MARKET INTELLIGENCE

Macroeconomics

 

2005 is coming to a close and the financial community is also starting to wind down. However, before the slowdown happened we still received a significant volume of interesting data and news which leaves us with quite a bit to think about for 2006.

 

The Fed raised interests–as expected–another 0.25 %. This was no real surprise and now the experts are trying to figure out if this is the end of the cycle or if there is still more to come in 2006. Not that it would really make much difference if interest rates increase by another 0.5 %, but the ‘experts’ remain  busy and are now reading things into every single comment–made anyone that is considered important–in order to throw arguments into the ring to justify comments and speculative decisions.

 

US$ falls

The first effect was that the US$ value was affected and volatility rose significantly. The US$ fell against most major currencies and worries about the value of the greenback in 2006 returned to the foreground. Our concerns, already expressed in previous issues of the MI, seem to be justified and we can only repeat our recommendation to watch the currency market even more carefully than normal in 2006 – at least where one feels it is relevant to business decisions.

 

As we are now entering the final weeks of the current year, it seems sufficient to plan your extended forecast in terms of the general global future for 2006.

 

Economic outlook remains positive

The general condition and outlook for the global economy remains remarkably intact and positive. The latest economic news delivered was all promising. In the US, unemployment fell again and a whopping 215,000 new jobs were created. Most emerging markets are delivering growth rates of more than 5% and large economies such as China, India and Brazil are growing at a rate closer to 10%. All of them are also generating massive trade surpluses.  Oil exporting countries are performing very well due to the high price and as a consequence some of the wealth in the world is now moving from developed countries into emerging economies.

 

Although many are still complaining that this trend is not developing fast enough or evenly enough, it is still promising and is slowly closing the gap between the rich and the poor. The major problem is that a whole continent–Africa–is being left behind completely and there are certainly other regions in the world where things are still by no means acceptable.  However, the growing global economy is, at the end of the day, still reaching more people, and this is the good news.

 

Consumer confidence is high

This situation is also reflected in economic statistics. American consumers are feeling optimistic and this was reflected in a rise in the Michigan index to 88.7. Low fuel prices have also stimulated retail activity. In Europe, industrial production in Germany rose by 3.8% and the forecasts for the European Central economy are positive with business expectations rising to record levels.

 

Stock markets also performed extremely well in the last quarter and many indices are close to record levels.

 

The rising wealth in emerging markets is consequently reaching very large populations.  For consumer products, such as leather, this is good news because the number of people attaining a position in which they can purchase leather products is growing quickly.

 

All the above is so positive that it is difficult to find a cloud in the sky and we have failed to find any real downside. The start of 2006 at least–as nowadays one can’t rally look further than a quarter ahead–looks mainly positive for the leather pipeline and this now just needs to be converted into better business, sales and profits.

 

Market intelligence

 

This issue of market intelligence will be the last one of 2005 and it offers the opportunity to look back and forwards.

 

Looking at the last 12 months, some highlights spring to mind. One of the most noticeable was the high stability of the raw material market.  Prices were trapped in between much better-than-expected demand for leather products and excessive production capacities. On the one hand there was very strong purchasing power and on the other there was price control from the retail giants. At the end of the day the even balance between supply and demand dominated and left no side the opportunity for a clear victory. Whenever prices started to test the water to see if there was room for more movement they were quickly controlled by buyers and sellers.

 

Narrow trading range unbroken

Even major disturbances such as the outbreak of foot and mouth disease in Brazil were not able to scare either side and, from the beginning of the year to the end, prices remained in a very narrow trading range of no more than 10 to 15%.  This is very good for the industry on the whole because it offers planning and budgeting security.  Some will complain because they often view the raw material market as a gambling arena to win in financial terms that business economics do not allow. Those, including a large number of raw material traders, will most likely be disappointed.

 

Those, however, that had a winning business concept entering 2005 were in most cases extremely satisfied and were forced to look for other issues to complain about.

 

 

What else can be said about the leather business in 2005? There were certainly other important issues. One was, in our view, the proof that leather remains a fashionable product. The tremendous success of ladies’ bags, fashionable ladies’ shoes and boots and general accessories were another example of how much can be done with the product when designs, quality and marketing appeal to the taste of the consumer and surprise, surprise all of a sudden the endless discussions on ‘price’ seem to retreat very quickly.

 

The focus of the leather industry, which has been on the impressive growth in automotive leather for so long, has quickly moved back to the more traditional production of leather and leather products this year.

