Macroeconomics

After all the excitement of the past few weeks, things have calmed down a bit over the last fortnight. After making the headlines as the ‘crash currency’ the greenback eventually turned around and took a break from its descent. It managed to gain some ground against most currencies after the market received slightly more favourable data about the US economy and the government indicated the possibility of helping private lenders with financing their homes.

At the same time the European economies have shown a moderate slowdown in their growth outlook and all this took away some of the pace in the markets and allowed the currency to return to $1.45 levels against the euro.

Last week the European Central Bank (ECB) decided to leave interest rates unchanged while the Bank of England lowered interest rates to offer some relief in the face of falling house prices and similar financial troubles in the UK and this weakened the £ against other currencies. In continental Europe the ECB is focusing most of its attention on inflation with CPI moving above the 2% mark and comments made at the press conference after the rate decision left most with the impression that interest rates in Europe will go up rather than down. At the same time the central banks in the UK and the USA are more concerned over the housing markets and the consequences this could have on consumer spending. This news led to the comeback of the US$ being somewhat short-lived and some of the gains made against the euro were erased to end the period at a level of $1.4650.

Looking at media reports and the forecasts being made by major banks, the opinions are tremendously split, which leaves the options for a further trend wide open. While some major banks believe that the recovery will be short and are preparing for a jump above 1.50, others believe that the worst for the US$ is over and are now expecting a gradual retreat towards the 1.40 mark — which would still be low.

Petrol prices fall but energy costs still rise

Oil prices have also seen their highs. With inventories now well-filled and some of the speculators losing faith the price per barrel went down to around the $90-mark. Although a bit of a decline was seen at the pumps, the price of heating oil and energy costs for households and enterprises are still pretty high and a massive burden. The Economist ran the headline ‘The end of cheap food’ this week which confirms the concern we have had for a long time that the rise in the price of basics could eventually become a massive drain on the disposable income of consumers worldwide. While statistics are still calculating inflation as being down we continue to believe that inflation in real terms is already higher and most likely to climb even further in 2008, driven by the rising purchasing power of the emerging markets and the increasing and subsidised use of bio-energy.  While the increasing costs for basics might be compensated by rising incomes in India, China, Russia, etc.,  would the same development in the ‘old economies’ result in a major shift of the disposal of income?

In any case, the present trends leave quite a few options open for the consumer markets in 2008.

Market intelligence

Most of the activity and news came in from Europe again where the market appears to be having the most trouble in sorting itself out. We would also like to focus mainly on Europe because we believe that it is here that most of the market activity and changes are happening which are relevant to the situation in the leather pipeline as a whole.

The situation in Europe is being particularly influenced, not only by the currency situation, but also by major restructuring processes underway in the entire trade.  The concentration of the beef industry, the shrinking competitiveness of the tanning industry, the sharp downturn in vegetable tanning, UK export restrictions due to FMD and automotive tanners moving away from their traditional core European raw materials are just a few examples of what has happened in 2007 to cause the market in the old world to be so out of balance.

While these are just local issues we also have to look at the major global trends which we have already debated in earlier issues of the Market Intelligence. The global market and retail structure is no longer separated into the many finely segmented quality levels which would be appropriate for the leather and leather products. We have discussed this with a few pundits in the leather pipeline again and all of them agree on the same trends no matter which market segment one is looking at. While at the finished leather products level more differentials can be seen by market and the design of the brand names and retailers, the situation looks entirely different when it comes to leather as a product. So, before we return to the leather pipeline in Europe we would like to go through this issue, because — along with others —it is hitting the raw material and tanning industry in Europe hard.

Mid-range leathers struggle

One of our regular sources summed up the situation pretty clearly by saying that leather production today is just separated into a) consumer commodity b) luxury, and that all other levels of leather valuation have quickly disappeared, accelerated by the rise of the euro which quickly made certain products too expensive. With the tremendous growth of wealth in the emerging markets the luxury — and we mean real luxury — brands were able to grow their businesses at double-digit rates every year. The second segment of growth was in the lower income community in the emerging markets which is obviously still pretty price sensitive. However, the existing middle-class in the old economies, which was traditionally the driving force behind average price items, is now seeing its disposable income shrink for individual reasons in different parts of the world.  One thing all parts of the world have in common though is the fundamental basics of life: food and energy costs have been constantly rising and weighing on family budgets so that saving on other products has become pretty essential.

In America uncertainty has arisen over the consequences of the subprime crisis, in parts of Europe the same uncertainty about real estate markets is a factor, but the rising need for healthcare and pensions have also made the middle-class more and more conscious of their expenditure. Although one might laugh, even flat screen TVs are tearing holes in family budgets as they top many shopping lists and belong to the big ticket items. When your income is not rising fast and you believe that you will have to spend more money on the basics in the future then the money spent on one item has to be saved on another. If then, at the same time, you need to buy shoes for the family then you obviously try everything to bargain and buy more cheaply to get the same on a reduced budget.

At the end of the day none of this is new, but the conditions in 2007 have changed considerably. Average families in most Western countries have had to tighten their belts despite the high standard of living because of the rising cost of the basics. As a consequence those who traditionally had a bit more to spend on better quality medium-priced products have quickly become bargain hunters too and this has left the mid-price and mid-quality market out in the cold. We are not saying that people are pleased with this trend as many don’t enjoy having to choose goods based on price rather than quality but in the end consumer behaviour and the sales targets of the big retailers are by far stronger than the wishes and feelings of the few.

