Macroeconomics

The mood and activity in the financial world has been overshadowed over the past two weeks by the disputes and riots in relation to the cartoons published in Denmark some time ago. This proved once again how fragile the international geopolitical situation still is.

What was noteworthy, however, was that the financial markets took very little notice and neither the stock markets nor the energy markets reacted in the way one might expect. Stock markets did not fall significantly and oil prices did not shoot through the roof and this was good news.

Although Mr Greenspan has left his post, he is still a factor in the international financial community. As a matter of fact, the private speeches he has given are probably more influential than the statements of his successor. So far Mr Greenspan has had the chance to speak in private whereas Mr. Bernanke, his successor has not yet had the opportunity to make his mark in public.

The US$, contrary to most opinions, remained buoyant and has risen to more than 1.20 against the euro. This comes as a surprise as the fundamental figures do not really favour the US currency. However, at present global investors still seem to be happier putting their money into the United States rather than investing anywhere else.

This may be related to a superficially robust US economy which surprised us again this week with positive figures on the labour market.

 

 

 

Market intelligence

The positive note on which we left our recent reports has been confirmed in the past two weeks. The fair in India added to the positive results already delivered at previous events. Despite the political turmoil we are seeing at the moment, it seems that the consumer markets and the leather pipeline are still pretty much in harmony and most indicators are signalling a positive trend for the near future.

This positive undertone was also reflected in the raw material markets and there was a slight but incremental firming of prices almost across the board. The only exception appeared to be extra heavy hides in Europe, which are battling against the attempts of automotive tanners to drive raw material costs lower. Most of these tanners are faced with falling leather prices for 2006 models and consequently they have to try to lower the purchasing prices for premium and privileged raw material from central Europe.

The rest of the market enjoyed a decent level of interest again. Hardly any of the main production centres around the world failed to deliver reports of active trading and tanners in search of raw materials for their production. The return of the Chinese tanners from their annual Lunar New Year break was also accompanied by a decent round of interest in purchasing in Europe as well as in the United States and other raw material supply markets.

Standard items were able to make some progress in price and moved up slightly. Tanners had to accept that the raw material market is not holding the same stocks as a year ago and the time when tanners were able to pick and choose from an extended number of supply sources with abundant supply and prompt availability is no longer the case.

 

Buyers and sellers remain calm

But, there is no panic in the market and buyers and sellers are dealing with the current situation quite professionally. Sellers are not asking substantially higher process for the product as yet, and buyers are extremely wary of actions that could influence the situation and lead to uncontrollable market movements. A similar situation some years ago could have easily led to a volatile raw material market with overambitious sellers trying to push prices up by a large margin each week.

It seems that the trade in general has matured and people are looking at the long-term consequences rather than at short term profits. Only time will tell if this will last, which will also depend on the progress of purchasing activity in the coming weeks.

One thing is clear: we are at the peak production time between the Lunar New Year break and the Hong Kong leather shows and there is a generally positive sentiment and a firm ground for prices.

The problem these days is that production and price calculations have become very transparent and almost everyone is aware that the margins are currently insufficient, but that a further sharp increase in raw material price levels would have very negative consequences for the trade.

 

Profitability is still a very serious issue as was illustrated again with the closure of a Dutch finishing plant for upholstery leathers. If raw material prices continue to advance in larger numbers, we would not be surprised if there were more victims, in Europe at least.

 

Inflation boosts prices

The current situation seems to in a way fulfil the predictions we made back in the latter part of 2005. Many of our regular readers will remember that we pointed out on several occasions that hide, skin and leather prices can only advance significantly when inflation returns. Inflation is back and no matter what the statistics show, the consumer still has to pay for significantly higher energy costs, public services and eventually for higher raw material prices such as metal, etc. one or the other.

 

It is not only inflation that is supporting the current prices for leather products we should not forget that many of the substitute alternatives are also becoming more expensive because their production is in many cases oil-related. Most of these products, or the raw materials used to manufacture them, have gone up by 20%- 25% for the production year 2006. In some cases, further increases have already been announced and the total rise could be even higher in the current year. This also certainly leaves quite a bit of room for the price of leather.

