MARKET INTELLIGENCE—15.07.08

Macroeconomics

We are entering the summer holiday season and this is slowing down traditional activities and news flows.

The main event over the past 14 days was the G8 summit in Japan, but what used to be a meeting of importance where serious global problems could be discussed and managed has become a small-talk media event ending with lukewarm press statements. For the interested global citizen very few—if any—ideas were produced to handle the present problems.

The best idea of all was certainly the discussion about extending the group of eight to numbers up to 16 including important global members from the emerging nations. It is questionable if this will make the group more productive, but with the rising importance of other nations the community would be well advised to integrate them and to let them share and take responsibility for the world.

The financial markets have not delivered much news in recent days. Stock markets are being dragged down by the fear of the effects of rising food and energy prices and, in Europe, a number of countries are starting to suffer seriously from the property bubble, which has finally burst. In the UK there is already talk about a possible recession and in Spain and Ireland things don’t look much better. The financial crisis doesn’t seem to be over and every week there are new estimates of bank losses. Bank shares are not a safe and profitable investment at the moment.

The oil and currency markets have taken a break. Oil prices remain high but have failed to reach the next magic figure of $150 per barrel. The dollar has also stalled and has been trading now for almost two months in a very narrow range to the euro between $1.53 and $1.58 and a further steep fall was prevented by pretty strong words of from the chairman of the Federal Reserve, Ben Bernanke, who finally admitted that inflation is a threat also for the US; a weak dollar is adding to the price-rises for energy and food. A rise in interest rates in the US would appear likely if the entire economy and the financial system were not so unstable at the moment. Only last Friday the dollar took another beating amid major concerns about the solidity of the main mortgage financing institutions in the US, and with new fears about huge losses in the banking system the greenback fell sharply and saw levels not far from the record lows of early spring.

This is a problem the US now shares with other economies. They can’t do or don’t have the courage to do what they should do: raise interest rates.

One doesn’t need to be a super economist to understand that the months or maybe years ahead could become pretty problematic for many economies, and seeing inflation also rocketing in other important economies such as China (almost 10 %) or India (almost 17 %) could also be weighing on their growth and societies. The world may be well advised to think about a new masterplan to manage the bumpy roads ahead.

Market intelligence

The leather pipeline is still in a situation of many different layers. There is an Asian market and European one. There is an upholstery market and a shoe market. There is a luxury market and a mass consumer market. There are cash-rich companies and cash-squeezed operations. There are many more different conflicting segments and the key question is only if the different situations are going to balance each other out.

As far as market activity was concerned the focus was again on the US hide market and the strength of standard big packer hides. While many had been predicting weaker trends for some time and did not believe in the never-ending high weekly sales, the market proved them wrong and reflected what we have discussed before. Despite all the terrible news from many economies, the sharply rising cost of production and transportation, the economic downturn and the influence of the Olympic Games we had, and still have, global growth and rising income even if it is not equally spread.

Following this situation we had and still have the increasing consumption of basics and also of luxury items. We consider that shoes are included in the basics and growth in emerging markets is easily compensating for the flat conditions in mature markets. Of course this leaves the question open about how this is going to develop in the future because the real steep increase in cost and prices has only happened in 2008, mostly in recent months, so that most orders were already in place. Nor should we forget that the last season(s) in retail were extremely successful,so that retailers, with empty stocks, had to place orders.

So, why has this situation been benefiting US hide supply all year? This is definitely related to various reasons

a) scale

b) uniformity of product

c) price

d) location of production

e) mutual interest of suppliers and buyers to stabilise price conditions and being able to plan output and input in volume and price

f) the attempt of many to stay independent from currency fluctuations.

There may even be some political reasons as well.

Large, industrial producers of standard shoes—in combination with large retailers—are looking for consistent supplies of volume. To manage the sheer size of order and production with acceptable overheads and administration requires adjusted and scheduled input and this includes, of course, supplies of leather. For the production of these the two main factors—volume and price—has favoured hide supply from the US. The technical aspect of having a consistent product should also not be underestimated. As we have already discussed in previous issues of Market Intelligence, big packer suppliers in the US have taken their chance to secure trade before other markets realised they needed to adjust their prices to be an alternative.

There is a never-ending discussion about the real value of hides for certain aspects of leather production, but since all alternatives have failed in at least on one or two of the above six categories, none of them really had a chance to compete. Another reason was, of course, that most other supply markets took the easy way out in the past and sold to the upholstery and bag leather tanners, where the production of lime split hides was more common and yield advantages were clear.

