Macroeconomics
The last two weeks again confirmed that the US economy remains on a robust footing. GDP for the third quarter was revised to a 4.3% increase and the job market figures, also published on Friday, were positive. Although market analysts are again fighting over how to interpret this, the start of the Christmas shopping season in the USA was also remarkably strong when one considers the macroeconomic conditions we are dealing with. High energy costs and interest rates, which are about twice the level seen a year ago, do not normally encourage people to go out and shop.
So, things look good in the USA, which is still the largest integral consumer market in the world. The world economy in general also remains on track and the Economist revised the global GDP indicator for the first three quarters, increasing it by 0.4% to 4.4%, which is still a pretty strong number.
Inflation trends unclear
However, experts are not in full agreement about interest trends in the US and the eurozone. While some believe that the trend of rising interest rates in the USA might slow down or even stop; the ECB has increased interest rates by a quarter of a per cent but they have called it just a signal and not yet a trend. If signs of inflation do not recede though, further interest rate hikes have to be expected in the eurozone too. Those who are optimistic that the rising interest rates will come to a halt are now pointing at low or even negative core inflation rates and say that energy costs are the only reason for the inflationary pressure. We don’t agree and the way we see it, higher costs for oil and other raw materials, plus the end of anti-dumping campaigns will eventually be converted into higher consumer prices.
Timing is essentially difficult on this subject and it might still be some time away, but it should be taken into consideration.
US$ becomes more volatile
The exchange rate of the US$ became a bit more volatile again and reacted strongly to news from the financial markets. However, the extent of the daily movements was limited and some kind of a trading range was maintained, which did not extend beyond 1.5 % of the value. So, the greenback was again unable to break the $1.1650 against the euro, which has now become a rigid wall to any extension of the firmer trend against the European currency.
We should not overlook the repeated warnings of Mr. Greenspan. Although departing from office, he continues to mention the problems and risks deriving from the large US trade deficit. Indeed the problem has been put to the background, but it has not been solved and still remains a high risk to global economic stability and also to the value of the US$.
Market intelligence
As 2005 comes to a close, it is still not completely clear how it is going to end and how 2006 is going to start for the leather pipeline.
Despite many people saying that trading activity is normal, we do not believe this and would say that the level of trading is substantially lower. Our opinion is confirmed by export statistics from the USA, although many people claim that this is more to do with the well sold-forward position of suppliers rather than a lack of interest.
All in all, over the past two weeks, it seems to have been more of a timing problem than anything else. The Christmas season and the upcoming Chinese New Year has slowed down activity in the pipeline and many businesses are more concerned with planning their production breaks than worrying about their raw material procurement. If this is right or wrong only time will tell. The only exception we could find was in the Italian market for dairy cows which remains pretty active, and European suppliers are definitely benefiting from this situation. Italian tanners seem to be in possession of a very comfortable order book for medium and higher quality upholstery leathers. As a consequence, they are trying to cover their raw material needs from their regular business partners in Europe and the demand for fresh, chilled hides and for wet blue cows from the UK remains very strong.
Many market players are reporting that the leading names amongst the Northern Italian tanners are already willing to book raw material supply until the end of the first quarter 2006 at present market levels. This allows various assumptions. First that the tanners have a reasonable order book; second, that they do not expect raw material prices to move substantially in their favour in the next three months to come; and third, it seems that selling and present buying prices are running reasonably smoothly, so that they can generate at an adequate margin – which is the best news of all.
Lack of interest in from Asia
At the same time, most people in the trade are complaining of insufficient orders for female hides from Asia. This may exclude heifers, which are mainly used in the shoe and automotive leather business. For the ordinary dairy cow, which is usually used in the upholstery and garment leather business, interest dried up some time ago and the volume of sales and shipments, at least in Europe, do not seem to have reached anywhere near the levels of 2004.
Having said that, there are good reasons to believe that the raw material inventory position of many tanners in China can’t be fully sufficient. But applying normal business logic, we also know that the big boom in upholstery business in China has definitely calmed down. On top of this, we have seen a shift in production to cheaper materials in China in order to combat price competition which favours lower price and quality raw materials. Last but not least, for standard suppliers from the USA and Europe, it means that they have to deal with shifts between the more favourable origins. Since this is mainly an operation that takes three to six months before the substituting market reacts, suppliers always have to deal with this kind of time lag before the markets adjust. However, all of this might be true and may deliver the impression that there is less demand, but tanners are still producing and need a certain level of inventory to keep their production lines running.