 

Before this happens, some of the overcapacity in the market still has to be eradicated to enable the existing production to convince buyers of the need for higher prices. Another thing that is also true—although tanners do not like to hear it—is that it is much easier to discuss this with the client when there is proof of higher raw material prices, however, to get to this point though, the higher prices have to have been paid already, which is a slight contradiction. Anyway, none of this is new and we have already been over this several times in the past. For some, if not many, it is a little strange because the past two years have been so different and it has been the leather buyer that has been able to command prices rather than the producer and seller. It might now be time for a change, although many are not yet convinced.

 

Inventories significantly lower

Analysing the present raw material situation, one has to conclude that our assumption that inventories are significantly lower than a year ago has proved to be correct. Continued purchasing and high production levels have absorbed the stocks for some time now and this has spread from light material into other categories too. Demand outstripped supply, for a large part of 2005 at least, and in many cases the balance we have already mentioned and the very steady price movements have been achieved by reducing raw material inventories in the pipeline, i.e. sellers taking the opportunity to raise cash.

 

For many raw material sources and categories most of the outstanding material stocks have been cleaned up and the reason for sellers disposing of their inventory on the market, i.e. the fear of falling prices, is now fading quickly. We are not yet at the point where sellers have the courage to bet on a sharp rise and as a consequence they are very reluctant to test the market with overambitious pricing. But, this could change quickly when sellers become really oversold or gain so much confidence in the market that they begin to protect against buyers’ interest with prohibitive asking prices. Many of these asking prices will be temporary and only exist on paper, but market volatility could certainly return and become a factor again. This would mean that the comfortable times for raw material trading in a very narrow range could be over.

 

Let's hope that things remain in order, because we all know that hectic movements and high volatility would not result in anything positive and would kill the business and the positive mood eventually.

 

Split market benefits from situation

The split market also took some advantage from the present situation and tanners were more active in buying splits. Less desired categories also found more interest and homes. There might be a further recovery of interest in splits even if this only happens to prevent rising prices of grains or hides. We would say the same applies for splits as for hides. Stocks are not very high and more enquiries and demand would push prices up in this segment.

 

There were also strengthening prices and good enquiries for skins. Sheep and lambskins are mainly driven by China and here we are seeing a combination of a positive outlook for garment leather and decent business for wool. Goats are also starting to reap some of the benefits of the very high prices for small calf and kip.  For many years goats have been largely neglected at the quality end of leather production. Now many tanners and designers are starting to remember the product which was so popular many years ago and are starting to test what can be done with it. In the good old days, using goat and calf as interchangeable products was pretty normal and they almost walked hand in hand in superior quality shoe and leathergoods production for many years. Maybe some are starting to understand that too many restrictions have been placed on those who know best what can be turned into a quality product and that this is not good for business, prices or margins. So, the downstream command in the leather pipeline should be questioned again and retailers and manufacturers should once more consider whether they should leave the tanner more room for production flexibility.

 

Optimism continues

For the coming weeks we are starting to feel more optimistic, and believe this optimism will be reflected in increasing prices. Maybe this is just a self-fulfilling prophecy as prices have already advanced when we thought that the market would only be steady. As a matter of fact, and we have already said this many times, price variations within a range of a couple of per cent are not considered to be a real difference. The long-term view that we adopted in the last quarter of 2005 and the advice we offered that one should ensure that raw material was secured at the levels we had at that time, proved to be quite accurate. Not that we have a crystal ball telling us the future, but rational logic is delivering better results than the wishful thinking of those driven by the daily problems of running an enterprise.

If things develop in the normal pattern, we should see more activity in the coming week and tanners trying to secure more raw material supply at the prices of two weeks ago. They will most likely fail and this will lead to difficult and tough negotiations to find some kind of an agreement between the buyers’ and sellers’ ideas. After this the market should, as usual, slow down with sellers asking for higher levels while buyers refrain from accepting them. Trading activity should consequently slow down. For the present moment sellers are definitely in better control of the market and they won't be scared because many of them possess a satisfying order book to take them up to their trips to Asia at the end of March.

The only exception to this generally positive position might still be the very heavy end of the market in Europe, where sellers still do not have the international marketing alternatives for their product and it will be quite interesting to see how the new negotiations between the small numbers of sellers and buyers will end.  There is a fair chance that the price trend might be in contrast to the rest of the market - for a short period of time only.