Macroeconomics

 

2006 started slowly as expected. Little information was delivered from the financial markets in the first week and the Christmas period was also reasonably quiet.

 

The main focus of attention for the international financial community is the developments in interest rates, currency movements, and the future of the US economy is definitely in the foreground. The global economic trends seen over the season were pretty much confirmed at the end of 2005.

 

The emerging markets continued their growth and Russia also reported a 7% increase in GNP. After Japan - which seems to be over the worst – recording tremendous development in the stock market, more and more information is now coming from Europe that things might improve.  German business indexes are rising month by month and forecasters expect the economy to report a moderate improvement in the year to come. However, positive forecasts have been made about the German economy many times in the past few years which have always ended in disappointment.

 

Financial markets expected to oscillate

Most financial analysts expect 2006 to be a rocky ride on the financial markets. The threat of rising prices, inflation and interest rates could eventually become a bitter cocktail; however, most are of the opinions that things will not become problematic before the second half of the year.

 

Oil prices rose again and it seems that there is little chance of any kind of reduction before the end of the winter season in the northern hemisphere. Furthermore, China’s appetite for energy and raw materials still does not seem to be satisfied and so most forecasts remain positive for oil, metals and other raw material prices in 2006.

 

Besides interest rates and energy costs, which are definitely the most important aspects for companies and global consumers, general imbalances, in particular in the USA, are the matters of most concern for the coming year. Mr Greenspan will step down at the end of January and many people are now debating whether this change will cause problems for the US economy, the real estate bubble and  eventually the value of the US$.

 

Dollar falls

One was already able to get a taste of this in the first week when the dollar made a steep fall of 1.18 straight to 1.22 against the euro. The US$ /Yen performance was not much better either. Even with some recovery and a trading range between 1.20 to 1.22 the volatility is rising and with the Asian countries piling up US dollars and the USA’s record trade deficit, things could become pretty tricky for bulls who have to calculate their exports in the American currency.

 

Tensions between the USA and China over the problem of the massive imbalances between the two countries are rising again and everything is pointing to the fact that the Chinese government has to ease its tight grip on the value of the RNB later this year. But, anything other than moderate revaluation would be a surprise.

 

As leather business rates are very sensitive to change in the financial markets it seems that one would be well-advised to study the daily news carefully in order to protect oneself from any nasty surprises.

 

Market intelligence

 

As mentioned above, the start into the New Year was quite slow.  But, business did not dry up completely and most people we were able to speak to confirmed that sales didn’t ever come to a complete stop and that there was enough product moved each week, from mid December, to call it satisfying business activity for the season.

 

This proved again that despite interruptions in production due to holidays, management remain active and continue to be trade on the raw material markets. Most of the business activity came out of the Orient where the Christmas break is obviously less pronounced than in Europe.

 

One can say that the period from mid December to mid February is just a continuation of the holiday season somewhere in the world.  It started with Christmas, then more holidays in Catholic parts of Europe, then the Moslem holidays, and now we are entering the Chinese New Year break in the Orient. What could more be called the low season than a period of almost six weeks when activity is reduced in the major parts of the world?

 

Under normal circumstances this should weigh heavily on the volume of trading and shipments, and in normal business logic that would normally lead to low prices, which most expected. However, this was not the case as mentioned above. Sales were reasonably steady, with no more than a two-week break and the flow of product in the pipeline therefore remained intact, it was just at a slightly lower level.  Since this has happened when beef production also drops, and considering that most people had already made their arrangements well in advance, the market did not react at all and prices remained in the same very narrow trading range that we have seen for almost the last six months.

 

Chinese policy clarified

Fortunately, the situation over the Chinese import tax policy was cleared up. All the rumours and reports, the excitement and anticipation proved to be premature and in so the changes should go smoothly into effect over the next six to 12 months. To sum up what has changed – well, it is quite important for individual companies, but we don't think it will change much for the leather business as a whole across the globe.

 

The essential change, in our view is that exporting businesses in China - who paid only 8% import tax and got a 13% export refund - are now going to have to pay the same 22% as everybody else, with a 13% refund. So, this means that there is now a level playing field for those producing in the pipeline and there is no longer a straightforward profit potential for people playing the tax game. Some would say that our description of this is a bit over-simplified and indeed there might be some more aspects. However, in most cases there is a tremendous difference between government tax regulations and the situation with other local authorities. The influence of regional and city taxes should not be under-estimated. However, for most players the situation is now clear, and the situation for individuals is going to change in 2006.