So, one doesn't need to be a genius to understand that this trend, in combination with a strong rise in the euro, has hit the European manufacturing base pretty hard. Only a few, if any, in the tanning field can actually be low-price producers.  Some of the Italians still believe that with their technical skills and productivity they can still compete with Asia, but even if they could on the simple point of cost, they cannot bridge the problem that their customer, the manufacturer, has also moved and is pretty far away in terms of speaking to him or shipping goods. With the rising standard of production quality in Asia, the ‘Made in Italy’ or ‘Made in Germany’ sticker on consumer products is no longer the key to success in the consumer markets of the Far East. So with fewer export opportunities in the shrinking European market for average-priced products it is pretty obvious why the European tanning industry has faced such strong headwinds in 2007, despite a pretty healthy global consumer business.

Knock-on effect for raw materials

This situation is also spilling over into the raw material supply chain. Many European suppliers have still been focusing most of their business on the traditional markets in Europe. This was for different reasons. For some it was the focus on fresh material, the money and cost savings as well as the quality improvement investment of the ‘90s.  For others it was the concentration of vegetable tanning centres in Italy using predominantly specific salted materials from European origins, although then the outbreak of foot and mouth disease in the UK this summer limited sales of material into China. And last but not least, the automotive tanners have also walked away from the full concentration of their European factories on domestic heavy material due to cost-cutting measures.

So, a lot of the European hide and skin suppliers saw their customer base in Europe quickly eroding as they were either producing less or covering their raw material needs from other origins. Most companies probably did not react quickly enough or, even now, have not accepted the realities of the situation and are still hoping for better times, which are becoming more and more difficult because of rising stocks. At present at least, there is very little hope of a change for the better in Europe.

China becomes a tougher customer

It would be easy if the answer were to just sell more overseas. It is, however, not that easy. In China and in other Far Eastern countries, too, the market has changed quickly in 2007. With tougher tax and effluent controls in China, tighter credit conditions, and a change in the VAT policy, many of the fly-by-nights in the tanning industry are facing a hell of a lot of difficulties and many of them have already closed down. This put a stop to the bonanza we were still seeing exactly a year ago when the Chinese tanning industry seemed to have an insatiable appetite for raw material and anyone looking to dispose of hides and skins seemed able to find a market out there. This brought a lot of trading for companies which had been considered a dying species or already history and brought them back to life opening outlets and sales opportunities for many smaller and unlicensed operations all over Europe.

With the present changes now in Asia, the customer base for these kinds of suppliers is eroding quickly. A number of tanning businesses which had been operating in something like ‘grey market’ conditions, importing raw material through obscure channels, tanning without licences, and paying little or no taxes either had to close down pretty quickly in the second half of 2007 or have just gone idle because the owners don't want to be at risk of prosecution by the authorities. These customers formed the main client base for many, of course not only European suppliers, and as it is now missing it has left many operations without sufficient sales opportunities. The strong performers in China are well-managed, large tanneries and they need suppliers that operate on similar or the same levels. Consistency and reliability as well as marketing and logistical skills are needed to qualify to be a regular supplier. Something that is pretty much out of reach for many in the still significantly fragmented hide and skin processing world of Europe.

As a consequence many of the smaller operators around the continent have had a pretty rough time finding the necessary outlets for their production over the past few months, and this explains the vast and extended differences in hide prices you get quoted today from the old world. With Europe still accounting for most of the higher quality (more expensive) materials it has also got another problem. These hides do not fit too well into the present demand structure and many of them are losing their quality bonus as nobody wants to pay for it anymore. This does not apply to the absolute ‘top quality’ lines, because real luxury is still doing pretty well, but the medium-to-higher-end supplies are finding it increasingly difficult to find buyers who are willing to pay the premium they have been used to for so long.

At the end of the day all this will sort itself out, even if it may be hard for some to accept a revaluation of their stocks and that things might be a bit more difficult for some time, but ‘good quality’ always sells — at a price — while low quality doesn’t.

Many of the European suppliers are now relying on a lower kill in the first-quarter in the hope that everything will then take a turn for the better and they will regain a feeling of normality. But, with the Chinese New Year ahead of us and the global hide and skin market being in reasonable balance, it might take a little bit longer and a lot will also depend on the general developments in the global economy in the first half of 2008.

Splits continue to struggle

We can't really report any news from the split market. Light weight split material for the tanning industry is still having a pretty rough time. Extra heavy splits are still selling and the collagen and gelatine industries are also reasonably busy.  However, for the traditional tanner, splitting in blue and depending on quick removal of the splits and adequate prices is still pretty difficult.

The skin market remains quite interesting. A lot of skin suppliers are still reporting pretty strong interest from China for economical wool-on skins. Talking to our sources in China, they confirm that the supply of domestic skin is not high enough at present to cover the needs of the industry for the next three months. Whether the upcoming Muslim holidays will change this we will find out shortly. For the time being tanners are, however, still advancing their seasonal purchases to December instead of waiting for January/February as they usually do, to get the biggest skins of the season out of Europe.

The next two weeks will be the last before the year comes to an end. Due to holidays the last week will be pretty much of a non-event. From what we can see now we find it hard to believe we will see much market activity, although the Asian tanners remain an unknown. Much still remains to be bought for February/March and if they step in it might offer the much needed support the European market needs. If the rumours we are hearing from China and Taiwan that some larger tanning groups are trying to bundle together in an attempt to squeeze the US packers down by a few dollars in the next round of buying are true, there is little hope that much can be generated in the market from there either. The currency market will most likely be quite volatile as year-end operations dominate decisions. So, all this leaves the market a bit exposed to coincidence rather than to a regular market trend.

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