 

Overcapacity remains

Second, the world had to finally accept that the global leather industry is still suffering still from massive overcapacity and European tanneries in particular drew the final curtain and decided to close. Across Europe prominent names have announced that they have or will shut their doors in 2005. And this brings us to the next issue which we think is important to mention.

 

Against all the forecasts and expert opinions, and despite everything mentioned above, a lot of European tanners are still fighting on and are performing extremely well. This is not only the ones that had already established their positions, but many others that faced the challenges and focused on their strengths. By the middle of the year it became obvious that even the Italian upholstery tanners were fighting back. Not much more than a year ago, the vast majority of the trade was convinced that there was no chance of competing against the massive and rapid growth in China and only a few still believed in the business concept of the ‘old economies’.

 

But in this case too, we had to learn that the leather business is not as simple as it seems. Prices and costs are important, but they do not count for everything. Size, the set-up of businesses, the quality, taste, design and fashion also matters. All this leaves plenty of room for those that are competent enough to handle the challenge. Those that were performed extremely well in 2005 and their outlook for the New Year is also very positive.

 

Mass production and a growing consumer market with its own styles, tastes and rules will now allow a reversal of the trend, but it proves that the ‘one-way street toward the East’ has not been established yet.

 

Garment continues to struggle

Last but not least, it has to be mentioned that the only segment of the leather industry that didn’t perform well was garment leather (excluding the very high luxury end–as usual). While this was disappointing, it offers a good opportunity for 2006. Fashion designers and retailers are being strongly urged to take up the unique chance of favourable raw material prices and after a long period when leather as a fashion garment product ‘hasn’t existed’ to look at the opportunities this situation can offer.

 

Looking to 2006 and trying to circle the highlights, we see a big challenge will be the calculations. Despite all of the positive things we have said above, the pressure on consumer prices persists. Many retailers still expect product prices to decline and this is in total contrast to the rising cost of production that we will have to compensate in the year to come.

 

Production costs increase

Energy costs, chemical costs, and effluent treatment and waste are all going to rise or have already done so and the effect of this will become apparent in the coming months. Regulations are already very tight and, as selling prices are squeezed further, it is going to be pretty difficult to deal with this. Many expect that this should be compensated with falling raw material prices, but if the assumption that global demand for leather products is going to be strong is correct, then it is pretty unlikely that raw material prices can actually fall to the extent that the leather pipeline would require. The logical consequence will be that margins will erode or even be turned into losses–and this will not be the first time that business is good in leather, but profitability suffers.

 

We have always been of the opinion that leather prices can only go up when we enter a period of higher inflation.  Economists are still struggling to figure out whether they believe that rising raw material prices will eventually turn into higher consumer prices, or whether rising productivity and freezing competition will keep consumer prices under control.  It is very difficult to make short-term decisions because factories can be built, output increased, and demand can rise very quickly nowadays. However, one day manufacturers may become fed up with building or investing for little return. Eventually, manufacturers will either have a fair chance to calculate prices or the distribution chain will have to be vertically integrated into production. Both options are designed to lower prices but, it may take quite a while until the effect of this is seen.

 

Market slows down

We haven’t missed very much on the market in the last few weeks. Trading was winding down in the western world and Asian buyers were still sitting on the fence, hoping that the global slowdown would deliver some bargains. Not much has really happened, although many report that there has been a noticeable increase in enquiries for upholstery hides from Asia. Bidding has been in vain so far and in Europe the falling value of the US$ was weighing heavily on calculations and left little room for manoeuvre, even for those who might have been intending to get something on their order books before the end of the year.

 

So, nothing really happened and prices did not move significantly. Only dairy cows in the USA were quoted somewhat higher and if they can establish these levels or even advance in the first quarter they would again leave the low end of the trading range, which we would not see as a surprise.

 

Future looks bright

The coming weeks will be affected by the holiday seasons. Christmas shopping – as far as current figures which are available – has been reasonable so far and probably even better than expected in Europe. But, shoes and sofas are not popular Christmas gifts these days, so the impact on the leather industry will be limited. In China we are now entering the shopping season for the Lunar New Year and this might be more import as traditionally the Chinese also shop for ‘normal’ products plus some fashion.

 

We are not pessimistic about the beginning of the New Year, although the holiday season will have some impact on activity. For 2006 we are quite optimistic for leather as a product, but at the same time we have to be more than cautious about the economic situation.

 

We wish all our readers a very Merry Christmas and a Happy, Healthy and Prosperous New Year!