However, as price is still the driving factor the situation might change—at least in the near future. If we assume that the reports of the US market are correct, the USDA export numbers are not misleading and that we won’t face any major destruction of the present market conditions, it will begin to have a strong effect on prices, as has already become clear in the past weeks. The big suppliers are in such a good position that they are willing, and have the courage, to raise asking price levels. If the price-gap becomes too wide or it becomes difficult for US suppliers to meet shipping timeframes, other origins could quickly develop and finally the great depression in, for example, Europe for hide sales could be over.

Something that has prevented this from happening, and has played into the hands of US hide suppliers, was the weak dollar. As long as the dollar keeps falling, it will remain hard to compete, but a only a return into the higher end of the recent trading range would definitely make other origins begin to look attractive.

But anyone betting on an ever-falling dollar should probably not bother. And anyone who thinks the Federal Reserve will have to raise interest rates eventually to battle inflation—no matter what the economy and the real estate market look like—could find today a reasonable number of bargains sitting around in warehouses, and buying them in euro would then be the right strategy. All this applies of course to hides suitable for side leathers.

In the upholstery section the situation looks completely different. Although we hate to be pessimistic and we always try to be realistic and not to be carried away by the sector’s emotions, it is very difficult to find a positive outlook for this sector, at least for the months to come. There is still a luxury market and some leather furniture may also find customers among the newly affluent. However, leather in furniture has lost a lot of its image and shine and is being hit hard by the collapse of traditional markets. It is also finding it difficult to take a fair share of the growth in emerging markets, so, it is completely different to the situation in the shoe sector.

As if things were not already bad enough for tanners, with a full list of negative influences (cost, currency, decline in consumption and so on), the Olympics are adding to the problem with a number of Chinese tanners in the regions where production has been stopped or is being massively hindered by government decisions. However, the problems in China are certainly not only—if at all—because of pollution controls imposed for the Olympic Games. Chinese tanners are normally masters at moving production to another part of their big country, if there is a market for the product and money to be made. With the very long lead time they have had to prepare for the present situation, it would not be China if they had not found a solution. The likely explanation is that there is simply no demand, and listening to the reports of stocks sitting in a number of factories and the shrinkage of the order books many are reporting that business in this field is bad globally.

It is a similar situation in the field of bag leather production in China. The sector—still buoyant six month ago—with producers being busy and holding order books of six months’ work and more, are today suffering and complaining that their plans and budgets have been completely wrong and well informed sources are reporting large amounts of raw material stocks in the tanneries. Supply sources we trust are admitting that there are still a number of contracts awaiting letters of credit and shipments since May or even April.

What has made this market suffer so much is still not fully clear. We tend to believe that the industry was poisoned by the success and growth of 2006 and 2007 and thought it would continue this way. Consequently, budgets were wrong and too optimistic as was the raw material purchase plans. Now producers are busy trying to get things back in order while avoiding being killed by cash-flow problems. At least this is adding to the jammed pipeline of dairy cows and other items which are favoured by the bag leather producers.

It is never all bad, but it is difficult to forecast any short term improvement. Conditions with the Olympic Games and the summer holidays in Europe are not allowing any improved market activity and anyone who is holding onto hides for this sector should either hope for a recovery in women’s boots and the use of soft nappa leathers, which can be made from cows, or get ready to secure enough warehousing capacity and cash resources to reach the shore later in the year when seasonal production will start again and the consumption of hides will improve again.

The split market for leather production is still in the same depressing state as for the last six months or so. Some people say that some shoe manufacturers are discussing using splits for boots, but so far it is just a rumour, one that we have heard already a number of times. There is almost no sign of any improvement. In our view there is no doubt rising demand, and abundant supply. Consequently any improvement in prices has been impossible. This will continue throughout the summer. However, with the increased demand from the food sector, which has to be expected after the summer, we would not be surprised if prices have reached a low in the middle of 2008 and that things could moderately change for the better later this year.

The skin market has lost also a lot of momentum. With the Chinese buyers being quiet for the season and the Olympics, and the buyers who are mainly playing on the wool return being hit by the closures in Hebei province, activity has slowed down considerably. The hope for a return of the Turkish buyers for new-season lambs in Europe was also in vain and so only the business for sheep and lamb suitable for lining can be considered normal. With the summer holidays now in full swing it is difficult to expect any major increase in business in the short term.

For the coming weeks we expect little or nothing for the leather pipeline for garment, upholstery and bag leathers. For the footwear business we are really interested to see what is going to happen. With the rise of prices in the US and the decent forward positions held by the big packers, there would be good room for some movement of European hides into Asia. It seems that the price gap is now large enough to attract buyers, even if only to show their US suppliers that other options exist. The dollar remains a problem, of course, and at an exchange rate $1.60 to the euro or higher our theory would quickly lose attraction. If the dollar recovers to levels of around $1.55 to the euro we see a fair chance for European sellers to move some hides over the summer into Asia and to get a bit of relief form the depression in their home markets for salted materials.

Share this story: