The macroeconomics appear to have been on a rollercoaster ride recently. Most significantly, oil prices shot up following a temporary dip to below $50 a barrel. A brief spell of cold weather and a great deal of speculation have sent oil prices up by almost $10 a barrel, destroying all hopes for a continued decline in energy costs. The supply pipeline has not reacted too sharply and prices for heating oil and petrol have not increased significantly, but the fear has returned.

Apart from this, not a great deal has happened in the financial markets. Despite a slump in the housing market, the US economy has performed reasonably well and the GNP growth for the last quarter was reported at 3.5%. Consumer spending and confidence in the labour market have kept people shopping and supporting the economy.

Stock markets continue to perform well and the US Fed’s decision not to raise interest rates has allayed fears that money supply could tighten in the near future, which was good news for investors who continued to pour money into the equity markets. The liquidity bubble is still supporting the investments.

Retail sales in Europe were disappointing, largely blamed on the Germans who had been buying in advance of the sales tax rise in December, so that the figures at the end of last year were inflated and the January results deflated.

From our perspective, the most interesting and significant long-term events are the steep rise in agro-commodity prices and the dramatic reaction to the UN environmental report and outlook. Although there was no news reported, media attention and government reactions were suddenly intensified and heavy floods in Indonesia and the warm winter in the northern hemisphere came at just the right time to cause a stir in both the media and the public.

Droughts in Australia, frost in California and spring conditions in Europe have not only frightened many in the developed countries about the future, but have also drawn more attention to the massive rise in agro-commodity prices. Prices for wheat and maize have climbed substantially in the recent past and the riots in Mexico caused by the trebling of maize flour prices—the core ingredient of tortillas—have indicated what could happen if fundamental foodstuffs become more expensive.

Inventories for many agro-commodities are at an all time low and a bad harvest could create rapid bottlenecks in food supplies. The developed global community is spoilt with low prices and unlimited access to food and many have overlooked the fact that food supply has not developed at the same speed as the rising global population and increased incomes, and that global distribution of food is highly unbalanced. While the rise in energy and metal prices in 2005 and 2006 has been understood by consumers, the real threat of a sharp increase in food prices still does not seem to have been recognised. Climatic conditions are a factor, but the reoccurrence of avian flu outbreaks could eventually affect the protein supply.

So, the macroeconomic situation is presently dominated less by the standard statistics and more by the long-term changes on a global level.

Market intelligence

Although superficially the situation looks much the same, we feel that certain changes are taking place behind the scenes in the leather pipeline and in the hide and skin market. There has been enough activity and a sufficient number of buyers to satisfy sellers and to keep warehouses empty and/or the forward position intact. This may be accurate as a general statement, but it might not be a totally realistic description of the present market reality overall. A generalised statement about the market does not help to describe the real situation, as recent changes within certain market segments appear obvious and the ‘everything is good situation’ of 2006 is no longer sustainable.

We have already mentioned in previous issues that there are several underlying problems. We were, and are, predominantly concerned about the cash-flow situation, particularly in Europe. Nobody wants to talk about it in public as the trade is superstitious and afraid of jinxing the situation further.

Tanners divided into two categories

Apart from this, the margin situation is becoming increasingly problematical. These days there are basically two types of tanners. One has been buying hand-to-mouth in the hope that raw material prices will eventually fall—which they haven’t—and so this community has already been hit for quite some time by higher raw material levels. The second group is the standard and regular buyers who try to keep a constant purchasing programme and hold onto a sufficient inventory position, either physically in the warehouse or in the form of a supply contract scheme with reliable shippers. Since they are rolling their position over and operating with a cost averaging system, the higher raw market prices are having a slightly delayed effect. In the period between now and when their raw material cost level hits the level of the hand-to-mouth buyer they are still reasonably comfortable, although the hopes for a decline in raw material prices have finally died. In the meantime, we believe that almost everybody is at around the same level and, with the market as it is, a growing number of tanners have to at least consider the possibility that average 2007 raw material prices could be a fair bit higher than they had expected.

This would help to explain why a rising number of pundits are reporting growing resistance against the present market conditions, even from the traditional standard players. The only problem is that they do not really have an appropriate tool as yet. With the constant need to buy there has been little room for manoeuvre, or at least most sellers are convinced that this situation is still a market reality.

Uphill struggle for European tanners in 2007

However, listening to more individual stories, the number of isolated talks about regions, segments or clients not following is increasing. This can be seen in the upholstery furniture business in China and Italy, the leading automotive tanners in Europe and, in part, the calf and kip fashion producers in Italy.

The simplest response to these concerns would be to expect a decline in demand and falling prices. However, we do not think it is this straightforward.

Everything points towards another round of restructuring. Once again the heaviest burden remains on the European tanners and the start of 2007 has been nowhere near as positive as the beginning of 2006. Most of the arguments behind this have already been presented in the 2007 outlook, but we will recap in part.

These include the weaker $, declining raw material quality, inflated cost increases in many parts of Europe (for example, the net cost of energy and water effluent has increased more than in Asia) and the new REACH regulation for chemicals, finally put in place by the EU commission and which has had a tremendously negative impact on the competitiveness of European tanneries.

Decline in quality and changes ahead

While costs are certainly an extremely important factor, the effect of quality should not be underestimated. With one accord, European quality tanners are complaining about reducing selection results. The top end of the quality range selection has always been the privilege of many in the European tanning industry. Having the access to the cream of the selection has always given them a quality niche with prices that others could not, or were pushed to, compete with. So, this segment has played an important role in the entire calculation. Losing on this due to deteriorating quality is weighing on calculations and, with the normal and standard selections, the question of cost and competitiveness with overseas competition is becoming increasingly problematic. Taking all this into consideration, we can see that there are certain changes building up, which have little to do with the generally positive outlook for the leather demand and industry.

We have a couple more arguments that we would like to cover in the near future and which we look forward to sharing with our readers in forthcoming editions of the Market Intelligence. In the meantime, readers are invited to keep an eye on the markets and share their ideas with us if these could have, or already have had, an impact on the market conditions. A logical consequence would be that isolated grades, and mainly those that have been dominated by European tanners, will possibly see market corrections against the global trend.

Purchasing slowdown predicted

In the other market we are monitoring, there is still a serious amount of anxiety. This may not be true for the lower price end of the sheep and lamb market, where the number of reports that the worst is over is constantly increasing. It might still be some time before it spills over into better prices but the chances of the last and remaining ‘cheap’ raw materials following their bovine counterparts into a better future are constantly rising.

We are predicting a further slowdown in the coming weeks. Whether it is related to the change of the seasons, the Asian holidays or the margin problems, we are ready for a remarkable slowdown in purchasing activity. This goes against those who still see a large need-to-buy situation. This may be true, but we cannot see this taking place at the present level. The saying that ‘The Chinese may lose everything, but not money’ may be significant here. A number of insiders from China have reported that tanners are stretching their holidays in order to reduce soaks and to get away from further purchases. In the end we assume that tanners will use the holiday break to talk to their clients and to give them the choice either to increase the leather prices or to expect that leather shipments will not arrive in the anticipated volumes and timeframes. For those Chinese tanners selling domestically, there is at least one piece of good news: the revaluation of the RNB which is helping calculations by reducing the cost of imported materials in $. All together, there may be more changes in the market fundamentals in the coming weeks, but due to the empty pipeline from raw material suppliers, the effects on standard prices should still be quite limited, while specialties could be a little more complicated with the pipeline in that area filling up more quickly.

Share this story: