Expectations in the build-up to ACLE
26/09/2007
Macroeconomics
The financial community is still hardly discussing anything other than the subprime crisis in the US, and the consequences for the international banking system.
We are hearing more and more voices that are correctly coming to the conclusion that, actually, nobody knows yet what the real risks are for investors and banks, and what surprises the market can still expect, until everything settles down again.
Banks especially are trying to figure out how they can calm investors and shareholders. Their view of the situation may not be entirely reliable though. They can see the risks in their own books, but they don’t know about the risks faced by their partners in each deal.
Many banks have also been keeping these risks off their balance sheets, hiding them on the books of subsidiary companies. In this way, these risks neither appear on the balance sheet of the banks nor come under the supervision of the controlling institutions. Anyway, so far only a few have got into trouble and the system was still in place to bail them out.
In the end, national banks had to pump big amounts of liquidity into the market to prevent a credit crunch and a domino effect. It isn’t the duty of national banks to bail private investors and banks out, but with the excuse that they were protecting the stability of the entire system, they have managed to prevent this subject from receiving much public discussion so far.
The financial markets seemed grateful. Stock markets stabilised and investors returned to normal action, almost; the problem may not be completely over though. It might be at least another three months until all the potentials risks have expired and the risk-takers know where they actually stand in whole story. In the meantime banks have found it pretty difficult to borrow money; they have felt unable to trust each other and only got by with the injection of liquidity from the national banks.
Better than expected data from the US (for example, revised gross domestic product and consumer spending figures, and the purchasing manager index) calmed the situation further. However we should not forget that most of this data still reflects the ‘pre-subprime crisis’ period and does not yet cover August.
The market reads these things the way it wants to, which is why the chances for interest-rate cuts in the US until the end of the year seem much higher than they did before. A rate-hike in Europe doesn’t look as guaranteed as it did some weeks ago either.
It is too early to draw a line under the situation, so market-members, business-owners and managers still need to pay close attention to the news. Speculators and investors at least felt comforted by the statement from Mr Bernanke and Mr Bush, who gave the impression they were willing to do almost anything to protect the market from collapsing. This will look like a pretty nice safety net for those who are willing to invest and to continue the gamble.
Market intelligence
The last two weeks have been reasonably quiet with buyers and sellers taking a break before the All China Leather Exhibition in Shanghai .
The expectations the market has of the event in China may, however, be too high.
It may be the chance for most of the trade to meet after the long summer break and to collect impressions and information from around the globe, but this is not going to have a serious influence on the fundamental market situation. Consumer product fairs such as GDS for shoes and Highpoint for furniture in September and October could have a much greater influence.
There have been some buyers around in Asia in the last few weeks and they might have left some impressions for market figures to interpret while in Shanghai.
Since the timing of this Market Intelligence isn’t the best, coming just as the show begins, and the next one is due a week after the show has closed its doors, we had better not speculate too much about the gossip and emotions the event will create. It would be better to try to deal with the real facts as we have them today.
We are at the start of the next major production-cycle for consumer goods and cars, so it may be worth looking again at where we were at the start of the last cycle and was has happened in the meantime.
Reading the report from the end of August 2006 a lot of last year’s situation and market analysis could be copied into today’s issue. Little of the evaluation then has lost its value for today. Readers can confirm this by reading the market intelligence report from a year ago in the archive.
If we leave aside the general uncertainty which has arisen from the financial markets, the situation is almost the same as it was a year ago. The uncertainty about the reaction of US consumers and the potential for problems to spill into other markets is presently dominating the mood within the supply chain.
In addition there are the never-ending discussions about the situation in China in respect to currency controls. The financial situation of many tanneries is also weighing on the confidence of market-players. The same issues are also the main concern in continental Europe where the weak US dollar is adding to the worries.
These circumstances are affecting the present mood of the players in the leather pipeline. But are they really justified? Can we really see any particular change in global consumer spending? Can we see any real reason for a substantial downturn in spending for leather and leather products?
There is very little that is really in a position to change the budgets and programmes of leather manufacturers. We continue to experience structural problems. We continue to expect fashion changes. We continue to face restructuring in the supply chain.
All this can certainly have short-term market influence and change temporarily the mood of those involved, but the fundamental reduction in global demand and consumer spending cannot really be justified in the short term.
You could take a positive view of the situation or a negative one. Perhaps there will be further negative implications from the financial markets that will influence consumer spending later this year. On the other hand, perhaps the global economy will withstand the rumblings, and the general positive trend of growth and expansion will stay in place.
Glass half full
We believe it is better to make the assumption that the global economy is not going to be hurt and that things are progressing on a normal track.
As we have said, the situation today is pretty similar to the one at this time last year. There were worries then about the housing market in the US, about currency issues and custom book uncertainties in China. There was no clear outlook for the global economy.
Everybody knows what happened next. We had probably one of the best seasons for a long time for leathergoods sellers, global consumer spending increased and growth in emerging market was easily strong enough to compensate for any negative effects elsewhere.
