Our gut feeling about the currency market was based on a certain amount of evidence. Speculators were ready for a party and their timing was excellent in taking advantage of the Thanksgiving holiday to use the illiquid markets to break out of the established trading ranges.

This has hammered the $ down by about 4% over the last ten days, one of the largest short-term slides in history. This move coming at the end of the year will either have made people’s performance or destroyed it for the year. This has lifted the € as well as the £, which has reached a 14-year high against the $.

The justification for the market move resulted from a grimmer outlook and interpretation in the USA. Players did not like what they heard and this started with expectations of falling interest rates in the USA later in 2007 and rising of the same in the euro zone. This was exacerbated by a sharp and unexpected slide in the widely recognised Chicago Purchase Manager Index which fell to 49.9 points, just below the critical 50 mark which is said to be the junction between a contracting or expanding economy.

At the same, Europe, and Germany in particular, is presenting good news and came out with much higher than expected growth rates (2.4%) and lower unemployment figures. Manufacturing also expanded in the euro zone. All this added to the positive mood towards the € and the shift of investors away from the $ accelerated. This may continue with all the positive news coming from Europe now and the poor accounts from the US. This allows currency speculators to continue to hold short-term positions against the American currency without too much risk until the exposure gets too far and profits need to be gained. For the moment, however, speculation is combined with the hedge operations of non-US exporters who are now normally hedging their next fiscal year (2007) against currency risks.

At the same time, oil prices increased suddenly and sharply passed the $60 per barrel mark in response to weather forecasts predicting colder weather for the USA. It may also be a reaction to the latest rumours about the treatment of people who criticise the Russian government, an important global energy supplier. It may have signalled to the world that, in addition to the continued problem in the Middle East, which remains more than unsettled, other energy supplying giants could also become a risky bet.

Market intelligence

The market activity is still not being equally shared between the market segments. When we suggested two weeks ago that market activity would calm down towards the end of the year, it was probably correct as far as a general statement is concerned, but individual standpoints and markets would not consider this an adequate description. We think that US hide sellers have still been feeling pretty comfortable and excited about the market over the last two weeks. A strong weekly performance of sales a fortnight ago expanded forward positions again and the general feeling continues to be that there is no scare about hides finding buyers in the first quarter, at least as far as steers, heifers and plump and beef cows are concerned. For dairy cows—which certainly don’t play such an important role in the US hide industry—the situation does not seem to be so straightforward and one could get the impression that the positive mood from the steer market is more instrumental in steering impressions than the business itself.

Shifting the focus to Europe, the situation is of course different for a larger portion of the market. Those who are predominantly offering to the European industry might not yet have felt many of the changes because they are normally selling for a certain period ahead and are most likely covered until the end of the year with contracts at reasonable € levels. Others, such as export traders and producers from origins that need to place a certain proportion of their production into Asia, will have had a horrendous time recently. While for weeks and months attention to the currency market has just been hitting the highs and lows of a very narrow trading range, the last ten days have reminded everyone how tricky the currency market can be. Hopefully they had all their exposures covered, as otherwise it could have been an expensive week. Without thinking about the calculations during the last few weeks, it doesn’t take a genius to realise that the trading range for the € is likely to be well above 1.30 for a while so this means revising expectations on returns for the foreseeable future. It means that with the decline of 3-5% € revenues from exports, sales suffer by about €1.50-3.00 per hide depending on hide type.

Concessions needed to achieve sales

While the firm trend in the US steer market might have assisted in compensating for part of the problem with slightly higher selling prices, the situation for dairy cows is certainly different. Speaking to reliable sources and exporters from the USA and Europe one does not get the impression that any price increases can be achieved. Quite the reverse, in fact a number of pundits admit that certain concessions need to be made if buyers are really willing or interested in getting some sales established. In China price levels for dairy cows declined moderately, while the upholstery market in northern Italy had already disappeared from the standard European cow market.  

Apparently, the sole leather and vegetable tanning section are not delivering any support anymore. Those who snapped up the heavy hides that had been left to the market by upholstery tanners were no longer willing to absorb the numbers becoming available by the higher slaughter and the lower demand either.

Besides the fact that they had already satisfied their requirements, they are also directly influenced by the weak position of the $. Many are forgetting that a great deal of the bellies and also some shoulders are ending up in Asia. It is not only that demand for the products is as strong as the quantities that have become available due to the strong market performance, the $ value is also weighing on calculations. Combined with the seasonal decline due to Christmas and the Chinese New Year, it has slowed down the market demand as well as the problem of profitability.

