Macroeconomics

The global financial turmoil has not calmed down and the drama continues. The ambitious US rescue programme was only passed and implemented last Friday and, in this case, one has to accept the concerns of those responsible in order to approve it.

Although the public believes that the $700 billion rescue package will resolve most of the financial turmoil, we remain pretty sceptical, as do the US senators. Despite the fact that profits have been privatised and losses are now nationalised and laid on the taxpayer, there is absolutely no guarantee that the programme will really end economic woes.

The situation in Europe is still a bit unclear. While some are saying that a problem of the same magnitude cannot happen in Europe and that banks are much safer than in the US, others, such as Mr Sarkozy, are already working on a similar bailout programme. The individual rescue plans being set up for banks in Germany, Holland, Belgium and the UK, among others, lead us to believe that the situation cannot be massively different from that in the US.

In addition to the general credit crunch, which will eventually spill over into general economies and make it more difficult for companies to lend money, the consumer business has also been hit hard and ‘big ticket’ items are suffering the most with sales contracting sharply. This can be seen most clearly in the automotive sector, where sales in the US and in Europe are falling rapidly. Not only are consumers reluctant to purchase, automotive companies are finding it difficult to obtain credit.

As if things were not bad enough already, even extremely wealthy consumers and enterprises are trembling these days at the thought that their bank or financial institution might not be secure enough to keep their deposits safe. Because of this, stock markets and commodities have continued their descent. This is bad news for the wealthy, but pretty good in terms of correcting exaggerations in the commodity markets and helping enterprises make better production calculations. It is also keeping another global problem under control: inflation.

Oil prices came back and finished the period at around the $90 mark per barrel. The global economy is likely to experience further declines before the OPEC countries intervene to try and protect their returns. The US$ has again been on a rollercoaster ride and daily movements of more than three cents have become fairly standard. However, towards the end of the last two weeks, the greenback strengthened significantly and ended the period at around 1.37 against the euro.

Everyone is now waiting to see whether the financial crises will start to impact on emerging global powerhouses such as China and Russia, where so far only the Moscow stock market has been affected. It would come as no surprise if these parts of the world are eventually hit.

Market Intelligence

Many say, and we can agree in part, that the leather pipeline has been a very accurate indicator of the general economical turmoil. The pipeline slowed long before all the drama began, with the upholstery sector experiencing declines as early as May. The fall in demand, tightening of credit controls and inflated product and energy costs had already made a deep impact on the industry before the general problems surfaced. The only segment that was hardly hit was the shoe business, which is now showing a much better performance and, because it meets a basic need, it continues to do well despite a slump in general consumption levels. 

Nonetheless, the problems are deep and intense, and the most serious threat once again comes from the financial side of the business. Many are reporting further slowdowns when it comes to payments and, as far as Europe is concerned, there are more reports of declining credit guarantees from finance companies. This is not only a consequence of the current issues in the financial markets; it has also been affected by incoming balance sheets from 2007, which were already starting to display some of the problems that have worsened this year. Falling margins, rising stocks and debt, and the deteriorating outlook by mid 2008 has made lenders much more cautious, and reduced credit limits are adding to existing problems.

As far as the market is concerned general pressure continues. Only the US steers market is still (officially) holding its levels, while most other markets are more or less losing value. Currencies outside the US$ area are still having a significant impact and, with fluctuations of 4% or more in a week, a lot can be made or lost when the time to hedge export sales comes. Consequently, hides that can be used as an alternative to US steers are much more stable than their counterparts used for furniture upholstery. 

Another significant factor at the moment is the individual positions of different suppliers. Those selling to a strong and trustworthy customer base are still able to move most or all of their regular production, while others are left with hardly any business at all because their selling policy in the past has been to take the best market bid rather than developing longer-term business relationships. In the end everything balances itself out.

Brazil and Italy battle it out

Looking at the various markets, two are particularly eye-catching at the moment. Brazilian hides, which traditionally play an important role in the field of economical furniture production, have had a pretty bad time with hundreds of containers getting stuck in Italian ports. For weeks, suppliers have been travelling to convince buyers to respect their contracts, to renegotiate them or in the worst case to resell them. This has led to price drops of up to 40% compared with the original selling price, for example in May, but this is the price many suppliers had to take in order to avoid further charges and to generate the necessary cash.

Why does this market reach such a quick and extensive price correction? It is the age old story of trading relations, particularly between the two markets in Italy and Brazil. Renegotiating contracts is not unusual when the market is in decline and it also happens frequently when the Brazilian market is on the rise so that suppliers make shipments for which price adjustments are on the upside. At these times they claim raw material prices at the abattoirs are rising rapidly, and this prevents them from purchasing hides at a reasonable price. Now buyers are getting their own back by blaming the general market situation for the corrections. Again, everything balances out in the end.

However, the problem is that this is also affecting other markets and triggering a downward spiral that is accelerating too quickly and falling too deeply. The main reason for this is that clients are trying to get out of their contracts because cash restrictions are preventing them from paying. Meanwhile tanners, who are in a position to honour their contracts, are now claiming that some of their competitors cannot take advantage of having access to the resold material. This forces their regular suppliers to lower prices, creating a price avalanche for the whole market in a very short space of time.

