Macroeconomics

We are right in the middle of the summer and consequently we can only publish shortened versions of the bi-weekly publication. However, while the leather business was more or less on holiday, the financial markets saw some more heightened activity during the last fortnight.

Both the Bank of America and the European Central Bank (ECB) left their interest rates unchanged.  However, discussions changed completely. The ECB, in particular, started to sound a little different; less concerned about inflation and more concerned about growth was what came across in their statement following the interest rate decision.

This did not come as a surprise as more and more economies in Europe started to struggle. Spain has shown very weak retail sales, but the UK and Ireland are also beginning to suffer significantly from the housing crisis. In Germany, where factory orders have fallen for the seventh month in a row, things do not appear to be more promising than they did six months ago. This was also reflected in the retail sales decline, which were 3.1% lower in June than in June 2007.

Although the financial markets are well aware that the ECB is not overly influenced by the general economical situation, and is actually far more affected by inflation, many in the financial community have now changed their minds, coming to the conclusion that the ECB is not going to raise interest rates any time in the coming six months as had been anticipated.

As a result, this has triggered a massive move in the value of the US dollar and we believe that our ideas about the relationship between the dollar and commodities, especially oil, have also played a considerable role in the change of the dollar trend. By consequence, the euro lost almost 5% of its value against the dollar at the end of the last trading week, while oil prices also took another sharp nosedive and ended the period at levels fractionally above $110 a barrel.  Let's not forget that just around two weeks ago we were still dealing with levels of around $140 and the greenback was trading close to its record lows of around 1.60 against the euro.

As we all know very well, the markets are often swayed by psychology and it seems that, for the moment, speculation has given up on the trend and people are ready to change their minds. This could mean that we are about to see a reverse in the trend, both for the US currency and for commodity prices. It might still be a bit too early to make final decisions and this trend would not be in one straight line, like with any other. But the fundamental arguments with the slowing global economy are probably a reasonable base for a new general direction in the markets.

This logic will also mean that speculative money will have to move again and this could mean that, after a certain period of settlement, other investments such as the stock markets may benefit. However, in our opinion this will still need some time before it sorts itself out, and it might be reasonable to set a timeframe of three to six months rather than hoping for a quick and immediate change of the situation.

Also, the war in the Caucasus may have been important and influential in terms of the development of the US currency. What seems to be a local issue is, in our opinion, another real global problem and the Europeans in particular have lost a lot of their strategic ambitions in gaining physical access and transportation to the energy resources in the region without having to pass Russian territory. We can only hope that the conflict will be settled quickly without more people having to die for the sake of other peoples’ interest.

Market intelligence

As far as the leather pipeline is concerned, one could have easily skipped this summer issue at the beginning of August, and if nothing unpredictable happens over the next two weeks the same will most likely apply for the mid August issue of this publication as well.

With the general drama in the leather industry or, more specifically, in the upholstery and garment sector, it seems that everyone is pretty happy that they are either on holiday – which applies to Europe – or can spend the day in front of the television to watch the Olympic Games. The opening ceremony on Friday can be described as a big success and, for someone who knows China a little, it was a fascinating mixture between Chinese pride and global expectations. We think the Chinese organisers can actually be congratulated for having managed a pretty difficult task perfectly.

The Olympic Games should not stop any more business than they have already done but in China, at least, a lot of people will change their focus a bit from doing business to the sporting events. And, since it is not unusual to find television sets in Chinese offices, it would not be overly surprising if managers are currently spending more time watching the success of the Chinese athletes rather than fully concentrating on making money. Consequently, we do not expect too much activity from China in the coming weeks, although far more activity is expected when the final curtain is drawn in Beijing.

With all the difficulties the leather producing and manufacturing industries in China are already facing, the news that the tanning associations and leather goods manufacturers have contacted the Beijing government for help does not come as a surprise. We must not forget that the industry’s situation in China has become increasingly difficult for about a year now. Tax incentives have been removed, labour costs have increased and, for many manufacturers, the fading export business is a new sensation. We are no longer the cheapest producers in the world. So, for those who cannot offer other arguments than the price of business on the export markets, it has become increasingly difficult, if not impossible, to find a reasonable profit. And that is something almost every business in the world does, but particularly the Chinese.

