Macroeconomics

The interesting statistical data to be harvested was only slightly higher than over the summer. The vast majority of statistics focused on evaluating indicators as to whether inflation is set to make a return and if interest rates will go up as a consequence.

While most economists still consider the risk of rising inflation to be reasonably small, because the core rate remains low, investors on the stock markets are more cautious and the markets in Europe and the USA all dropped in the past week in expectation of higher interest rates and further repercussions from the hurricanes. Only Japan seems to be in better shape, but even there, deflation seems to be over as wholesale prices have increased by 1.7%. In the USA prices rose by 1.2% in September which equates to a 4.7% increase on an annual base. The UK reported 2.5% and the EU zone also came in at around the 2.5 % figure.

Oil prices ease

Although most of these increases have been blamed on higher petrol prices, everyone has to understand that at the end of the day the reason is not as important as results.

Fortunately, oil prices are slowly but surely continuing to ease and if this trend persists and prices fall to levels lower than $50 a barrel, worries could be eased slightly. However, for 2006 it would be unrealistic not to expect further increases in consumer prices, because the high average level in 2005 will only come to market in the next year.

On the currency markets trading ranges remained within those that we have seen for quite some time and the US$ continued to trade against the euro within the range of €1.19-1.21, and it was still a safe bet to buy and sell at the upper and lower levels.

Market intelligence

The activity in the leather pipeline over the past two weeks also remained reasonably quiet with low expectations.  Looking at the available export statistics and reports from various countries around the world, one still gets the impression that the market is reasonably well-balanced even though there is no excitement or hectic trading.

US dairy cows attract more interest

In the main and standard grades of raw material only American dairy cows continued their decline and price adjustment. However following the price adjustment they became more attractive to traditional buyers in Asia again and so interest and selling volume increased. There is still some disagreement within the trade as to whether the recent decline in prices has stimulated enough demand to clear the volumes of inventories which have built up. This surplus mainly built up in the second quarter when US prices were far too expensive in comparison to their competitive origins from Europe and South America.

Difficult quarter for Europe?

In the meantime, most reports from Europe stated that sales and interest for standard dairy cows from China has declined substantially. Shipments and incoming letters of credit have slowed down and new business cannot be generated in the same volume as before, which is needed to clean up the increased slaughter productions in the third quarter so far. This applies for the lighter weight categories at least.

It could become a difficult last quarter now for the European sellers, if the Asian tanners do not receive a large round of finished leather orders in the coming weeks. Assuming that Asian tanners have now covered their needs for the coming 6-8 weeks in the USA, there is very little left for other suppliers in the mid-quality section to ship for the rest of 2005. With a higher seasonal kill and the end of the fiscal year in Europe approaching, it could become a disappointing end to the year.

Brighter outlook for heavier material

For the heavier end of cows things look a bit brighter. Tanners in Europe - Italy in particular - remain active in this field and are keeping the demand reasonably steady. Since these are not long-term contracts and under the condition that the production cycle remains strong, tanners will have to remain in the market and have to replenish their supply in the standard 4-6 week cycle. This could deliver some support for the cow market in the coming months.

FMD causes unnecessary panic

Some suppliers are still trying to play the FMD (Foot and Mouth Disease) card. News coming out of Brazil is quite conflicting about the extent of the outbreak or the threat that it could become a severe outbreak. Many of Brazil’s major export markets for beef have now banned the import of beef which could reduce the slaughter numbers in the short term.

However, we are not of the opinion that this is going to have any significant impact in the medium term – neither on supply nor on prices. It remains a mystery as to why the outbreak of FMD is always hailed as a major threat to slaughter and beef consumption and the reaction of the importing countries to ban beef from countries suffering from the disease is more the result of a media-frenzy rather than scientifically justified. FMD is no longer contagious when the beef has matured on the trip from the supplying country. The same applies for salted hides which travel overseas. So, FMD can’t be put into the same basket as BSE or the ‘bird flu’ which are completely different.

The problem should not be taken lightly though. FMD is a threat and also dangerous, but mainly for the country where you find the outbreak because it threatens the local cattle herd. So, action has to taken quickly and effectively to avoid a rapid spread. The danger for other countries or a wider area arises from humans travelling, or from transportation, so effective action can be taken if the authorities take quick and appropriate local measures. As far as the threat to overseas destinations is concerned, the authorities should be realistic and act according to the facts and not the panic. During the last outbreak of FMD in South America, many countries banned the import of beef and containers which were already in transit or arrived in ports that were not cleared by customs. After several days of hysteria and reflection, matters eased and when the media lost interest everything was sorted out quickly and no beef or hides where actually destroyed in the end.

The essential problem today is that the public is scared too quickly by ‘danger stories’. Governments are not well prepared and clear on their positions and the media sees attention as more important than facts. This applies to the less problematic dangers as well as for the really important threats and as a result we see over-reactions and decisions that are taken too late or not clear and/or strong enough.

Unknown effects

Regarding the present problem of the FMD outbreak in Brazil and the effects for the leather pipeline, it is still far too early to draw any final conclusions. So far it is a local and regional outbreak and – if one believes the official information – measures have been taken and have worked so far. Herds have been culled and quarantine measures have been taken. If these are effective, in a country with landscape like Brazil, improvements will be seen very shortly. With the importance of the beef industry for the country, one can believe that the government and the beef industry will work hard to get things under control quickly.

