Current data received from the financial markets has largely confirmed recent findings and predictions. The global economy continues to expand rapidly and ‘The Economist’ world GDP indicator rose by 5.3% in the second quarter. Looking at the low rate of expansion in Europe and the slow down in the USA, for which the GDP growth rate was revised to 2.5%, it is easy to see the extent to which global growth is presently being driven by the emerging market, in particular by the BRIC countries (Brazil, Russia, India and China) where growth is still around double digit figures.

In the USA, the housing market continues to slow with house prices only increasing by 1.2% in the second quarter. Consumer confidence also fell to below 100 from 107 in July while the job market did a little better with 128,000 jobs added and unemployment remaining at a low rate of around 4.7%.

Oil prices are fortunately experiencing a moderate slowdown due to the end of summer travel season in the northern hemisphere and reduced tensions in the Middle East. However, the level still remains well above $60 a barrel and is consequently still quite high. Despite this, there is a greater likelihood that oil prices will slide further at the end of the hurricane season.

The currency market saw the euro rise to record levels against the yen while the trading range for the $ remained intact, fluctuating between 1.27-1.29. Therefore, the general global economy has not delivered any variations significant enough to change the fundamentals for the leather pipeline.

Market intelligence

Everybody has been eagerly awaiting the ACLE and its results in Shanghai. Not that the fair itself was expected to bring any particular news as far as business was concerned but, being the first global event after a long break and with many Europeans and Americans taking the opportunity to visit the region, it was the melting pot for information and opinions once again at a time when the industry was desperately looking for direction.

We are sure that many of our readers will remember the comments in our last issue concerning problems related to the supply chain which were confirmed during the event. One could even go as far as to say that it would be enough to read the last issue and draw your own conclusions, because most of its description of the market situation were realised during the event.

South American and Russian prices rise sharply

Raw material supply shortage, and specifically the low price origins, is dominating the market situation with tanners suffering from a shortage of adequately priced raw materials. A price hike had already been seen in South America and Russia in the first half of the year and this has actually accelerated significantly in recent weeks. Prices for low grade materials have risen by anywhere between 25-40% in 2006, while medium higher qualities have increased by approximately 10-20%. The reasons for this are also fairly obvious. With the massive pressure on finished leather prices, leather producers were more and more pressured in discussions with buyers to make quality concessions and to buy cheaper raw materials to meet the price targets given for finished products. In combination with the generally strong global demand for leather products, this has created the strong current in the raw material markets.

Any confirmation of this that was needed was shown during the days in China.

Emerging markets lead to good demand and orders

There are several other confirmations to add to these. The first is that leather orders and demand continue to be strong and there were very few people complaining about a lack of finished leather orders or finished products. Secondly, the strong order situation is mainly a consequence of the good performance in the emerging markets. China, India, the Middle East and the former Eastern bloc are the strong performers in the markets and account for most of the rising demand on finished items. The ‘old economies’ are delivering a mixed picture but, in general, hardly any of the large producers are mentioning significant performance from these markets, indeed quite the reverse; it is these markets that are not yet accepting the huge problem of manufacturers’ leather products calculations. It has also been frequently mentioned that the domestic business for many producers is not only rising in volume, but that revenues are also much better than on the export side. So, from the demand side the situation confirmed the current good mood and situation and those who are simply focusing on this end of the pipeline will have very little to complain about.

Upholstery and furniture cause concern

However, as we all know, the industry is much more complex than this and for the pipeline to remain in a healthy state it will require more than a strong performance on just the demand side. So the time spent in Shanghai was not so much about how business is, but more about what effect the price situation will have on the future of the leather business. As we described in our last issue, the imbalance between raw material availability and leather demand must eventually be sorted out.

To start with there was no common answer to this question as nobody really likes making predictions in this trade and it is very difficult to get anybody to position himself clearly. So we have to formulate our own guesses and try to read between the lines when talking to those who generally had a good feel for the future.

The volume production of upholstery and furniture leather seems to be the least prepared for the market. Although people, and in particular tanners in China, mention the better yields and split credits, we fail to see where volume producers can find acceptable profitability and, with the massive production overcapacity in the market, it is difficult to believe that tanners in this sector will be able to get their calculations right any time soon.

This leads to another major object of discussion, which those who have been in the business for a while are constantly coming back to: the issue of cash and finance. Although there is no evidence of any financing problems at the moment, many are facing the fact that higher prices for raw materials and higher costs require additional finance. This may have been compensated so far by the acceleration in turnover and the reduced inventories which have improved cash positions and enabled many producers to keep up with their financing needs, but this is only a one-time effect and very little would need to happen to knock the finance budget off balance. While in the western world commercial banks are controlling the situation tightly, the governmental attempt to control growth in China could be the key for such a capital intense industry.

Chinese custom books remain a topic for discussion

Here we return to another familiar issue: the customs books in China. While so much has been discussed and so little has happened in the last year, we are now entering the final lap. Even if the industry is facing another transition period, extra cost and extra finance will weigh heavily on calculations and financial resources. Whatever the final figures are, one thing is already sure and has been tested — the refund from the government cannot be expected before six to nine months after the import tax has been paid. It is quite obvious that this is going to increase the cash needs of those tanners that are tremendously affected and, if there are no adequate and quick ‘Chinese solutions’ available, it will affect imports and volumes.

To summarise the market situation, it is fair to say that the leather pipeline is still active and holds a good order book for the months to come, but the question of how the supply/raw material price problem is going to be resolved remains unanswered.

Split market faces new difficulties

The split market—after having been so stagnant and uneventful for such a long time—is now starting to provide some news. Most overseas tanners are complaining about insufficient demand and sliding prices. The sharp increase of hide imports into China has also lifted the available numbers of splits and the need to buy overseas splits has declined. There is concern among the large tanners producing outside China and relying on the consistent outlet of their splits. With the high hide prices the split credit is more essential than ever. The difficulty in the split market sounds rather strange considering the high price for hides and particularly the prices for low grade material. However, as usual a change in fashion and design is needed before the shift from nappa to more split can take place. For both the seller and producer the wait is always far too long.

The skin market continued to show little variation. A small amount of low price material was also moving here, but significant change can only be expected when the Chinese start their production season again later this year. Nappa articles seem to be making some return to the market and tanners have been showing some ‘cow-look-alike’ articles produced on large and cheap raw material skins. However, it appears that it will be well into the autumn period before the market response can be seen properly.

Sellers have the upper hand

People will be slowly returning from their trips in the coming weeks and it might take a few days or even weeks to digest the situation. For the time being the positive sentiment is dominating, but those who are already seeing some dark clouds on the horizon should not be ignored. Consequently, raw material sellers will manage the market in their favour in the coming weeks and buyers can expect little mercy as they are no more lenient when the market is in their favour. Those who have to buy must be prepared for tough discussions and at least steady and possibly even higher prices. Sellers are so comfortably sold that they don’t need to consider anything else. However, we believe in the present market environment that trading volume will slow down further and, although it will be more than two weeks before a better balance between supply and demand is achieved, we believe that the upside on prices in this market remains limited despite all the optimism and positive mood that is being generated at present.  

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