MARKET INTELLIGENCE – 23.11.07

Macroeconomics

Anyone who had expected the situation in the financial markets to calm down was disappointed. The turmoil continued and all of the efforts made by politicians and ‘experts’ to alleviate the situation failed. The current trouble in the housing markets and the possible consequences for private mortgages could enter a second round as more banks will soon have to adjust interest rates. After the problems in the USA the trouble could now also spill over into other markets such as the UK where speculation about the potential risks has finally hit the headlines in the last couple of days.

The problems which had seemed so far away for many, and just something that was happening across the Atlantic, are now starting to concern people in Europe too. The media, which has until now been celebrating the success of the EU economy and the restrengthening of the lame ducks in Europe (Germany, France, etc.) is now starting to wonder whether the situation could be about to finally affect Europe and whether it could see the start of a serious recession — at least in the old economies.

Problems ignored?

The problem these days remains that business and finance have become more a media and PR issue for politicians and managers rather than a rational and scientific issue for experts. Whilst success and favourable conditions in the business community, as well as on a national scale, are claimed as the result of good leadership, problems are viewed as the result of circumstances. Therefore an appropriate plan of action for such problems is not put in place during the good times because it is much more convenient for those involved to preserve public opinion and enjoy the limelight of success — even when ship is already taking on water. In short, nobody could say that the problems which have already hit the USA and are now approaching the ‘old world’ came out of the blue or that there was no opportunity to take precautions in anticipation of such a situation.

And so the world now has to deal with the problem in order to avoid a credit crunch in some economies, but, there are not many tools in the drawer. Liquidity and interest rates are the ones that are always implemented quickly and with great ambition, but one should realise that there is a price to pay for these — inflation — not to mention the fact that this would accelerate the trend of the rich getting richer while the poor get poorer. We have already been seeing this trend for a while in Western societies and it is not good for global stability.

In the meantime we have seen oil prices reach just shy of the magic $100-mark in the past two weeks and the US$ at just a fraction away from the 1.50 rate against the euro. The yen saw a solid recovery against the US$ and the currency which is at the centre of attention, the Chinese RNB, hasn’t been revalued but at least reached about 7.4 — the highest level against the US$ since 2005. However, none of the above has reduced any of the serious tension in the markets with self-nominated experts and politicians pushing opinions for their own interests.

Market intelligence

As far as general market activity was concerned the last two weeks delivered neither much excitement nor any extremes where trading was concerned. The world is already slowly but surely winding down operations and preparing for the Christmas break in the Christian world and for the summer break in the southern hemisphere. Most overseas origins that ship to China are also realising that they only have about two-to-three weeks left to get their goods on the boat to reach their destination before the factories close for their two-week break until the end of January 2008. This situation is offering a bit of an uncertain outlook for business until mid-January.

Market activity in the USA was cut short last week by the Thanksgiving holiday and, with leather predominantly being a consumer product, most interested eyes were on the results of shopping sales on ‘Black Friday’, which traditionally accounts for almost 5% of the whole shopping season. As far as the first results were concerned the shopping season started pretty well in the USA and most analysts believe that activity will be sustained until Christmas or even beyond through some after-season buying.

Positive shoe reports

However, as far as products were concerned most of shoppers’ interest was pretty specific and electronics and toys topped their shopping lists while apparel is still not under the preferred items. We believe that fashion might be the stronger driver anyway and looking at a short survey we did of shoe retailers’ results, they were pretty positive. Shoes are selling pretty well and with most expecting at least a ‘normal’ winter, warm boots are not only on ladies’ shopping lists, but gent’s are also looking for a warm pair of boots, which is also being  supported by the general trend for casual outdoor fashion. With a good start to the winter season and an early arrival of the cold weather in the northern hemisphere the  shelves are emptying quickly and normally this not only has a good effect on the mood of retailers with respect to the next season, but opens also the door for some re-order business which keeps the pipeline flow intact.

With a pretty cold November in Europe too, the shoe business at least — which still accounts for the vast majority of leather consumption — has had a good start to the winter so far.

One is hearing pretty much the same from Asia and Russia too. Shoes are selling well and the ongoing fashion for leathergoods and ladies bags is supporting business there. Asia has still got the shopping season ahead of it and one can hardly find a retailer or producer who hasn’t got high expectations for sales.

