All eyes on Italy
MARKET INTELLIGENCE – 26.10.07
Macroeconomics
The financial world is almost completely focused on the situation of the US economy at present. Is the subprime crisis over or not? Will the Fed lower interest rates or not? If the answer is ‘yes’, by how much and when? How do the US consumers feel and how will it affect their spending? Has a large injection of liquidity by the Fed eased the pain or just maintained the equity bubble? These and other questions are dominating the headlines these days and seem to be the only real subjects that the financial community is discussing.
We have been given this impression because the media is dominated by US-oriented publications and as most of the financial world is anchored in the USA it is obvious as to why the majority of interest is concentrated on the US situation. As we have also been used to the US economy being the benchmark for the global economy over the past few decades and with so much in other regions across the Atlantic having depended on this market it is understandable why there is still so much interest in what is happening.
However, it seems that it could be time for a bit of a change. The US$ is losing more and more importance in global financial systems. National banks are reducing their greenback currency reserves and although US consumers are still a very important factor one has to admit that other markets now account for a rapidly growing percentage of global consumption. As a result, nowadays it is certainly more important to get a full reading of the global situation rather than to just watch isolated regions too much.
Rising prices, falling confidence
In the past two weeks we have seen the US$ fall yet further against most other currencies; we’ve seen oil prices soar above the $90-a-barrel mark and the magic $100 number is now in sight. Food prices and other commodities are also rising and, as a result, consumer spending/confidence has been damaged in various markets, dependent of course on how much the increases have actually reached the people already. Under these conditions the debates currently going on in many countries as to whether inflation is rising or not remain rather theoretical for families when reviewing their monthly budgets.
Politicians and national banks are still trying play down any economic risks, but we tend to believe that 2008 could become a pretty tricky one when trying to resolve the fundamental imbalances by lowering interest rates can no longer be the one and only solution; the problems will need to be dealt with more intensively in the near future. Tensions between the different regions also seem to be growing and this will inevitably affect the leather pipeline.
Market intelligence
Two weeks ago almost everybody was biding their time, waiting for the results of the Bologna leather fair so as to get more of a feeling for the market and the direction it is likely to take moving towards the end of the year or maybe even rest of the season.
A lot of things have changed since then. During the fair one already had the impression that the situation there was not just about leather and the leather business. Under normal conditions there should have been plenty of excitement in the market with tanners’ margins being so tight, the cost of energy and chemicals still rising, rumours about cash flow problems in Europe, the problems with intensified pollution controls and China and so on and so forth. With such a mixture of complications the normal reaction in the industry as a whole and in particular at the leather fair is an animated one, with many complaints and a desperate attempt from buyers to at least try to depress the raw material sellers circulating the aisles. Not much of this was seen during the event.
Many people were disappointed with the number of visitors seen during the three days and it is sadly becoming very common for the first and the last days to be pretty much a ‘non event’. The discontinuation of Tanning Tech, which means that the chemical suppliers no longer show at the fair, has reduced the number of visitors quite significantly. However, although this may have had an effect on the number of visitors, and the aisles may have looked much emptier, it says nothing about the quality of the visitors or, much more importantly, about the activity and interest of the leather buyers there, and this is forgotten far too often. The show was held in order for tanners to show their leathers and for leather buyers to get an impression about new fashions, new articles and to have the chance to meet a bigger number of existing or potential suppliers in one spot within a short period of time.
Bags and boots still going strong
Before we move on to the real excitement and the breaking news from the last two weeks, let's stay for another moment with the impressions and results from leather fair as far as the products on show were concerned. No really new articles were really seen. Ladies boots continue to play a great part in the new fashions, and there were plenty of bag leathers — mainly in combinations of textile and/or leather types and prints — as well as plenty of large, baggy ones that use a decent amount of leather. Patent leather seems set to stay for the next season and the technology for working with this material has made great advances and some of the patent articles really don’t look artificial at all anymore. Some are round and very flexible in contrast to the flat, dead sheets of plastic we saw in the past, whilst other even look like a top quality fine grain calf with a transparent finish on top. Shoe leather again looked very classy with new browns in all variations and shades. There were also crunched, shrunken and printed leathers of all kinds. We saw also less black this year. This might just be because black isn’t as eye-catching, but it could also be that it’s moving more into the background. Although it is a different season, the colourful, metallicised leathers which dominated in May were hardly seen either.