We have seen an enormous luxury boom, with almost all the top brands growing at a double-digit rate. Other brands have also seen substantially better business, with a fierce price competition.
Fashion has helped, with handbags becoming a real fashion factor and ladies’ boots being one of the driving-forces for leather consumption, aside from the normal growth in the shoe sector.
Automotive leather consumption has been shifting between brands, models and production sites, but the total consumption globally is still strong. This is a sector with changes in the supply pipeline, but not with a major decline. At the same time, upholstery leather has become more and more of a commodity, but the struggle has been with economics rather than quantities.
The raw material market has reflected the positive situation in the leather business. Prices even in lower-cost countries, such as Brazil, have been between 5% and 8% higher than a year ago.
At least as good as last year
Those who believe in a global recession should stop reading now.
As we all know, most big companies around the globe are working on budgets. The budgets for next year will definitely have been completed already and, as we discussed in previous issues, will certainly be based on a very good market performance in 2006/2007. Consequently, one can hardly believe that these budgets will specify less volume for 2007/2008. Maybe some will have even bigger numbers. As a result it is pretty hard to believe that demand for leather products will be lower in the production pipeline.
This tells us nothing about the kind of products, and at what price levels, will be on the shopping lists and in the retail programmes of the large retailers and brand names. However, statement number one is that the total demand for leather in the coming season is not going to decline.
Demand patterns
This suggests the following question. Can we expect any change in fashion or in the structure of leather demand?
If there was one surprise over the last season, it was the big success of handbags and leather accessories. This has sharply increased the demand for this type of leather. Many tanneries in China have already changed their production from upholstery to handbag leathers. The demand is higher and the price structure and the cutting yields are better. From this, it’s only natural to wonder if there is going to be any revival in prices for upholstery leather and if the good performance of handbag leather is going to continue.
At this early stage of the season everything points towards upholstery leather receiving no mercy on the price front, while the demand for handbags and leather accessories, in particular in Asia, is going to remain intact.
As far as the shoe business is concerned, anything other than another season of growth and rising demand would be a surprise.
Leather consumption can only be negatively influenced by changes in fashion, if, for example, the consumption of ladies’ boots falls, of if consumers demand a change of materials.
Actually, though, for the forthcoming season, the designs and materials will be ones chosen about six to 12 months ago, and at that time there were few signs of the market going in a completely new direction.
However, we should watch the autumn footwear exhibitions with great interest to see if, for example, splits or other materials such as rubber, textiles or PU are on display in bigger volume.
In the automotive market, leather consumption does not seem to suffer. The successful car companies are growing and despite the problems of the US industry or lagging sales in Europe, the total sales of leather-consuming cars is growing rather than declining.
Only the shift from more expensive raw materials and manufacturing locations to more economical ones could have any effect on the raw material markets.
Hard times in furniture
Furniture upholstery tanners are the ones who are going to have another difficult season.
Although upholstery leather is selling reasonably well, thanks to increased demand in emerging markets, the price structure for this kind of material extremely complicated for the tanner.
There is a lack of sufficient demand in the mid-price segment. There is also competition for suitable raw material these days, with the upholstery tanner often losing out. More and more handbag and leather accessory tanners are using classical upholstery hides, such as dairy cows, and can pay better raw material prices because they can obtain better returns.
It would come as no surprise if this situation caused further financial problems to tanners in the next season.
The split market also remains in the doldrums. However, the demand for gelatine and collagen production will increase with the end of the summer season and this will lift some of the pressure, at least from splits deriving from lime-split operations.
For wet blue splits it is far too early to make any reasonable forecasts. Unless we see a return to splits in standard leather production, the misery of this product is not going to end. It remains a surprise that, with all the price pressure on them, splits have not caught the attention of more designers and manufacturers yet.
The skin market is not yet really taking off either.
Skins that offer a good return of wool find buyers because the total calculation suits them. Sheepskins that are suitable for nappa production also find buyers.
The situation for the double-face market remains up in the air. Even the problem with shipments from the UK because of Foot and Mouth Disease has not created much more demand or any kind of panic in the market. We have to wait for the development of the weather conditions in the main consumer countries such as Russia. Fashion trends will have an important influence too.
For the next few weeks, most of the interest will, of course, be on the meetings that take place in Shanghai.
As stated above, we think expectations may be running a little too high and, even though, the situation in the market is fundamentally good, people might be disappointed. Not because things are bad; just because expectations are running too high.
Like last year, it could be that it will take well into October before the whole production cycle is back up to full speed. The Golden Week at the beginning of October in China is also going to make an impression on production in the coming weeks.
So market activity over the next month could still be reasonably subdued, although this would not make any difference to the market activity and trends for the high season of production between November and April.
It will be important, then, to analyse the situation in the coming weeks with great care, and not to follow up on wishful thinking. It is important to be realistic about the information that can be gathered from the market in the weeks to come. Manufacturers are probably in the best position to judge by looking at their order books for the period between now and mid-October.
If things develop in the normal way over the next few weeks, it could be a good period to make sure material needs are covered for a while.