Big ticket items struggle

At the moment this leaves only the big ticket items as an uncertainty. A big question mark is still hanging over car sales (with leather) and upholstery. The traditional markets such as the USA and Europe are not performing well in these segments. For European manufacturers export sales have been compensating well for declines in the domestic markets, but with the rising euro and increasing fuel prices the outlook is neither as easy nor as positive as it is for shoes and leathergoods. More and more tanners and manufacturers of these products are either moving manufacturing in the US$ region or at least using US$-related raw materials to reduce their currency risk. While producing abroad does indeed resolve a great part of the problem and buying in US$ certainly helps as far as the total currency risk is concerned, it does not solve the problem of production costs or the vicinity of the final product to the manufacturing site.

In short, while many business sectors in the old world are still pretending that the currency situation is not a hazard to their business, we believe that the strong euro is probably the biggest threat to the industry in Europe at the moment and definitely more threatening than the evils of the past such as high labour costs, legislations and bureaucracy.

We should not forget that this problem is not just limited to Europe; countries such as Australia and Brazil are also facing the same or similar problems.

So, the present currency market is only favouring the leather industry in Asia or, better said, in all of the countries which are pegged to the US$.

A global split

This is really bad news for the industry which had already been fighting hard in terms of international competition. Ever-sharper environmental laws, rising labour costs and not forgetting a disappearing customer base have already made life difficult enough and it really did not need the currency concerns to come on top of this. This doesn’t really leave a very good outlook for the leather industry in general and it is hard to see a positive outlook for 2008 for the sector in the beleaguered regions. The only ones that might have a fair chance to escape are manufacturers in the luxury industry where the price is secondary and quality and image are the foremost criteria.

For the mass markets and in the emerging markets price has become the only determining factor and this means that for manufacturers outside the US$ world life is becoming almost impossible if they want to produce and sell volume on the international markets.

It might be an exaggeration to say this, but it seems their only chance would be if the US$ reversed its trend and the value of the RNB represented economical fundamentals more fairly. Next week another delegation — this time from Europe — will make the pilgrimage to China to speak with officials in the hope of reaching an agreement on currency relations. Well, the Chinese will never react to direct international intervention and so one can only hope that the risk of imported inflation will convince China’s leaders to allow their currency to be revalued at a quicker rate than seen so far. So far, they are just controlling what other central bankers are complaining about: they are preventing abrupt and brutal, short-term currency movements. So when the delegation that is travelling to China now reads its own statements from the recent past, it will see how quickly the officials over there are learning, and not just on a technical basis.

So far the market round-up has reported good parts and bad. Although this was less of a reflection of the trading situation we feel that, at present, other than the normal balance between supply and demand, this might be the more of a determining factor for the markets. As 2008 approaches we will also at the final issues of 2007 in order to deal with the general situation and outlook for the year to come.

Normal activity

As far as trading was concerned we heard of pretty normal activity. While most global markets were treading water with normal or quiet levels of activity, Europe is still suffering from isolated stocks of material which still haven’t been fully absorbed. Overweight materials in particular are suffering due to the problems in the European upholstery and vegetable tanning industry which we specified in short above. Since they haven’t yet found a regular outlet overseas, a certain surplus of production will build during the winter months when weights traditionally rise.

The split market isn’t showing any further progress. The activity seen in the last weeks hasn’t been enough to talk of a further improvement in the market situation. A lot of inventory is still burdening the market and it doesn’t seem that the market will take a turn for the better in what is left of 2007.

The skin market is also following the same pattern of the previous period. Low price nappa skins are still selling pretty well; and even better when they carry a good value of wool. Chinese buyers are still around trying to buy all they can get within a certain price frame and it seems that buyers are still around to absorb what they can get.

Low expectations

For the coming weeks we don’t expect much from Europe. It seems that most buyers are quite happy to wait for further declines and most might already be covered going into 2008. With production breaks, which are sometimes as long as three weeks, not many hides will be needed. In Asia the situation is a bit different. Most tanners seem to be covered until the Lunar New Year break, but within the next three weeks they should need to make decisions for their arrivals after mid-February. Our regular sources are reporting that Chinese customers are not refusing offers and are giving the impression that they are just trying to get the timing right. US sellers have the currency situation on their side and others against them. So far, the market forces still don’t seem to be strong enough to move the market either way, but the currencies could.

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