Macroeconomics

 

Very few in the world of finance can see a cloud in the sky at the moment. Stock markets are moving upwards solidly, GNPs—particularly in the emerging markets—are rising at accelerated speeds, global enterprises are reporting healthy profits for 2005 and the first quarter of 2006, and raw material prices are rising, with gold and other metals reaching new highs every week.

 

So, for anybody who has invested, except for those who have put their money in bonds, is happy and the wealth of the rich is expanding fast. Furthermore, with rising incomes and growth in most of the emerging markets, some of the poor are benefiting a little too.

 

Polls in the business community also reflect this high level of confidence and most financial analysts are–although cautiously–still predicting splendid progress in 2006.

 

All this is safely based on research data. Business confidence in Germany has hit record levels, as has consumer confidence in the USA, and Japan seems to have left deflation behind it. Nothing seems able to spoil the good mood.

 

However, with all respect, and without wanting to be seen as being pessimistic, no-one should ignore the signs that are out there and that would have been considered worrying signals in the good old days.

 

Oil prices are hitting record levels again; gold prices have reached long-term highs; and interest rates are rising around the globe. Despite a positive business mood in Central Europe, there are massive problems in Italy, France and Germany with declining net income in the middle and lower classes. Economic growth in the USA is mostly based on private consumption, there are still imbalances in the US economy, and tensions in the Middle East which now include Iran too, could all add up to a pretty explosive mixture. As long as there is no spark things will remain quiet, but it would not take much for the situation to ignite and cause everything to change very quickly.

 

So, one remains well-advised to keep in mind that saving and securing wealth is as important as making it. However, although we remain cautious, at least our outlook for global economy is better than it was some while ago.

 

Market intelligence

 

Well, we have found that most of our opinions stated in the last edition of the market intelligence have been confirmed. When the trade came together in Hong Kong last week, many of the topics that had been circulating the leather world for some time were the focus of discussion and it was clear that meeting face-to-face still offers an advantage over talking on the phone or e-mailing.

 

Activity at the trade show followed the normal pattern seen at most fairs these days.  The middle days are very busy, attracting the most visitors, while the first and the last days are normally very quiet and are reserved for the exhibitors that have to stay on their stands. The same pattern applied in Hong Kong this year. Consequently—and following some complaints from exhibitors about cost and time spent—the organisers have decided to shorten the exhibition to three days in 2007.

 

Coming back to the leather market and to the results of the fair…. at the risk of repeating ourselves, most of the opinions that we had published before the fair were confirmed.

 

So, we will summarise how we see the present standpoint and try to add in some more details having had more of an insight into the situation over the past few weeks.

 

The leather business has to be segmented into major divisions more than ever before. The bright spot remains the side leather business, led by shoes and the fortunate situation that leather accessories are still play an important role in global fashion.

 

Footwear and fashion support side leather

The shoe business is benefiting from a number of different influences. The traditional markets such as the USA, Japan and Europe saw reasonably good shoe sales during the past season and the long and cold winter in many parts of the world added to the positive results for many shoe retailers.  They were able to clear most of their inventory and, with empty warehouses and shelves, ordering is traditionally much easier and budgets are usually increased. This adds up to very positive business between shoe manufacturers and buyers. Fashion is another issue and the continuing fashion for ladies knee-high boots and the fact that men are still wearing a reasonable number of casual or dress shoes made from leather continues to boost this sector.

 

The biggest impact, however, may be the natural growth of sales in the so-called emerging markets, with China clearly at the top, but also the Middle East, India, and Central and South America seeing a rapid increase in the standard of living. Consequently a pair of shoes is quickly becoming affordable to more and more people in these societies. Many shoemakers have reported strong domestic growth in sales and those that are in the fortunate position of having their own local brands and distribution systems are even saying that margins from sales in their own countries are significantly better than those that their export buyers are producing. In any case, the total consumption and demand of shoes has improved significantly over the past six months and this explains the strong demand for raw material and the very positive outlook for the next season.

 

We cannot remember speaking to anyone involved in this part of the industry that was not satisfied with the level of business and there were not even many complaints about margins or profitability either. It is quite difficult to imagine how these positive fundamentals could be turned into something negative in the coming two to three months. The one question that remains is how some of the shortage in specific raw materials and the problem of raw material prices in some more privileged sectors will be managed.  When it comes to small calf skins, for example, some people are saying that there is a strong movement towards goatskins and hairsheep as a substitute for the traditional material that has not only become pretty scarce but also extremely expensive. As far as other raw materials are concerned, several people are stating that leather buyers are now easing their specifications and are allowing tanners more freedom to search and select materials themselves. This means that it is the tanners’ problem to ensure that expectations are met in terms of price and quality.

 

Upholstery market unclear

Looking at the upholstery or better said the furniture leather trade, we fail to see the same positive mood and business environment as in the side leather business. Many claim that sales of classic upholstery-related raw materials, such as dairy cows from the United States and Europe, have been quite good not only over the last quarter but also at the show itself. Whilst this might be true, the question remains as to whether the demand and prices for furniture leather actually reflect this activity in the raw material market and justify all of the purchasing activity that has been seen.  We, in any case, have neither been able to pinpoint any additional demand for furniture leather, nor a realistic opportunity to raise leather prices. Any rise in price would be a surprise, as this is definitely not the time of the year where anyone is willing to negotiate new leather prices on leather orders for furniture leather, except for domestic sales in the emerging markets where long-term seasonal contracts are not yet commonplace.

