Macroeconomics

There has been some excitement in the financial markets recently and developments will provoke a variety of different opinions and predictions for the future of the world’s economies.

As was largely expected, the European Central Bank and the Fed left interest rates unchanged. However, bank representatives have confirmed market expectations for the future: interest rate hikes in the euro zone and at least a chance of interest rate cuts in the USA later this year. Whatever the decisions turn out to be, the markets are still only seeing the positives and, despite some more vulnerable stock market reactions, investors are still more welcoming of good news than bad news, returning quickly with the money whenever there have been setbacks.

Although nobody is hoping for a weaker or a rumbling economy, we have to admit that we still do not perceive things as being entirely positive. By contrast, analysts and experts do not see any threat of inflation and, quite the reverse; they expect consumer prices to ease later this year and in 2008. Of course, one can interpret what one wants from the statistics and it also depends on how they are collated, but we not only believe that there is more inflation than economists are admitting but, considering the continuing high raw material prices, we also expect product prices to rise. In addition, we believe further rises in food prices in the coming year will be the biggest threat for consumers. For low income families this is probably the most serious threat in terms of inflationary pressure that there could be. Retail sales in the USA were weaker in April, and the community is now discussing whether this is a one-time statistical event or a trend.

In France, the presidential elections ended in favour of the right-wing candidate which has increased hopes for economic reforms to strengthen the EU economy, but which could also—as we have seen in the past—increase social tensions and unrest in the country.

The $ saw a significant increase against the € having set new record lows two weeks earlier. The market fundamentals could not explain the trend so most people are expecting a short-term correction as speculators cash in profits from the steep fall of the greenback and unwind positions. Since there is no particular reason for a short-term change in the trend, the correction could eventually be even more pronounced but, at the moment, there is not much to suggest that the greenback will gain any real strength in the near future. However, one should keep an eye on the situation because, if the Fed changes its mind regarding inflation, it could quickly turn market ideas. Nevertheless, since inflation is not yet on the agenda, there is little to support the $ in the short-term.

Market intelligence

The general trend in the leather pipeline developed pretty much according to our expectations and seasonal trends. The market remains in a sort of correction mode and is adjusting differently in the various supply regions of the world. Even the huge export sales figure of over 1.2 million from the USA two weeks ago were not strong enough to scare buyers, as it would have done some months ago. Buyers are covered well enough and cannot be frightened at this time by a possible shortage of raw material of the year. Most of the tanning industry seems to be in good shape as far as the inventory situation is concerned and, with the onset of the slow season, stocks are sufficient to cover present production needs.

Consequently, the market remains in slow gear and if there is any price variation it is downwards. The key indicator for the market remains the US-Asia relationship, which is where most of the influential activity can be seen. If a proper report can one day be obtained from South America, or more specifically Brazil, this could eventually change.

Further declines in ‘market classics’

The shoe and side leather business, which has been the market maker for such a long time, is in its low season at present, as are the market ‘classics’. Light US steers are under pressure and have lost another 3-5% in recent weeks. The main question being asked today is when they are likely to find their bottom and most buyers are hoping that the levels will fall back to the 70 level, which would allow the tanning industry adequate margins again. Sellers are obviously taking the opposite stance and are desperately trying to generate enough sales to get into their desired forward position in order to gain control of the market again. For the time being, it seems that they will have a tough time and it might be necessary to make further price concessions to attract their key accounts for purchases in the volumes that the sellers desire.

These market fundaments are creating an interesting situation, as has been the case once in a while in the past. Despite the demand, buyers must lower raw material prices to get back into reasonable and profitable calculations; they are not interested in seeing a sharp fall in prices or, at least, they will not want these declines published. In this respect, they have something in common with the sellers, although they are less concerned about what is published than about what they get. However, ends are being met in this case. In a perfect world, big players amongst the buyers like to buy product more cheaply than the published reference prices in order to protect their leather prices, while sellers like to have a reference for their price levels which they need to justify in front of their ‘normal’ customer base. So, it would be a surprise if we were to see a rise in reported sales and official prices staying more or less the same later this spring.

Buyers take control

If leather demand remains as strong and as steady as all of the indications and research suggests, it will be no surprise if larger private deals are eventually concluded at undisclosed price levels that are well below the public market levels. Since the pipeline seems to be sufficiently full at the moment, buyers are more in control of the market and can enter discussions with more self-confidence than they have done in the last 15 months or so. However, they should not get too carried away as the strong business has not led to the accumulation of too many raw materials in the pipeline so far.