Calf skins slide
The main news from the raw material market was definitely the sharp decline of extra small and light calf. The shining stars of the 2005 and 2006 seasons took a pretty hard beating and have fallen drastically from their top prices at the end of 2006, with some losing up to 35% of their value in the first quarter of 2007. As this market is exceptionally cyclical this is no real surprise. As usual this kind of product trades within a certain price band and we had already well-exceeded the top. Although the correction now might be exaggerated, many of the satellite manufacturers which only come into the market when there is enough demand for immediate supply have withdrawn because buyers were unwilling to pay the leather prices which they needed to cover raw material costs in the first quarter. This trend had already been seen for some time and many of the buyers have now shifted to cheaper alternative raw materials. Sheep and goat are just two examples. With the price correction we’ve seen, the price level for this kind of raw material is back to what we consider to be the bottom line and the key manufacturers of top quality calf leathers were probably the most satisfied to see this happen as their calculations should now work out pretty well again. Furthermore, there is no sign that luxury brand names have seen any reduction in their business and tanners’ order books should remain decently filled.
It was not only the light calf skins that struggled amongst the traditional top quality and top prize materials, kips and calf up to 8kg or 10kg also suffered. There has not been enough of this material for nearly more than a year and as a result prices from all origins reached almost record highs, which was pretty difficult to understand. These items have also simply seen a case of price correction and one got the impression that a fair amount of material that has been piling up since the second quarter was not placed and is still looking for a home.
There was a bit of a mixed performance in other raw materials during the show. Origins which traditionally focus on the market in Italy probably had the most difficult time. Bovine hides from the UK, Ireland and France for example, a large proportion of which are sold into the Italian market for various reasons, were under substantial pressure and one didn't get the impression that every supplier was in the position to sell what he wanted to get rid of by the end of November. Under these conditions the spread of prices quoted was very wide and a 10% difference between the bottom and top end range was frequently heard. This was not only related to the optimistic quotes made by buyers and sellers but also, in many cases, the simple truth of the situation, i.e. producers found themselves in very different positions, and those that were pessimistic took what they could get while others, who were probably in a better position, were unwilling to consider the ideas of their colleagues.
Dirty deals in Italy?
From the results of the show we now have to move on to the really exciting news which has completely overshadowed everything else in the past week. Some sources and people we have spoken to in the raw material, tanning or chemical business have been saying for some time that there are a number of issues that they didn't like in the market and in Italy in particular. Although nobody ever made concrete or precise statements or was in a position to tell us what was really happening, a lot of people have been talking about so-called “gut feelings” since spring this year. When asked to be more precise, their biggest concern was that they didn’t believe that the cash flow situation in the tanneries in Italy would allow them to pay their invoices on time. However, with the exception of the bankruptcy of Nicopel nothing had really happened and many of the people voicing concerns about the situation were considered to be too pessimistic about the capabilities of the Italian tanning industry to compete with their global competitors, but that could all change soon.
In private, there have been whispers about VAT fraud activities in Italy for a while. Due to the way that VAT is paid and controlled in Italy it is relatively easy for short-lived trading companies to avoid VAT payments which account for 20% of the invoice value. With checks taking place reasonably late, companies that are operating fraudulently there is a good timeframe in which to make money before they are audited and with the volume and size of invoices in the raw material and finished leather trade, decent amounts of ‘profits’ can be accumulated.
For those who are not familiar with the VAT laws in Europe: Company A from anywhere in Europe sells to company B (trading company) in Italy and pays the local VAT correctly. Company B sells to company C (tanner) including the 20% VAT. Since the trading company never had the intention to pay the 20% VAT to the tax office, but is actually claiming that 20% VAT deductible on their purchase there is a gross 20% to be shared between the related parties. The supplier usually gets a small premium above the market price level and the tanner gets a reasonable discount while the rest goes into the pocket of the trading company. Except for the criminals in between, the supplier and the final customer feel pretty happy about the deal as neither of them is acting illegally in the first instance and one gets more than they usually get whilst the other buys cheaper than the market.
