Macroeconomics 

Economic data has slipped into the background a bit over the last two weeks. The terrible hurricane that hit the south of the United States and the effect of rising oil prices on the future of the American economy has concerned people much more than financial statistics.

Most economists are of the opinion that the destruction will cost America’s GNP about half a per cent in growth. High energy costs are dividing opinions amongst financial specialists and, while some believe that high oil prices will not have a particularly negative effect on global economic growth, others are seriously worried about it and are forecasting a decline in consumer spending and increased inflation. As per usual, it is most likely that we will see a bit of both, but as we have already pointed out several times, we cannot assume energy costs continuing to rise to the extent we have seen in recent months and this smaller increase may not influence consumer spending, or there may just be a change in spending habits rather than less spending.

The biggest concern could be for the car manufacturers that are rushing to announce new developments and collaborations to employ technologies which are either more fuel-efficient or avoid oil completely.  

Despite all of the concerns over the price of a barrel of oil climbing above $70, it has already fallen back to the mid $60 range. Energy companies as usual are using the opportunity to their advantage and have pushed product prices much higher than the real market in order to widen their margins. They are not really making friends with this policy and unless prices come down in the near future there are going to be questions asked about the size of their profits.

Hurricane dominates

The higher energy prices and the damage caused by hurricane ‘Katrina’ have almost completely dominated the news. Unemployment in the United States fell, stock markets digested the bad news extremely well and unemployment in Europe was also a fraction lower. Most people see this as a clear sign that the global economy is still in a robust state and has the strength to overcome the present situation. We stand by our opinion that the key to the future is still the level of energy prices and the question of how the global consumer will react to it.

Market intelligence

Everything in the last two weeks focused on the leather show in Shanghai. Traditionally, people don’t only visit the show, but many also take the chance to extend their trip and visit their customer base in the area. This applies, in particular, to the American suppliers who are still dependent on the Asian market to a much greater extent than, for example, the Europeans.

Positive feedback from China

Most people we spoke to were quite impressed by the generally optimistic position they found their customers in. As usual the interpretation of what people made of their trips and meetings was pretty varied. While we have spoken to many who were quite optimistic, or even positively impressed, a number of people also complained about the outcome, in particular regarding the price situation. Despite certain negative individual opinions, there was a general consensus that the order situation has been improving since mid August and, as far as business volume was concerned, very few reported anything negative.

Brighter outlook for garment and upholstery

Even the sectors that have faced difficulties in the recent past, i.e. garment and furniture upholstery, seem to have emerged from the doldrums. The upholstery tanners, in particular, had no complaints about the order situation and were quite optimistic for the coming weeks and season. The shoe upper sector is growing in line with the increase in global population and wealth in the emerging markets, and the same applies for the leather goods sector which is being buoyed by the current fashion for ladies’ handbags. Surprisingly few concerns were aired about the global economy as such. One has become accustomed to the slow performance in Europe and nobody seems to feel the need to take a strong decline in consumer spending in the USA into consideration as yet, well the buyers, at least, have not yet mentioned it to their manufacturer base in Asia. Luxury goods are also still in the fast lane. The results just released by the LVMH Group reported record profits again confirming that the rich are getting richer and are willing to spend their money.

Automotive remains unclear

The true outlook for the automotive and upholstery market remains unclear. Since these are items with a higher individual price and do not fall into the category of basic needs, they will be influenced by the general consumer sentiment to a much greater extent. Big ticket items usually react in a more pronounced way to basic changes in the economic climate. But as we mentioned above, the Asian week did not deliver any concerns about the demand for furniture leather at the moment. Automotive remains an interesting subject. Most brands are still quite optimistic about sales and potential sales and the upcoming IAA fair in Frankfurt will display a record number of new models – over 100. However, the rush by almost all the carmakers to announce developments for alternative concepts, such as hybrid and others, highlights their concerns over whether the new models will hit the market at the tight time, after the surge in fuel prices.

A fair number of the new cars coming onto the market that could include leather do not fall in the fuel-efficient sector, but are in the high consumption heavy section, such as luxury and SUVs. In the luxury segment one doesn’t need to worry too much, but the middle or executive class cars could be affected to a much greater extent.

Will clients move to smaller cars with smaller engines? We will have to wait and see. This could also lead to less leather being used, because they could reduce expensive extras, however, it could also work in reverse that cars are equipped to a higher standard or that manufacturers push options for free in case they would need to stimulate demand. Anyway, according to a report in a Shanghai newspaper last week, the number of cars expected to be manufactured and to be sold in China’s markets in the years to come is set to reach a whopping 15 million by 2006.

Knock-on effect?