Shoe and bag leather market continues to thrive

So, all that is left is the strong performance of the shoe and bag leather market. Tanners are well covered with orders and, from what one can gather from the finished product business, this will cover leather and product production for at least the next three to six months. With the dramatic rise in raw material and production costs, tanners were trying to protect against margin problems as much as they could and so they were willing to cover the maximum of their raw material needs to be sheltered against further raw material price increases. After they fought so hard for leather price increases recently, they are now trying to hedge raw material as much, and for as long, as they can.

This was, and continues to be, the driving force behind the market at the moment. Raw material sellers feel secure in the knowledge that they have their catch safe in the net for a while. Knowing that their clients have full order books, they have been slowly but efficiently testing how high they can raise the pain level in the leather industry for quite a while, and this has turned out to be higher than many – including ourselves – had anticipated. Looking at the mainly fantastic results in growth and profits from brand names and retailers for finished leather products in 2006, the manufacturer may have a difficult time, but in the total supply chain there is still a good size of margin which could be distributed downstream.

This leads to a key question for later in 2007. With most of the business already fixed for the next three to six months in price as well in quantity, there is little flexibility left for the market in the short term. It is and will be driven purely by the few tanners that are still insufficiently covered. They will be the victims because they are what the sellers are still waiting for and, as contradictory as it may sound, the tanners who have good coverage are also the least interested in a falling raw material market. Their biggest scare is falling raw material prices in the near future as this would quickly build new pressure on leather prices or even invite leather buyers to renegotiate existing contracts.

So, what are we in for in the near future?

• Upholstery related hides are looking at headwinds. The market currently faces much more difficulty in price and calculations than shoe and bag leathers.

• Shoe and bag leather business will remain strong for the next season.

• The raw material market for males and heifers - side leather production - is sold forward. The average sold forward period appears to be four to eight production weeks in Europe and the USA. Considering the holiday breaks it could even be six to ten weeks.

• Side leather order books seem to be filled for a period of up to six months, which leaves an open-to-buy for the second quarter.

• Reaching or exceeding $80 for a standard big packer steer and similar price levels from equivalent European hides seems to be the present threshold. At this level, the Chinese have now started to openly discuss the option of cutting soaks, no matter what it means to their business. Only another rise in leather prices would move them away from such thoughts.

• The US economy and the financial markets are indicating problems, or at least increased volatility. Europe and growth in the emerging markets may offset this, but with different fashions and market conditions.

• Raw material supply is steady within the seasonal frames of the different regions of the world.

• Fashion changes could alter the market patterns. e.g. splits or suede, the end of the ladies’ boot fashion and nappas, or the final discovery of abundant raw material availabilities such as certain sheepskins.

• The custom book policy, in combination with environmental issues in China, is starting to have an effect. Certainly indirectly, if not directly, due to increased raw material and production costs or cash-flow issues.

• Higher cash requirements and lower profits are burdening the tanning industry.

This list may not be comprehensive and the order may not be in its correct sequence of importance, but it should offer a sufficient overview of what could have an effect on their business in the near future. It could also assist in forming individual expectations in order to make decisions.

The other markets did not deliver any major information or changes once again. The splits market is suffering at the hands of fashion and at present splits cannot really perform because they are unable to find a home in the present market hotspots.

Mass market ignores leather garments

The skin market has been separated into the ‘go’ and ‘no go’ for quite a while with the market for nappa garments still not strong enough with the first quarter of 2007 being the first period in which a change could be seen. Leather garments are again seen as a fixed segment in designer collections, but so far haven’t seen any success in the mass market. Luxury selection and top quality and lightweight double skins continue to perform well and run their own course.

We are now covering almost the last part of the year. We have been voicing our concerns about the leather market for a while and so far we have been too pessimistic. However, our predictions listed above include more clouds on the horizon without ignoring the strong performance of the side leather market. However, at least for upholstery hides, one must become more cautious by the day and suppliers from non-$ regions will already be suffering from the currency market even without any change in the market. The only question in our minds is whether more hides, in particular dairy cows, can find a home in the side leather business to support their levels, or whether the spread between the various grades will increase. We are certainly pessimistic with regard to dairy cows, high priced veal and kips and European automotive hides. Standard side leather hides may still benefit from the strong market performance and little will really change until the New Year. However, without being too specific on timing, we consider the risks are now certainly higher than the chances for the short and medium timeframe. The reasons haven’t changed.

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