the furniture market.

The same would apply for cars if the cost of fuel rises further. In the largest car market, the United States, car sales have already been supported by high incentives and most likely those considering buying a new car have already taken the chance to get one while the higher discounts have been offered. The general defensive mood in the car market could hurt sales enormously. Not only could the total number of sales be affected, but higher fuel costs will generally depress sales of medium and higher end cars which are normally equipped with higher end finished leathers. The consumer decision to address higher fuel costs with cheaper cars would definitely also weigh heavily on the average price of the finished leather used.

Market still split

The split market did not deliver any great news. The demand for material remained quite strong but this could not be converted into significantly higher prices, which is pretty logical due to the plentiful supply of full substance cheap hides on the market that places a natural cap on the existing price level.

Skin prices also remained completely directionless. The end of the summer holiday season has brought some of the Turkish interest back to the market and the same applies for other markets in the Middle East. However, despite the slight improvement in interest, it was not possible to convert this into higher prices. It might be still a bit early to make any final judgment and so we will have to wait and see what indications might emerge at the trade shows over the coming weeks.

The next few weeks will certainly determine the future for the market. As we explained above, the market is pretty dissected at present. There is still no change in the situation for side leathers and luxury products that are supporting the leather market, while garment and upholstery remain in the doldrums. This is also reflected in the raw material market. Dairy cow hides across the world have finally adjusted to some kind of uniform price platform and are now looking for a direction for the rest of the year. Steers, light weight hides and premium quality products remain reasonably scarce and if they are not supported by large production they will remain scarce and consequently expensive for some time to come. However, producers in this delicate market section should not forget that overpricing raw material will eventually eliminate the product from the manufacturers list.

On the condition that we do not see any substantial financial turmoil over the next few weeks, we think that there will be a firm settlement of the present market levels. US steers and European bulls might consolidate within a price frame of one or two dollars while cows should be able to sustain the present market prices. For the non-US$ markets we still believe that the currency factor will have more of an effect than the market itself. While the large players in the shoe sector seem reasonably well-covered with raw material, we would not say the same for the upholstery tanners. However, a good flow of incoming orders as a result of steady global consumer spending should stimulate raw material demand.