The global economy, and particularly that of the emerging markets, remains on good terms and global growth for 2007 is expected to be around 5%. The Euro zone is slowly but surely stabilising with a more positive outlook for the next year and, with more than 109 points, sentiments have reached a level that has not been seen for the past five years.

It is worth noting that general commodity prices nosedived in September. This not only affected energy and metals, and agro-related commodities also fell across the board. The biggest boost for the global economy has been the decline in oil prices by roughly $20 a barrel. This has helped to keep inflation under control and consumer feeling, particularly in the USA, is improving.

The survey of the conference board, as well as that of the University of Michigan, has seen gains over the past two weeks. Consumer spending in the US also increased by 0.2% in September. However, it has not all been positive as far as the US economy is concerned. The US housing market is still looking rather gloomy; house prices have dropped and the supply management index has also fallen slightly.

The US labour market did not offer any clear indications, but the figures released were, in general, interpreted positively and the unemployment rate fell to a five-year low. The market viewed this as a sign for a soft landing and the labour market could offset potential problems in the housing market. As a result, the $ received a fair boost and ended the week on a firm footing against the €.

Market intelligence

Although the market situation has not revealed too many public changes, we believe that the market fundamentals are starting to change moderately. Our regular readers will remember that we made a bold statement at the end of the summer in considering the possibility that, on average, raw material prices for the last quarter could well be lower than average prices in the third quarter.

Having taken another close look at the market, however, we find we are able to find some explanations and arguments for the present situation and the justification for our medium- and long-term expectations.

Let’s start with the some of the observations from the past two weeks. As we know, the leather pipeline is increasingly driven by the changing situation and speed in the various market segments. However, the high quality, luxury, brand name segment is still outperforming all the other sectors. It is also unsurprising that the raw material markets—despite the levels they have already reached—are still firm and sellers’ prices have to be and are being paid by a small number of privileged manufacturers. One example of this is quality light-weight calf in Europe. The only significant factor now is whether the next shows will reveal a change in fashion. However, as far as we are concerned, it may depend much more on general global business in the luxury sector and there is very little evidence at present that the world’s wealthiest citizens will alter their spending habits and refrain from pumping money into expensive consumer goods of all kinds. Price is not an issue.

Expensive apartments and houses built or under construction require exotic furniture and the ‘nouveaux-riche’ have a tendency to decorate themselves with the signs of success and wealth, for which consumer leather goods are perfectly suited. With the emerging markets still booming and the rich growing richer, including in the old economies, city centres continue to fill up with luxury shops all over the world, in addition to the duty free shopping centres at international airports.

We see the same fundamental situation in the mass markets. There is growing demand due to rising purchasing power in the emerging markets. Questions also apply in this market where demand has been exceeding supply, with familiar consequences. However, in this segment price matters and the market is competitive despite the good demand.

The problems connected with leather prices and the raw material needed continues to be linked with the problem of selections, particularly in the upholstery sector.

In a market like the present one, most tanners buy raw material mainly for the key products and/or those where they still can realise a margin. They try to secure customers and production even though they are unable to dispose of all the selections coming out of the tanning drums. The biggest problem here is the average selection and price segment.

As discussed above, there is little problem converting top quality raw material into top quality leather products and selling it at a profitable price level. There is also little problem producing and selling mass products, albeit not always at profitable prices. But there is definitely a problem producing and selling leather products in the mid-price segment. As we well know, the global consumer market trend in recent years has reduced the mid-price segment so extensively that supply in this segment is exceeding demand and the internal valuation price level is way above the obtainable market price level. So how has it come to this, and why could this have an influence on market trends?

At the beginning of a firm market cycle the leather pipeline normally sits on a reasonable size of stocks at low valuation levels. With demand growing and sales and prices performing well, a larger part of the inventory can be turned into cash and used for replenishment. During the cycle, raw material prices increase, but demand for leather does not grow in equal proportions across the selections. In the last cycle, more so than before, the average selections could not be moved either at the price or at the volume in which they were produced. As long as the average valuation of the stocks, in combination with the ‘old’ ones, is neither excessive in price nor burdening in volume, the enterprises are not concerned. Quite the reverse, in fact: in view of rising raw material prices these stocks are considered as a safety net with rising values.

Upholstery sector badly affected

The problem starts when it becomes increasingly apparent that output cannot meet input and the growing stocks with rising average valuations cannot be sold at the ‘right’ price, because the market potential is simply not there. Consequently, more and more capital is being tied up and, instead of being a safety net and cashbox, the stocks become a growing risk concern despite the fact that raw material prices are rising.

This is a classic market pattern in the upholstery field and we are under the impression a rising number of tanners is having to deal with this situation at the moment. The situation has already taken hold in parts of the European upholstery industry. Experience also tells us that it will remain a hidden problem as long as the raw material market remains firm, but could turn into an avalanche when the trend finally turns around.

In our opinion, automotive upholstery tanners are one of the driving forces behind the problem at present, although they don’t normally stock unsuitable selections. However, at present we are seeing a strong demand for a number of premium line cars that are more often equipped with less finished and embossed leathers and require an increasing number of top selections. The unusable selections do not perform for many other articles and need to be wasted in the corrected leathers. To satisfy the premium end of the production lines, the vast majority of total production is wasted in low-end productions. With the strong demand and limited output of qualifying hides we see an inflated absorption of hides again and a ratio of one out of ten is nothing unusual, in other words to obtain 100 hides for a specific order, 1,000 need to be tanned, in the knowledge that 900 of these could have easily been recovered from much more economical raw material selection. As much as this might make sense from strategic standpoints, it makes little sense as far as the use and return of raw material is concerned.

Positive news from skin market

The splits market continues to deliver mixed results. While some volume and standard productions continue to complain about insufficient sales and shipments, other more specialised productions are still reporting a strong performance, sufficient availability and premium obtainable levels.

The skin market is finally showing further improvement. The medium lower end of the product range now seems to be emerging from the doldrums and more interest is being reported from a number of different sources. While the premium end continues to enjoy strong demand and has already been trading at high levels for quite some time, other origins are also starting to benefit. British and Irish lambs have climbed a fair 20% over the summer and other suppliers that had been on the sidelines are talking about an improvement in sales and moderate price advances. Whether this is just a speculative move or a real change for the better remains to be seen in the coming month. Demand from China will be the determining factor after December. In the meantime it is going to be important what transpires at Lineapelle in Italy and whether goats and lambs as well as crossbreeds will make more inroads into general leather production and could substitute some of the calf leather.

Lineapelle to unveil future trends

We think that the market will remain trapped in the close trading ranges over the next few weeks. Suppliers will continue to squeeze the last drop out of the market and prices and buyers will resist as much as they can. The success of either party will depend on the market segment and the individual situation. The results of Lineapelle will confirm the future of leather in fashion and whether new fashion trends could have an influence on market trends. However, the key to the basic trend is activity from Asia. There is no question that the speed of sales and shipments has slowed down and if Chinese tanners are not going to support the raw material markets with another major round of purchases there is little doubt that we are in for a correction. There is little chance for a substantial drop, but a market slide into November would not surprise us in the least.

Share this story: