Macroeconomics

As far the currency markets were concerned our forecasts were quite accurate. The US$ extended its gains against the euro and the trend only lost a small amount of its momentum when the ECB announced on Friday that an increase in interest rates is not far away in an attempt to keep inflation in the euro zone under control. The US$ reacted sharply and lost about 1% of its value on Friday afternoon. After America's merchandise trade deficit came in at 71.1 billion for September, it appears that the fundamental problems in the American economy might come to the foreground again after the market has neglected them for some time.  In recent weeks, many banks and experts have leaned towards a weaker outlook for the greenback. Although we are not overly impressed by the opinions of experts, there are good reasons to look carefully into the currency market again and at least to consider the possibility that the trend of the US dollar could go into reverse.

The coming weeks will be very interesting as far as developments in the currency markets are concerned. The latest statistics seem to prove that the euro zone might start to emerge from the doldrums. The GDP grew at 2.6% in the third quarter, Germany has finally got a new Government, and the financial analysts and markets are still to decide on their expectations for the future or what decisions will be made to get the largest European economy back on its feet. The biggest obstacles the government has to overcome are cuts in the social benefits and the reaction to the announcement of a 3% increase in VAT that will be introduced in 2007.

Uncertainty in Europe

In general the situation still does not look particularly good in Europe.  Riots in France and rising social tensions in Germany and Italy could lead to more social unrest in other leading countries in Europe and hinder economic growth and a reduction in unemployment in these important economies.

In the meantime the markets will have to digest the financial reality and this means, in particular, rising interest rates and the return of moderate inflation.

Oil prices are beginning to decline slightly and if the winter in the northern hemisphere does not start really early or is not too cold, we have a fair chance of remaining around, or maybe even breaking, the $50-mark for crude oil again.

Except for Europe most other consumer markets are still looking quite buoyant and growth rates are still staying close to double-digit figures. So, we need to watch to see if consumer spending remains reasonably strong, and to do this it will be quite interesting to analyse the Christmas shopping period, which has become an important issue around the globe.  In China, the Chinese New Year, which is also a very important shopping event, will follow at the end of January. Therefore, the next eight weeks are going to be very decisive in terms of the behaviour of consumers around the globe.

Market intelligence

Recent weeks have delivered much of what we expected.  Sellers gained more confidence and tried to raise their asking prices to see how far the leather manufacturers were willing to follow the market and how much they were able to squeeze out the customer.  This was maybe a bit of a trial and error situation.

The assumption that tanners would be so desperate for raw material that they would anxiously follow rising raw material prices proved to be wrong. As soon as prices increased we saw the traditional reaction from buyers. They simply refrained from buying and disappeared from the market. Many raw material markets around the globe and in particular the dominant ones of the United States and Europe have again reached the upper end of the long term trading range that we have seen for almost two years now. As we mentioned in our last issue of market intelligence, quick, sharp price increases would definitely break the market dynamics and this is exactly what has happened.

True reflection of the market?

The interesting question which might be a topic of discussion in many meetings is again how far the official price lists of the leading suppliers of hides really reflect the trading activity and market.  One could come to the conclusion that the public offerings at present are more of a political issue rather than a real reflection of trading activity. What does this mean? It means that many tanners need to renegotiate their existing contracts with their customers at present. Everybody knows that due to increases in transportation, energy, chrome and, in some cases, also labour costs, leather prices need to go up. Everybody knows how difficult a price increase in the present situation could be to achieve, since in contrast, many leather buyers are still of the opinion that they want to buy product cheaper than before. The easiest way thing is for sellers to continue convincing the buyers that leather prices have to go up as a result of rising raw material prices, not to speak of the many contracts which are based on publicly available raw material price reports. As a consequence, it would also suit some of the big raw material players as well as some of the big tanners to show price increases in their published lists in order to prove to their customers that there is a need to increase leather prices.

Since this policy is basically restricted to the really big players around the globe, raw material suppliers are also quite pleased with this policy, because they have now a better chance to average out their selling revenues by convincing smaller customers to pay higher prices.

We know very well that we have already dealt with this subject in the past, but it seems that for the time being at least, the situation is quite similar to that we have seen in the past.  We have no way to prove this as hardly any of the big players would ever admit what the true situation is, but we believe that the reality is not too far from this theory.