China poses a taxing problem
Here we come to the other main concern of the past two weeks. The industry is still worried about the impact of new import regulations in China. Nothing has been decided yet, and it seems that more information will only be delivered on December 10, when another meeting between the concerned parties is scheduled to take place. The uncertainty over the situation is weighing heavily on activity and the interpretation of the outcome and consequences are very varied. The general consensus is that it is going to be negative for raw material price development.
This might be true for the short term and, as a matter of fact, it is probably more psychological than rational. The total volume of leather produced globally is not going to be affected and one consequence could be that we might just see some of the overcapacity disappear. Many of the global players will also reconsider their positions and exposure in China, because on top of the present issue - that will definitely increase leather prices - there are also ongoing discussions about the implementation of quotas or import duties on shoes from China. So, some of the production might close down or be relocated, but will not change anything in the basic balance between supply and demand. As already mentioned above, this might have a short term influence, but it will quickly be balanced out by market developments.
Automotive still causing concern
In Europe the trade is much more worried about the further developments in the automotive business. The increased hide prices for the heavy premium male hides that we saw in late spring are still having some consequences today. While the business in medium and higher leather qualities is constantly deteriorating and automotive manufacturers expect further declines in leather prices, the raw material market has not taken any notice as yet. This is mainly down to structural and political reasons and with a higher kill towards the end of the year; tanners are finally seeing their chance to correct price levels back in their favour.
With a limited market outlet for extra heavy hides, it is basically a showdown between the few suppliers. With a handful of players and little chance for substitution on either side, it is basically about where everyone takes short term chances to have the upper hand. For the time being, buyers are definitely in the driver’s seat. The high kill and abundant supply with only moderate demand is giving them a chance to drive prices low again with suppliers with unsold inventories for the coming weeks. For the seller the only option would be to restore the hides and hope for a lower kill at the beginning of next year to put the hides back into the market due to lower supply. This is a risky game considering that apart from the limited outlet potential in vegetable leather, there will be little possibility to place the material somewhere else. With the exclusivity of this particular hide for so many years both sides, buyers and sellers, find it extremely difficult to get used to the fact that their positions might be fading.
Tanneries to close
Europe also produced some other interesting news. On one hand, there was the sad announcement that another well-known and reputed tannery in Europe is going to close soon. The restructuring process in this part of the world is continuing and it is now noticeable how many enterprises have either had to shut down or have voluntarily decided to cease business operations. What is more shocking is that is that this is not happening to smaller tanneries, but, it is well-known operations that are deciding to close.
Another subject that caught our attention was the fact that many tanneries are going to shut down over the Christmas week and, in some cases, even longer this year. Looking at the calendar and seeing that only a Monday is an official public holiday in most countries, gives a clear indication that the order books of many tanneries can’t be fully sufficient. The argument that these are planned holidays to reduce the vacation days of the workforce would never apply if the order book allowed them to keep production running and if customers were asking for quick deliveries. This shows that, for many tanneries in Europe, business is not as good as it should or could be at the moment.
Splits and skin markets remain stable
The split market had nothing special to offer. Business is neither booming nor in depression and specialties are still in good demand. Splits which do not fit into niche productions or fashion items are still struggling to find enough homes, but in general, and with the firm price levels in some parts of the world and the cut of soaks to be expected in the next eight weeks around the globe, there seems to be little danger for the market as such.
Skins can’t really decide if things are now going into another depression or if they are coming out of the doldrums. The higher sales of some UK and Irish skins recently do not seem to be sufficient to regain full confidence. The Muslim slaughter festival at the beginning of next year will bring additional quantities onto the market again and so far there is no proof that the leather garment business is really going to pick up. We hope and believe it will, but we still need some solid evidence. If it does improve, it would be no surprise if the market quickly becomes more dynamic, because nobody will want to miss the boat. But, if interest dries up and the recent activity was only speculative, it could be a rough first quarter for those who have not been able to move some of their material in the recent past.
No upturn expected
For the coming weeks, anything other than a further slowdown of activity would be a surprise. The only exception one could or should make is in Asia. For many of the tanners, the time is approaching when they have to make decisions on their raw material supplies for the first quarter of 2006. We think that the ones with a clear idea of their needs have already acted and locked in what is needed or is possible. The others will have to sit and wait, either for fresh leather orders or for falling raw material prices to fill the drums with less financial risk.
Leather prices and rising production costs for tanners in 2006 will not allow rising raw material costs, but is something that everyone with insufficient coverage should keep in mind. Inventories of preferred raw materials are not as high as they used to be. Suppliers have done their homework and reduced stocks of cattle hides - at least in the medium and higher end. It may be advisable, therefore, to check requirements and make sure that the uncovered production doesn’t get too big for the first quarter.