Chinese shoemakers remain relatively unscathed

If the general profitability problem was not already enough, the upholstery leather producers and the manufacturers of upholstery have also been badly hit by the global housing crisis, which has significantly reduced demand, and this could never be compensated by domestic business. At this stage, we can leave out the problems that have occurred because of production restrictions connected with the Olympic Games.

While manufacturers normally move quickly and just search for new and cheaper locations to produce, there was no need for such an activity at this time because there was simply no demand in the global market to justify it. This has not hit the shoe manufacturers as badly, and has also not affected China as seriously because demand has remained reasonably steady and the price problem has been handled by shifting some production to other locations in Southeast Asia. 

Since the new options for shoe production could never absorb the volumes that are manufactured in China, the pressure on prices might be stiff but it is definitely not easy for the big retailers and brand names to totally substitute production in China. So new productions may have opened in Vietnam, Cambodia, Indonesia and other places, but a lot of the leather production and part of the manufacturing pipeline can still be found in China. We also expect this will not change dramatically in the near future. Again, this explains again why raw material imports designated for the shoe production sector have not really suffered so far in 2008.

Upholstery leather producers may switch

No matter what is still to come from the general global economy, we still believe that the consumption of shoes on a global scale will remain steady, at least, if not even increase slightly. Only fashion and designers deciding on other materials can influence the demand for leather. With alternative materials often frequently based on oil, it leather is likely to remain competitive for the next several seasons, particularly as the recent decline in raw material prices has made leather for shoe production even more competitive.

In our last issue we discussed the possibility that hides that are traditionally used for the production of upholstery leather could enter the shoe production arena again. We still fancy this opinion when we consider that a number of tanneries in Asia are presently in the process of converting their production from upholstery to shoes. At the same time, the price of hides for shoe production have not really substantially declined, so we can easily see that in order to achieve a profitable expansion in shoe leather production, cheaper raw materials will be needed, and this would again lead to the use of many resources that became freely available as a result of the decline in upholstery leather production. 

As far as market activity was concerned we couldn't find anyone who would tell us that much trading had taken place in the past two weeks. However, having said this, it is not the case that raw material demand has dropped to zero. If we just monitor the only reliable source for short-term sales and shipping activity, the export statistics from USDA, we could argue that numbers are not as impressive as they were in the first three or four months of this year, but we still see 400,000 to 500,000 hides sold and shipped per week and this is not supporting the very slow demand for raw material.

Business continues

Whatever other information we were able to get it was pretty much the same story. Speaking to the weak spots in the trade, which is certainly the upholstery sector and those in Italy or southern Europe in general, the information is rather dramatic. The same definitely applies to the regions in China suffering from government decisions related to the Olympics. However, leaving out the sports, we found out that quite a number of businesses are fighting with the general problems such as sharply increased costs and high uncertainty about the future of retail demand. But so far they are still busy and are selling and producing pretty much the norm.

This just leaves us asking the Oracle how things will develop later this year. And here we are in the position that we do not feel prepared to make any judgement right now. However, it seems to us that things might not, in due course, be as bad as they look like today. We will all still have to pass a pretty difficult time to reach October/November when all production goes back to its higher seasonal activity. We will also know how the credit crunch of the summer played out and, most importantly, we will know whether the general psychology that has been depressing everyone almost since the beginning of the second quarter has changed for the better.

Time to dwell on the positives

For those that don’t want to see things entirely negatively there are good reasons to start preparing for the future. Raw material prices for many items are pretty attractive and there is a good chance that some items become even more attractive over the next few weeks. Cheap raw materials have never been a negative basis for business. Those that have confidence in their business futures may be well advised to example the opportunities available up to the end of the year rather than the risks.

We leave the splits and skin section at this time because we do not see anything of any importance to report. While the splits market is in the doldrums, we can see that in the skin market nothing of particular importance is happening. Also, the Olympics play quite an important role here and fashion comes out on top.

For the coming weeks it might still be best either to enjoy the holidays or to watch the athletes in China competing for glory. As far as business is concerned, there does not seem to be any particular reason to rush and so it might be better to lean back and watch for a few more weeks. However, at the same time, take this relaxing time to think carefully about the business potentials for 2009 and to make appropriate decisions. Continue to enjoy your holidays!

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