With a lot of investigations into this currently taking place in Italy and with plenty of rumours around, one has to assume that the extent of this kind of operation might be much bigger than anyone expected. If, and we stress ‘if’, this is true then the mystery over the problems of profitability people have been talking about would be solved. However, it is hard to believe that this could be the solution sought by the whole industry. The most influential factor is, however, that companies in Italy could now face intensive tax investigations and traditionally we know that where there is smoke there is fire. So far, however, very little has been proved and no names have been mentioned.
… And dirty money?
If this were not enough, another big scandal hit the Italian newspapers on Tuesday concerning money laundering for the Mafia, cocaine smuggling in containers of hides and, once again, VAT fraud that is said to run into many hundred of millions of US$. An Italian hide agent along with two bankers have been arrested, as well as suppliers from Canada. According to reports, the anti-Mafia squads in Italy had been working on the case for more than a year before they took action this week and arrested the suspects and sequestrated the enormous sum of $600 million from various accounts.
The name of a tanner in Arzignano was also mentioned within this investigation concerning VAT fraud of €20 million within the same operation. So far it appears to just be an investigation as nobody has been arrested and the evidence does not appear to be sufficient to bring about a prosecution. But, considering the recent bankruptcy of a large and well known skin tanner in the south of Italy, where few tens of millions of euros are also said to have gone missing, one can imagine what this could do to the reputation of the whole sector in the country, and the problems it can bring.
Banks and credit insurers will undoubtedly tighten controls and the cash flow situation within the Italian tanning industry could become extremely difficult. We must not forget that one of the larger tanning groups is in the spotlight and we have to see if the group can be bailed out so as to be able to continue operations at the same level and in the same way as before.
So, the concerns we voiced more than a year ago about the situation and the problems in the Italian tanning industry have now come to the surface. No matter what the final results or repercussions are, the present situation and the insecurity that will reverberate throughout the trade will not be without negative effects. It will not change the global demand for finished leather, shoes, leather furniture, leather garments, etc., but in the short-term the product flow in one of the biggest producing countries will be negatively affected until the normal product flow is reorganised globally, and this could take a while.
Splits still struggle
Back to the markets and the split market did not shown any signs of a change for the better. In fact it did not show any signs at all. A small customer base is still looking for extra heavy splits over 3mm and splits with a little less substance are also still doing OK. There still isn’t any light at the end of the tunnel for the rest and lighter material. Stocks are still increasing and we are still waiting for an improvement.
The skin market is also pretty disorderly, at least as far as Europe is concerned. Heavy sheep and big lambs with good wool are still in strong demand from China. All other cheap skins suitable for nappa are also finding interest from buyers in the Middle East and China. Double-face or new season lamb business is, however, a non event. Turkey and Poland are not seeing much interest from Russia and here too the money flow is not sufficient. Although it is only the end of October it seems that double face garment sales to Russia is already almost lost for the winter season. If business still picks up – and it will – it seems that existing stocks left over from the last year’s warm winter are still good enough to satisfy any immediate needs.
All eyes on Italy
The next two weeks are going to be exciting. Most of the trade in Europe will now watch for any further news from Italy to understand if this week’s reports remain isolated cases or if it is only the tip of the iceberg. Whatever happens, one can’t expect trade to be normal and we have to see if this also spills over into China. The problems in China have been pushed into the background although effluent issues and cash problems have still not been sorted out and could have all kinds of effects if the problems spread. For the moment, however, things still look quite intact and there are no signs of the industry slowing down.
Under the present conditions the market will certainly stay under pressure. Anyone who is cold-blooded should watch the situation now carefully. Despite all of the problems and the shockwaves sent around we can still not trace any reduction in the demand for leather. Consumer spending in Asia, South America and Russia is still compensating for the flat conditions elsewhere. So far growth is still intact, and that means that the consumption of consumer products also remains intact. We have already had concerns for a while over consumer spending in Western Europe and the USA, because we cannot believe that the subprime crisis, higher energy cost and increased prices for food will not affect family budgets eventually, particularly as disposable income is not rising at a higher rate. For the weeks to come the focus will be on Europe. There is little positive to be expected and we are possibly now going to see some of the negative influences we were afraid of. The market should stay steady this week until everything is sorted. Those who feel secure and confident about their business and orders should now look at the short- and the long-term benefits.