Chinese policy causes concerns

The last two weeks in general were basically dominated by discussions about the Chinese policy on imports and taxation. Most of our readers will already know about the situation, so we will not go into it again too deeply. The facts are that the Chinese government is planning its new policy on import tax, or better said VAT policy, and this would mean that tanners will have to pay full VAT on imports, and exporters would only get a partial refund. In addition, and this might be the much more problematic issue, people are talking about the fact that the VAT refund could take as long as six months to reach the importer again. Reports on this subject are assuming that the government is planning to implement this policy and that it could go into effect as early as January 1, 2006.

This situation would affect most of the smaller tanneries and those selling mainly into the domestic market. Discussions on the topic acted as the usual psychological trigger and slowed down activity in the market last week. Many market players believe that business with China in raw hides is going to be influenced in a negative way. But on the other hand, most people we spoke to thought little had changed in terms of activity and it seems that many Chinese tanners are not too worried about the situation. Further government meetings will be held over the coming weeks and the tanners’ association will also take part in the decision process. We certainly have to keep an eye on the subject and we will monitor the situation carefully over the next few weeks.

The other issue which has been keeping the market and the gossip going was the FMD situation in Brazil. There are many stories circulating the trade, but at the end of the day, it all comes down to what we expected - which is a quick normalisation of the situation. Although many countries are still blocking imports of Brazilian beef, the kill is already picking up again and if no further cases of foot and mouth disease are discovered, it is most likely that production and exports will be normal again pretty soon. Furthermore, the importing countries will not be able to cut themselves off from the supply of cheaply-priced beef for too long.

Dynamism slips away

Looking again at the last two weeks, one can easily see that the dynamism that the market took away from the leather fair in Italy has slowed down significantly. It is not really a case that leather business has deteriorated, rather than the fact that many tanners have realised how much their margins are shrinking and how the situation is going to become difficult in 2006 if they cannot achieve higher leather prices. So, many raw material suppliers are now complaining about more difficult discussions with their clients and dealing with a lot of complaints that might not be directly related to raw materials.  Buyers are trying, in various and different ways, to save money and lower costs and the easiest way of doing this is by trying to get some benefits from suppliers. It is not the big things people are talking about, but many are complaining about small quibbles such as discussions about freight charges or financing terms. In the additional small parts of the calculations, buyers are now trying to negotiate further rebates and cost reductions with their suppliers.

Pressure eases on raw materials

One thing can, however, be said is that the massive pressure on the raw material market seen in the first six months of 2005 has faded. Sellers today feel that they are in a much more comfortable situation and many of them have reduced their stocks massively and in some cases have even built up forward positions.  All this is generally making the seller feel much more relaxed and this also explains why some have had the courage to test the market with further price increases over the past few weeks. This has failed so far and for the time being, the balance between supply and demand has not been disturbed enough to really expect a massive potential for price rises in the near future. One could also see how sensitive the market was to the news from China regarding the change in the VAT and import policy.

The split market did not change very much. The demand for splits has definitely improved over the past few weeks and specific items enjoyed a good level of interest and probably more buyers than offers. This has helped prices to improve, but the situation still remains pretty isolated for some privileged materials. However, the old pattern is still valid: if something is no longer available or is too expensive, interest just moves to an alternative. Consequently, some other split grades which had been kept on the sidelines found more interest from the market and more of the inventories that were still available are now finding homes.

Lamb and sheepskin still unsure

The lamb and sheepskin market still did not know exactly where to go. Many sources and rumours hint they are expecting better nappa business in the spring and summer season 2006, but so far this has not yet been reflected in raw material demand. Although it must also be mentioned that there are rumours circulating from China that some big players have now finally taken a chance and are buying big volumes of lamb and sheep, particularly in the UK. This could be the confirmation that tanners do not expect to be able to buy raw material any cheaper in the weeks to come.  It must also be noted that the Chinese tanners, in particular, prefer this season and the first quarter season because they like the larger sizes and better wool revenue. Since it seems that there are not too many inventories that are still burdening suppliers, further interest and sales could now finally support this suffering market.

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