Macroeconomics

 

As far as macroeconomics are concerned, the situation remains quite uneventful.

The data coming from around the globe is very unexciting and no clear insight into possible developments in the global economy or the influence these could have on the leather pipeline is being delivered.

 

The general consensus remains positive for the outlook over the coming months and the individual data currently being delivered is not offering too much to support the arguments being put forward by the pessimists too much.

 

The situation with inflation – our major concern – remains hard to pinpoint as the inflation figures delivered recently can be, and are being, interpreted either way. In the USA this week consumer prices rose by 3.6% in the first two months of 2006. Excluding energy and food, they increased 2.1%, while producer prices rose by 3.7%. Most are still not viewing this as a threat, but considering that numbers above 2% start to indicate a true direction, and knowing that we are facing a time lag in terms of the influence of the increase in raw material prices, we still believe that that some concern is justified. Mr Bernanke, Mr. Greenspan’s successor as head of the Federal Reserve, is now close to making his first decision on interest rates and most pundits expect the US interest rate to rise during the year in order to stem inflation without affecting the US economy.

 

The stock markets remain on the steady and firm side, as do oil prices, and the US$ is rising and falling within its firmly established trading range of €1.19-€1.23.

 

Political unrest in Europe

Strikes and demonstrations have been hitting the headlines in the two large EU economies of France and Germany. While the reasons for the action vary, it highlights a fundamental problem—a large part of the workforce in these countries is unwilling to accept the governments’ chosen action in attempting to reform the labour markets and stem the rising problems of budget deficits. The Italian government, or rather the Prime Minister, is still dominating the media too, although for different reasons. It can only be hoped that these three large EU economies do not see further political unrest, as it could hinder the very small chance that exists for economic recovery in Central Europe.

 

The EU has imposed an anti-dumping tax on shoes from China and Vietnam, which will eventually reach 19.8% and 16.5% respectively. Right or wrong it will certainly not bring back any of the jobs that have been lost in Europe over the past few years and one has to believe that this decision is a political signal rather than a real threat of any kind for either side. This coincides with continued demands from the USA to re-evaluate the Chinese currency (RNB) which have been made for the same reasons.

 

 

 

 

Market intelligence

 

It is not really good timing to write about the leather pipeline. Why? Well, mainly because the situation and activity haven’t changed much and the leather sector is now awaiting the results of the extended trips to Asia and APLF in Hong Kong before deciding what to do next. However, after careful consideration, we decided to follow our normal rhythm for publication and rather than going to press next week, right after the show, we decided to publish today and then a week after the fair has closed its doors as it might be better to let things settle for another week so as to have a clear picture of the events before analysing them.

 

Uncertainty remains over future demand

The key question that remains on everybody’s lips and for which we are all awaiting an answer is whether the extended demand for raw material that we have seen over the past three months is a true reflection of the actual demand for finished leather or if it just a case of stockpiling.

 

While the answer is pretty clear in the case of European tanneries, the situation in China in particular, if not all across Asia, remains much less clear cut. In Europe at least it seems that tanneries reduced their inventories in 2005 by far too much and they are now running after raw material in order to replenish stocks and cover their existing needs. This activity is also related to the fact that many of the tanneries are now working on a just-in-time basis with raw materials so that any increase in leather orders cannot be fulfilled with stock held in the warehouse. Consequently, for this part of the world, it is evident that the last season of leather production, which started after the summer holidays 2005, generated much more leather business then the industry had expected.

 

Nobody is denying that global leather demand has been much better than expected and we have covered this situation many times in this publication. However, a big question mark remains over the purchasing pattern of the Chinese. While everybody pretty much ignored the situation in China at the end of 2005 and the beginning of 2006, people are now starting to scratch their heads in confusion, and, as yet, we have not found anyone who can really give us a final and confirmed opinion of the situation.

 

At the end of 2005, the slower than normal purchasing activity from Chinese tanners was justified due to uncertainty over the Chinese government’s tax policy. This was a fair opinion and may well have reflected the real situation.  When the situation was finally clarified at the beginning of 2006 it didn't really help either. At that time, many were of the opinion that this would reduce raw material demand due to the new costing situation. However, as per usual, China plays by its own rules and so the situation developed differently than everyone had expected.

 

One way or the other it seems that many producers have been, and still are, able to use their so-called custom books to import raw material in 2006 without being liable to the import tax. If this is not the case, many of the Chinese players have obviously found ways around the problem, temporarily at least.

 

Clarification needed over China

The vast majority are now demanding some clarification as to why Chinese tanners have been so active in locating and buying raw material in the first quarter of 2006 and are wondering whether it is connected to the fact that they can still buy it without paying import tax. If this is the case—and one can be pretty sure of this opinion looking at the export statistics to China from the major origins such as the United States and Brazil, both of which are reporting increases of more than 50% versus a year ago—this would mean that tanners in China are currently stockpiling and not just covering existing leather orders.