 

While exporting companies are generally complaining about the new policy, many importers and domestic operators have welcomed the new situation since it offers them a fairer chance to compete. It is going to be quite interesting to see how Chinese companies will handle the new situation and who will come out as the winners and the losers. It is more than likely that it will not be as simple to calculate as many people tried to make it in the past, but neither will be entirely negative for the business, as many had expected.

 

As far as the general trends in the markets are concerned, we are most interested in the leather fashion trends for the months to come. There has been a great deal of discussion and speculation about fashion and its influence on raw material supply. The fact of the matter is that another situation has not been considered: if fashion remains the same and the demand for light weight kips and calf does not decline, will there be sufficient supply?

 

Skin supplies may run low

 

Skins up to 15 kg were probably the only item in the bovine section that saw a real movement in price in the last year.  At the start of 2005 suppliers were sitting on large inventories of unsold material in this weight range and consequently prices were reasonably cheap. However, after almost two years when this type of product did not fit any kind of finished leather production or fashion, skins were discovered as an attractive and cheap raw material, mainly for ladies fashion. With the success of bags and boots the existing stocks were quickly used up and in the last quarter the shortage had already become evident.  Prices soared by 15% to 30% depending on the product. However, production of such kind of raw material remains very limited and global production can by no means meet the demand if the current fashion does not change soon. Another solution would certainly be to become more flexible in the choice of raw materials. The limitations for raw materials set by the shoe and bag manufacturers are far too tight and do not allow tanners to be flexible when there are such kind of supply issues.

 

The leather fair in India at the end of this month might give us some kind of an indication as to whether there is any hope of solving the problem. The worst that could happen is that the demand for leather declines due to price and the inability to substitute raw materials as a result of technical and manual restrictions that are not justified. It still remains the tanners’ duty to be creative and to propose solutions which are accepted by retailers and manufacturers. These days one has more and more of an impression that those selling the product believe that they understand more about it than those who actually make it.

 

Change unlikely in bovine market

For the rest of the bovine market, most pundits are discussing whether there's any chance that the raw material market could leave the very narrow trading range we have already seen for such a long time. The conclusion of most of them is that there is no reason why it should exit the trading range; but experience tells us it is unlikely that we are going to have another full year with such narrow price movements as we saw in 2005. However, most fail to find an argument for any major change and are even unable to give an opinion on which direction it will go. Well, it might be better not to give any answers if you don't have any.

 

We tend to agree that the market will not move much this year, however, with the balance of raw material supply and general global demand, temporary price corrections must be seen as an opportunity to replenish stocks. As far as the balance between supply and demand is concerned, something major would have to occur to depress raw material prices. While others still believe in a strong and rising bull market, they must understand that packers are also well-aware that you can pay dearly for stretching raw material prices as it can result in a steep fall in prices. Finally it also seems that we are living in a period where business logic rules and this is definitely not appreciated by the traders.

 

As far as we are concerned, the split market did not rouse too much interest over the season. Interest here is again steady and reasonable and prices remain the same. However, an exit from the present price range can not be expected here either and what has been said about the hide market seems to apply to the split market too.

 

Chinese interest increases

Skins delivered a bit of a different picture. In Europe, at least, the Chinese interest has finally arrived and quite a few reports are circulating that larger quantities have been booked.  Compared with the prices paid at the beginning of December, leathers have advanced by 25% to 50%.  The Chinese buyers love the current season and prefer to buy the late season lambskins which are killed between December and February. They also like hand-salted material and with the weather conditions until the end of the first quarter, they prefer to receive the shipments not drum-salted. Next week we will see the leather fair in Istanbul and the reaction of the Turkish tanners will be interesting as they might find that the material they were looking for could have already been sold to China.  However, it could also be that they don't mind, because they actually don't really need any more North and European skins. With their emphasis on higher quality double-face material the standard items may no longer be good enough for their productions.

 

For the coming weeks we don't expect any major changes.  The Chinese buyers will make their final decisions on raw material procurement prior to their holidays and we would not be surprised if this delivers a reasonable number of business opportunities. As many Chinese tanners do not seem to be at fully satisfying levels with inventory positions, and they may face price pressure for their finished products, they will have to decide how to fill their drums and to make sure that the raw material pipeline does not dry up. An observation that we have made various times in the past certainly applies now - that calculations and margins will certainly be one of the biggest if not the biggest problem in 2006 – and we cannot see any way that the tanning industry can escape this for the moment.

We wish all our readers good luck in 2006 and wish you all a very happy, healthy and prosperous New Year.