With the large wet blue stocks still sitting in Brazilian tanneries, the problem for these economical hides is likely to persist for a while. It is dragging other markets down quickly: suppliers in South Africa, Central America and Australia are also feeling the pain because they have little chance of escaping the problems. European suppliers of dairy cows will also be far from pleased with the present market conditions, but may be at an advantage if raw hides now offer greater market potentials than their wet blue counterparts from other origins.

Changes for heavy bull hides

The heavy bull hide market in Europe has also been rather interesting in recent weeks. Traditionally, raw material has been dominated for many years by automotive tanners and was fetching a decent premium. Basically, demand was always outstripping supply. This became even worse in the 1990s when many tanners decided that producing from fresh, chilled hides would suit them even better. Since not all of Europe possesses chilling facilities and a lot of hides still had to be salted, demand for this type of material was never really satisfied.

As a result, fresh hides fetched an additional premium to market levels for quite some time. The production gap from the automotive tanners still had to be filled with salted material and, with good demand from shoe tanners as well as vegetable tanners, good quality heavy hides weighing more than 40 kg were thriving on their own for a long time.

However, this has changed quite a bit. With declining demand from the automotive tanners, combined with reduced production for vegetable tanners, the entire size of the European market for extra heavy hides has been continuously shrinking for a while. This slowdown stepped up a notch after the summer break when automotive manufacturers made it clear that they would cut production and automotive tanners’ order books were very quickly cut short. Traditionally in this pipeline, just-in-time deliveries dominate and the security stocks that are held along the pipeline are reduced very quickly. This was reflected in the extensive production cuts made by automotive tanners across Europe, which started in mid September.

Price divide widens

This has pretty much jammed this pipeline, albeit with slightly different consequences for the various suppliers. Premium suppliers and reliable trade connections for fresh material have been relatively unharmed because they are still able to supply the remaining basic production. However, others that had been offering a more supplementary supply are facing big problems and many hides have been piling up since the beginning of the summer. There was some relief from overseas buyers in August and September as buyers were attracted by the opportunity of buying hides they cannot normally access. Despite this, demand has not been enough to clear all of the production in order to balance out the increased slaughter, which traditionally starts at the end of September in Europe.

The result is that there is now a phenomenally wide spread in terms of price, and many in the trade are offering levels to suit their own circumstances. This means that tanners are using the lowest level that gossip can offer and suppliers are stubbornly defending the highest price levels. One thing is certain: an unprecedented price spread between good quality fresh material and regular salted hides from various origins in Europe has been established. Those who haven’t pursued alternative markets are now suffering from an almost nonexistent sales market, and those that are desperately in need of sales are starting to dump in order to turn stock into cash. However, this market segment may recover sooner rather than later as the real value of these hides is certainly higher than their present market value.

Summarising the past two weeks, we saw pretty much the same as we did before and after the summer holidays. Everything related to the upholstery sector continues to be in deep trouble while the supply chain for shoes has lost some of its dynamic, but has still had a steady performance so far. Budgets were pretty ambitious after an excellent 2007 and, if some growth remains, we should be pretty satisfied.

Good news for splits and skins

Despite all the problems, prices for gelatine and collagen splits are rising, particularly in Europe, and have sharply gained from the lows we saw in April and May. In some cases prices have almost doubled even though we have to accept that levels have been very, very low. Since there is little hope that the soaking volume will rise in the next few weeks, the fundamental shortage of lime splits should persist. This will continue to support prices and, until generally high production in Europe increases again, prices should be pretty well cushioned. We will not be surprised if prices continue to rise.

The sheep skin market is also refusing to show the same fatigue as the hide market. Despite the general problems and consumer markets, Chinese buyers are still monitoring the market and, with the season of their preferred skins starting in Europe now, they have been quite actively investigating their supply potentials with regular suppliers. With the strong US$ exchange rate, European skins are still pretty attractive as long as they are big enough and carry decent amounts of wool.

The Turkish and Polish markets remain in the doldrums and are suffering Russia’s protectionism; most cross border trade is still very restricted. A reasonable amount of Chinese interest for goat skins has been noted and suppliers are reasonably optimistic about sales in the coming months. This should not be misinterpreted—we are not expecting any price rises—but gaining a fair expectation for market production at today's levels is more than many could have expected.

More doom and gloom

It is still very difficult to paint an optimistic scenario for the weeks to come. The financial crises will continue to dominate the headlines and there is absolutely no reason to believe that the bad news will fade quickly. We will be happy providing we do not end up in further trouble in the near future. Business decisions will continue to be driven by fear and caution and, in addition to the simple order book, the cash position will weigh heavily on the market. We just hope that regular sales and shipments to China will not be negatively influenced by bad news. Knowing how many Chinese tanners are also having problems with their banks it would be surprising if nothing negative comes from this part of the world.

The situation in Italy remains very difficult and we must wait and see how much production cuts in the automotive industry will affect automotive leather producers. Fortunately, the latter are pretty strong financially and the majority may have a fair chance of getting over the present negative cycle. We remain fairly optimistic for the shoe business. Not everything will go well and the sector will have its difficulties, but with global demand proving reasonably steady, the sector will enjoy most of the benefits of falling raw material prices and production costs. Shoe prices are pretty steady and falling hide and energy prices are already having a very positive effect on calculations.

Leather as a material is becoming more competitive every day and this will eventually help the market in general. However, problems, fears and risk are also much higher at present, so we are not expecting any real market improvement in the weeks to come.

We wish all our readers the best of luck in their financial decisions and that hope that banks will be strong in the coming weeks.

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