 

However, many experienced members of the trade, and even some Chinese, are claiming that this is not the case and say that leather orders have been so good over the last three to six months that this is simply a case of tanners having to replenish inventories in order to cover existing orders into the summer. If this were the case, it would signal an extraordinary improvement in the production and sales of leather products. At the end of the day, it sounds too good to be true, and if this were the case not only China but other producers would also be reporting significant increases in production numbers against 2005.

 

Although we became stubbornly optimistic sometime ago, it is hard to believe that things could be as positive as recent developments would have us believe.

 

Maybe the truth lies, as usual, somewhere in between. Considering production cycles and the unresolved situation over import taxes, it appears that Chinese tanners were maybe overcautious about raw material procurement at the end of 2005 and simply needed to replenish the pipeline in early 2006. This could never account for the volumes we have seen in the first quarter, but it would go someway to explain the rise. If you then add an increase in leather orders in China, as has happened around the globe, this would account for another part of it. But does this explain all of the increase? We tend to believe it doesn’t. One can’t escape the feeling that there has also been some purchasing in order to bolster inventories and use up existing orders that are still covered by the so- called custom books in order to get round any import duties which may have to be paid in future.

 

Since discussions at industry meetings have not really clarified the position we can only hope that the fair in Hong Kong will finally offer us an insight into the real situation.

 

 

No room for manoeuvre in raw material market

Looking at the status of the raw material markets at present, it is quite important to note that there is hardly any buffer at the raw material end for the time being. If suppliers, such as the USA, are not already fairly well sold-forward, they are by no means in possession of big inventories that would cover any additional demand that could arise in the months to come. Only the higher kill that is expected in United States could ease the current tensions that we are seeing in many of the raw materials categories.

 

If the opposite to this scenario comes closer to the truth, then one day the Chinese industry will have satisfied its demand and the effect of the import tax issue will come into play with a sudden halt in purchasing.

 

We don’t agree with the argument made by many that anti-dumping duties will slow down general demand, as this will just shift some of the production out of China and into other production locations. At the end of the day, whilst the demand for footwear remains strong, neither higher prices for leather nor higher prices for shoes will reduce this demand.

 

We are finding it extremely hard to take a position or follow any of the arguments. However, a great deal points towards the fact that the purchasing volume of Chinese tanners has been exaggerated and could lead to a substantial decline in the second quarter of 2006. Having said that, one has to consider that the Chinese industry is also fully aware of the situation and this raises the question as to why they are acting in the way that they are. The only possible answer we have to this is that it has happened before. We often see this kind of ‘me too’ effect and assuming that the big raw material sellers were able to scare their customers over the security of raw material supplies, this could have shaken the market and led to a psychologically driven bull market. This is a situation we have seen before.

 

As a consequence, those who are in possession of the fundamental information on the leather business are well-advised to use their information and make the right decisions, because one thing is obvious: the market is now nearing a decisive junction.

 

Upholstery causes concern

Looking at the leather markets, there is little doubt about the continued strong performance in shoe and leathergoods. Nobody is denying healthy order books and the positive outlook. The upholstery market, however, is cause for a little more concern. Even though business was certainly better than expected last season, leather prices have not moved much and most of the raw material price increases have come out of the pocket of the tanner so far. Automotive tanners are not very happy either as the situation in the car industry is weighing heavily on finished leather prices, which have been solved, up to now, by using more economical hides and improved technology. However, from what we’ve heard, we know that there is little chance that the car industry will react positively to higher asking prices for new models or contracts. With the industry still burdened by overcapacity, the only answer would be further production cuts and closures.

 

Whatever happens, the mist should settle a little over the weeks to come and maybe we will be able to take a clearer position following the event in Hong Kong.

 

The split market is in a similar state to the hide market. Supply is tight and buyers are finding it difficult to secure enough supply at the right price, however, things do not seem to be as agitated as in the hide market.

 

Skin market trend firms

The firm tone in the raw material markets is now spilling over into the skin market too. Linings in particular are scarce and expensive while the situation on the nappa side is still reasonably easy. For more economical skins for garment nappa production there is still sufficient material is circulation, although this could change more quickly than you think. With the shortage of calf and kips it would come as no surprise next season if more and more manufacturers discovered hairsheep, for example, as an alternative if the first choice of raw material is no longer available. The start of the ‘new season’ lambs in Europe has been delayed due to the cold weather in many areas, however, the Turkish industry is already in its ‘early season’ buying mood and prices for lambs are looking for their levels at the moment. It is still a bit early to say where the levels will be, but they will undoubtedly be substantially higher than the levels at the end of last season.

 

It’s not easy to give an outlook for the week to come due to the situation as stated above. However, it doesn’t require too much courage to predict that sellers will see no reason to reduce prices in the current environment and in fact quite the reverse is true and they may feel justified in raising them a little.

 

The fair in Hong Kong and the exchange of opinions will hopefully lead to a common opinion for the start of the next quarter and we will see what we can expect running up to the summer. We think that the market will remain stable for some time and the only problem it could face is shipping requests slowing down suddenly and significantly.