What will this mean to raw material and leather prices as a consequence? In one of our previous reports we took the position that some parts of the raw material market could see some strength later this year while short term, i.e. until mid-October, bargains could be around. While the second part of the statement has almost happened already, with prices of some of the Northern American mainstream products and their European counterparts having seen some adjustments over the past few weeks and might see more over the next weeks; the question is if there is any potential to turn the first part into reality. Frankly speaking most will disagree and there are many arguments against the opinion for the moment.

Overheads create pressure

While leather prices continue to remain under pressure and buyers are again attempting to squeeze the last drop of margin or price concession out of their suppliers, we are seeing an increase in production and transportation costs at the same time. Chrome prices are surging and all other oil-related manufacturing products will also see increases in the near future. Not to speak of transportation costs and the basic energy bills a factory has to pay. Simply put, an increase of 10% in costs should be turned into an approximate 5% reduction in raw material costs to keep calculations intact.

Tanners will definitely try to convert this into the same pressure their suppliers of raw materials are facing and, with the market stability that we have seen in the past year, one can say that downstream calculations in leather have worked reasonably well and there has been a solid cap on this market. However, this only applies as long as there is an abundant supply of all hide types and tanners were able to downgrade raw material and use lower quality in accordance with their clients’ demands. This is going to be difficult for two reasons. 1.) The lower the quality of the hide the higher the effort and product investment required to turn it into reasonable quality leather, which leads to rising costs and 2.) if all of the indications are right, the demand for medium-to-higher quality leathers seems to have the highest growth potential at present. 

As a consequence one will ask how can raw material prices rise under such conditions? Well, the raw material market doesn’t follow the needs of the leather calculations. It follows its own rules and this means that the butcher selling his by-product is only interested in the highest price that is achievable. With fewer hides being traded and more being distributed directly from the beef producer to the tannery, the ghost of speculation may have been brought under control, but the strong and powerful desire of the beef producer to obtain more for the by-product is as strong as ever. Even more so now when calculations for beef production is pretty squeezed in many parts of the Northern hemisphere.

Specialty hides rise

Many have probably not even realised that, on the sidelines and in specialty areas, some hide types have already gone up. Just recently high quality heavy European bull hides, which against all of the forecasts made by tanners, increased in price by a remarkable 5-10%, this market had just followed some other preferred specialities.

If business is as good as it seems, and considering that some sellers were a bit scared as to whether they would move enough of their production in time and therefore made concessions to keep the product flow intact, we could see more market strength in the medium–to–higher quality sector. In all fairness we can’t see this for lower quality material at the moment as this is always easier to substitute with non-leather products.

We should also mention the risks. If you consider the possibility of consumer spending falling rapidly due to rising energy costs, failures occurring in the supply chain due to increased costs or restricted financial resources, or further financial restrictions in China to dampen growth, all of these carry a high risk potential which should certainly not be ignored. As a consequence, we continue to believe that everyone should stay on high alert and collect and study all of the information to hand in order to react as quickly as possible. The world doesn’t seem to be as stable as it may look at the moment.

Having said that, short term disposition of raw materials might be the best choice at the moment.

The split market remained steady with reasonable demand for everything short-fibred and wet blue split. We did not sense any changes in the price structures, none worth mentioning at least.

Future for nappa looks brighter

The skin market did not get too much support although many agreed that the outlook for leather garments, in particular in nappa, are a bit brighter. Sales to China did occur, but prices – at least for European skins – were on the very low side and did not improve from the low levels they were at. Most sellers were ambitious to clear out stocks which had been piled up and any reasonable bid was taken. This was, on the whole, well below $5 per piece. It seems that a bit of the pressure has now been lifted, but it is most likely still too early to announce a real recovery. However, it seems that the worst might be over with skins prices in Europe hitting record lows and in many cases hardly covering processing costs.

More interest was seen for goatskins. In particular cheap, suede-suitable grades were requested, but also light kids found quite a bit of interest. Both items were popular, in particular, for ladies’ shoes.

Prices settling

The market is now waiting for the return of the travellers and will need to digest the information that they are bringing home. We got the impression that quite a few sales were still left over from Asia with tanners waiting to see if there might be another chance for a reduction in price. We think the market has bottomed out for the moment, except for maybe some sales flurries from latecomers or those who did not feel that they had had brought home what they had expected to. However, on the levels now reached it seems that prices are settling for the moment. Consequently, apart from isolated movements from both sides we think that the market is now waiting for the outcome of the numerous trade shows taking place, running up until October, and we will have to wait until then to see if our theory is correct. In any case those who are basing their production on the specific needs of specialty raw materials should concentrate hard on their needs.

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