We think that the likelihood of raw material supply will be affected by the problems remains limited.  Even if slaughter numbers in some regions of Brazil slow down for a limited period, we do not believe that this is a major threat to the supply base. One should not forget that, in Brazil in particular, large stocks have been hanging over the market for some time; and other countries that mainly produce lower grade raw materials are suffering from insufficient sales potential. The risk that the global leather industry will face a shortage of raw material can be considered very low.  Short term and isolated problems can, however, not be excluded.  If tanners have bought Brazilian material and are now facing potential problems clearing and importing the goods, this could create individual problems, but nothing that would count on a larger scale.

Since we rate the problem as not being too important and one is to believe that in a few weeks from now things will be under control again, it is hard to believe that the problem will influence the global trade and production of raw material and leather.

However, how far the psychological effects will go, nobody knows. Many sellers today are facing problems getting the right price for their product and these individuals will definitely used the FMD argument to convince their buyers to pay adequate prices.  How well this will work and influence decisions nobody can guess. It also depends on how much the problem is mentioned in the news and public.

Medium and higher end under pressure

This problem, however, will only influence the lower quality end.  In Europe, we have noticed another story, which is affecting the medium and high end market of upholstery leather. In the automotive industry,  price pressure is rising and creating the same kind of problems that we have seen in furniture leather before. The medium quality price level is starting to disappear with more and more price concessions being asked for by the automotive industry. This is placing a heavy burden on some of the privileged raw materials such as medium-high quality male hides produced - and particularly those produced in Europe. So far the problem has been redressed by better demand from the shoe and vegetable leather tanners.  However, more raw material is coming to market, with increased autumn kills, and it will be interesting to see if the prices that have been achieved in the past quarter can be sustained for the rest of the year. We definitely feel that the market for this privileged raw material is at a junction at the moment and a clear direction will be taken in the next few weeks.

Industry heads to Italy

In the coming week most of the trade will gather in Italy for the Linea Pelle leather show. Although this event focuses particularly on shoe and leathergoods, Tanning Tech will be held at the same time, which will bring the technicians and chemical people to Bologna. Consequently a lot of people will meet up and a lot of market gossip and information about the present status of individual companies will circulate. This will deliver much more information and a better impression about where the leather industry really stands at present and how the players rate the future outlook of the industry. The key question is definitely how leather buyers will present themselves and what the final reactions will be when it comes to price discussions for 2006. How companies plan to cope with increasing costs will be essential in determining further development of the industry in general.

Let us swiftly summarise the basics at the end of 2005

• Rising energy costs (20-40 %)
• Rising chemical costs (5-50 %)
• Rising cost of transportation (1-5 %)
• Rising cost of affluent treatment and labour (2-5 % but only in some regions)
• Massive resistance to rising price levels due to overcapacity and the purchasing power of retailers
• At present limited potential for additional reductions in raw material cost
• Rising financing costs (10-20 %)

All these calculations will already have been considered in the company budgets for 2006 and other influences such as split credits, grain selections, productivity gains, technical progress and cost control measures will be individually considered in looking at how to deal with the problem.

However, the logic remains that it is unlikely that the effects of rising costs can be compensated by cost reductions and productivity gains. What will be required is reduced or negative margins and/or rising selling prices.

It will be interesting to see how the industry digests this in 2006 and whether this will lead to repercussions in the leather supply chain.

Splits steady

The split market remains pretty steady and it seems that splits are slowly but surely finding more of a return into leather production again. Suede and ‘easy to use’ splits are dominating and receiving a high level of interest. The offer of extra heavy splits continues to decline further with a reduced output from tanners using extra heavy raw material for upholstery use.

The skin market remains under fire. Despite hopes for a rebound in interest and consumption of garment nappa leathers, the world is still waiting and now it is once again a matter of waiting to see what designers and retailers do for the next spring/summer collections. A bit of movement seemed to be registered from the Middle East, but China didn’t move due to a lack of domestic and Russian interest. However, the fundamentals at least are looking better for 2006 and if consumers are triggered by leading designers, garment leathers could be a better story next year.

No surprises expected

For the coming weeks a lot will depend on the results and impressions coming from the Bologna Fair. Anything else other than a good result for high quality leathergoods and shoe leather would be a surprise. Brand and fashion conscious consumer markets like the Asia, the Middle East and Far East are currently enjoying the strongest growth ever and in the case of the oil exporting countries, they also have expendable cash to spend on luxury items. The wealthy in this world have not done too badly either due to a good stock market performance of 2005 in most parts of the world. The weak economies of the World - Europe in particular - are not displaying any signs of improvement, but these have not been the driving factor in recent years anyway. The big question remains as to how the US consumer will handle his money. We have slight concerns about the upholstery markets. There is more than one question about the outlook for the automotive market and even more for cars which consume large amounts of medium and higher quality leathers. Furniture will depend on Europe and the USA for a large share and even in those places one can’t totally dismiss our worries. We believe that European hide prices will face pressure over the next few weeks while other markets might be able to hold their own. Light weight material will remain supported for the simple reason that demand outstrips supply.