 

Consequently, there must be other reasons and we can only speculate as to what these reasons are.  Some of the activity must be a result of the Chinese government’s import tax policy. Tanners who still have customs books to import raw material under the old regulations might use it and try to get hold of as much raw material before their customs book expires. However, this can only be part of the reason. Although interest in more economical origins has also increased in the past weeks and prices in countries such as Brazil have gone up, the fact remains that the average or higher than average origins, such as dairy cows from Europe and the United States, are still favoured.  The one and only reason for this that we can find is quality. 

 

Looking at the low-end of the price range, it is hard to believe that any tanner can make a profit at the current finished leather prices for low-end material.  Consequently, many are trying to secure their future by trying to go upmarket or are taking orders in the medium-to-high end of the quality range in the hope of eventually finding better margins. This theory is backed up by the fact that various tanners in China that had been focusing on buffalo production for cheap furniture leathers are now trying desperately to move into bovine materials, in the hope of achieving their average leather prices.

 

This particular situation puts a question mark over the situation in the raw material market and in particular over dairy cows. We do not feel that the present demand is being cushioned by anything other than buying for production and hoping for the future. This might support the situation in the raw material sector for a while, but at the end of the day it always has to be justified by the general market environment. We fail to see either any substantial growth in the leather furniture market or a fair chance of turning the present raw material level into profitable leather sales.  It seems to be that the market is just reflecting the overcapacity that exists and producers are searching for a way to get out of this problem by upgrading quality. Well, this is a long way around and the higher end market is smaller than many believe.

 

Automotive losing its shine

Automotive leather is continuing to lose some of its shine. While it was the success story for so long with massive growth and healthy profits, it is now maturing. Prices for finished leather are falling, the medium section of the market is disappearing and overcapacity is an issue here too. However, we are still hearing big names in the (furniture) industry talking of their plans to enter the automotive market, obviously in the hope of benefiting from economies of scale.

 

Under the present conditions, many of the established names are trying to downgrade raw materials to meet price and budget targets. With stagnant car markets in the USA and Europe the focus is once again on the markets which promise growth in production such as China and India. Consequently, there are announcements and rumours about factories opening, with people looking into either new start-ups or joint ventures in the region where they believe the growth is going to come from. Setting up there, however, also casts doubt over some existing production locations and some of the ‘growth’ might in fact just become relocation.

 

Little activity in the garment sector

One market sector that hardly anyone was talking about was garment leather. The Korean tanners and manufacturers are hardly surviving and there was little activity in bovine garment leathers was noted. For small skins, there was a real mixture of opinions. While Chinese producers are still complaining, there are an increasing number of manufacturers in the Middle East who are actually admitting that business has been better for the past six months and they are also cautiously optimistic for the near future. This might be related to quality and fashion, as the Chinese still seem to lag behind, at least as far as quality is concerned. However, if a trend for small skins is going to be established in the shoe and accessory business, the garment sector could become increasingly complicated. If business isn’t good, even with reasonably low raw material prices, it would need a strong boost from fashion to improve the business in the nappa field. Things might be a bit brighter for double face productions and the Turkish buyers, at least, are already circulating like flies in Europe to get the first slaughter of the new season lambs.

 

Market expected to slow

So, drawing a line under the past two weeks, one can be reasonably satisfied with the present situation. Excitement, however, and any realistic prospects for substantial further rises in the raw material market might be too much. Although one has to accept that the strong recent performance of the raw material market was to a great extent justified, nobody can ignore the fact that material is just being pushed through the pipeline now and the inventory position is only moving one or two steps further down the line.  It would require a very strong performance over the summer as well to allow the raw material market to make further substantial advances. Everybody also has to be aware of the fact that in the middle of the year could also see a slowdown in activity and the markets cooling off. Trade fairs also often have a pronounced effect and exaggerate the fundamental trends and although they offer a good indication, they should not be viewed as providing good short-term advice.

 

For the coming weeks we believe that trade activity will slow down. Most people need to settle back in at their desks and as most tanners have been travelling they need time to digest and analyse the present market conditions before making decisions. For the next six to eight weeks—in the raw material markets at least—it is hard to envisage any major change in the present price levels. With a reasonably low inventory situation for raw material suppliers, they will not find any reason to lower their price ideas, no matter how good or bad their business is. If we are wrong and tanners still need, or want, to buy more material moving into spring, one would not be surprised if sellers even raised their asking levels further. Everybody knows that sellers only ever begin to change their minds when they fear that they are accumulating material that will eventually need to be sold cheaper. But enjoying a comfortable sold-forward position, hardly anyone is facing this problem at present, with maybe one exception, the privileged market of extra heavy bull hides in Europe, which is still struggling as the concerns we aired some time ago have not disappeared. Even with a low slaughter moving into the summer, one has to believe that the present soaking is not enough to absorb the quantities that are circulating or coming from the abattoir floors. This is one fundamental change in the trade, because this privileged raw material hasn't had to deal with this problem for probably more than a decade. If the pattern of automotive leather demand does not change soon we could see a restructuring of the price table in Central Europe and one raw material moving against the trend until its prices become attractive again for production.