Today we have been discussing amongst ourselves as to whether there is any chance that global leather business will be slower next season than the forecasts and budgets are leading us all to believe at the moment. To cut a long story short, the possibility is certainly higher than it was a while ago. So, what has changed?

We would not go as far as to say that there is any proof of a fundamental change in the situation yet with good to strong global growth, particularly in the emerging markets and a recovery in the euro zone. On the other hand, we see question marks around the US retail market in the second half of the year and a massive conflict between the price trend of raw materials and production costs and finished product prices. With the inventories at production level being more adequately filled and the demand being seasonally slower, the movement through the supply chain is considerably lower than in the past year. So, the key to the situation, in our view, is the US retail market, as it still holds a dominant position for production in Asia.

Potential weakness in the retail sector

So, if the US consumer is forced to slow down in terms of shopping, some of the larger importers would have to review their purchasing activity and budgets. Also, if statistics in the next month(s) confirm the April numbers, it would still be early enough to alert manufacturers in Asia to the situation which would lead to the logical consequences in production and purchases.

Consequently, the next decisive step for the market will still come in the second quarter, or even at the beginning of the third as, by then, decisions about order volumes for the shopping season will have to be made. There is an increasing chance that retail business is not as strong as the initial budgets expected them to be.

We are also entering an interesting phase on the supply side for cattle hides. Our regular readers will remember that we have already discussed some developments that could possibly influence the short-term supply situation for cattle hides. To recapitulate, this was:

• Rising prices for animal feed
• Increasing production of bio-energy raw materials
• Increasing per capita milk production
• Declining herds in central Europe
• Lower beef exports from Argentina to combat domestic inflation
• Drought conditions in Australia

One can easily see that the issues are mainly kill negative and one of the few arguments to be found for an increased kill is consumption in the emerging markets and a rising herd in China. In the meantime, only the seasonal rise of the kill is supporting the supply side.

We believe that the biggest threat for beef production is the sharp increase in feed prices and the attractive alternative of bio-energy production. Basically, the equation of effort, investment, work and return is favouring farmers that are producing corn, oil producing crops, sugar cane and reeds rather than cattle breeding. The short version is: more money for less work.

Agricultural production could impact leather pipeline

Are we at the beginning of a trend or cycle? So far there is no guarantee that this is going to continue. At present, it is more about fashion hype than a justified change in agricultural production, as most of the business is still heavily subsidised. Governments feel obliged to follow public and media attention and pressure to fight against rising oil prices, the dependency on oil imports and CO_² emissions. Although everybody knows that global energy policy has to be changed, a number of current trends will not really provide a solution and are more likely to become a challenge for global food prices which could lead to an even higher risk than the energy situation. Even if one does not consider the situation to be too significant in terms of the leather pipeline, we are convinced that the various influences will be much more important than the ‘day-to-day breaking news hunt’ which many consider to be the answer to all their questions in the gamble. In any case, we will follow the developments in agricultural production and consumption in the global balance with interest.

No improvement for splits and skins

The other markets continue to attract little interest. The splits market is not moving favourably and, with a general slowdown in hides, splits are not going to be the high flyer in the market either. Reports about business remained pretty depressed and there is still no change for the better to be seen. If there is to be any kind of turnaround, it appears that it will have to wait until late summer. Gelatine and collagen use is also less exciting and this is really a seasonal issue as demand in the summer is always lower. So this should cause little worry if any at all.

The skin market has also fallen dormant again. After a strong performance in February/March, things have slowed down and the market can be called steady at best. The political situation in Turkey is weighing heavily on the courage of manufacturers, while currency issues and uncertainty have also kept the Turkish tanners pretty quiet. Chinese importers always have their busy time in the first quarter because climate conditions and seasonal factors have kept them out of the market in the summer. So, there is little that can change the market at the moment. The interesting issue for European suppliers now is demand for new season lambs. Since this market is still normally dominated by the Turkish tanning industry it could be a very interesting period until June/July when most of the decisions need to be made.

Everything suggests that the market will continue to remain in correction mode in the coming weeks. Tanners will, as usual, try to hit the bottom and, as explained above, a lot will depend on the general sentiment if the next consumer season is as strong as expected. If this is the case, buyers are well advised to buy into the market and to secure product and calculations. It could be a very favourable time to negotiate with the large suppliers and to secure supply and profitable levels. If the outlook becomes less enthusiastic and budgets need to be revised for the second half of 2007, there will be little reason to act frantically and prices still have space for further corrections. However, we are not too pessimistic and believe that, for the medium-term—for example, up to September—the next few weeks might be a good time to make the necessary arrangements for raw material supply over the summer.