Macroeconomics

With all the drama in the financial markets, we can only wonder how many more upsets there will be. Too much has happened to keep track of individual economic events now. Whenever it seems the turmoil is coming to an end a new calamity strikes.

Even Switzerland, known as a safe haven, has been affected by the crisis. UBS has had to fall back on a government rescue plan worth CHF60 billion ($52 billion). In the meantime, one country has almost gone bankrupt (Iceland), innumerable financial institutions have had to be bailed out, various government rescue plans have been hammered through parliament and stock markets have melted down. Furthermore, commodity prices have collapsed, companies are cutting production, consumers are closing their wallets and are trembling with fear over savings and pensions, and the list goes on.

For about a month we have already been in what has been described as the worst economical crisis since the Great Depression. We feel this is extremely exaggerated because, so far, most ordinary people haven’t suffered too much (excluding some homeowners). This may eventually happen, however, and steps must be taken to avoid it if at all possible.

We are in deep trouble but there is still a good chance of getting out of it. The main problem in most countries is the media and the general sentiment. This will cause real trouble if fear grows any more, which could lead to a major decline in investment and spending. Looking at the situation it might already be too late, and the catastrophes within the financial markets in recent weeks may have already caused enough damage to ruin the public’s confidence. Nevertheless, we should not give up yet. A substantial cutback in consumption and production will cause a massive rise in unemployment, which would lead to rapid deflation.

Despite all the bad news and the risks involved we should try to remember the positives. The risk of inflation has quickly faded and commodity, food and energy prices have fallen substantially. The ordinary guy on the street is unlikely to have made huge losses as the majority do not own stocks and shares, but the biggest threat is that of job losses. The most serious problems will occur if consumption and production slow and if investment stops, so it is vital that confidence is restored and consumption gets back on track if jobs are to be saved. This is not an easy job, particularly for big ticket items such as cars, but it should at least work for the basics in the short term, and this would be a good start.

In the meantime, oil has continued to drop in price. It is now trading below $70 per barrel, which is about half what it was some months ago, and the US$ traded firmer against the euro at around the 1.34 mark. Currency changes have been a major factor in terms of general asset meltdown recently. Many currencies lost a lot of their value against the US$ and, consequently, against other currencies. The Indian rupee, Korean won, South African rand and some of the newer European currencies lost quite a bit, which made trading more difficult for many in these countries. 

Market intelligence

The leather pipeline is still very much influenced by the situation in the financial markets. The fundamental problems are private consumption has fallen, or is expected to fall, drastically within the automotive and upholstery sectors. The logical consequences of the crisis are reduced cash flows and limited access to credit. Credit insurance cover is still proving difficult to obtain.

This is more than unfortunate because falling raw material prices and production costs have actually laid a positive basis for leather producers if they could find sufficient demand. The recent price correction for hides (not so much for skins yet) and the drop in energy prices has had such a positive influence on calculations, that a return to profit in leather production has been achieved.

Many will argue that this not true because of old and expensive stock, increased overheads caused by lower production and long-term contracts for chemicals that were renewed when prices were high. This is all true as far as certain individual situations are concerned, but looking at the simple numbers for today, leather production is profitable again and, for the strong companies, this offers a good base for the future, while weaker enterprises may disappear during the washout. This is a natural consequence of the present crisis which began for our industry about a year ago.

Today’s market is presently controlled by fear, which is the worst possible advisor. In a short poll we presented to a number of European tanneries, fears about the future and what the present crisis will mean for individual enterprises was the key question. With nothing in the media apart from the negative impact of the financial turbulence, almost no one has spoken about the opportunities that have arisen, while everyone has covered the risks and the grim outlook. It is interesting to weigh up what the actual numbers are compared with the sentiment. The facts simply confirm what we have already known for some time.

Uncertainty for car upholstery tanners

Upholstery leather producers have reported a decline in orders of between 20% and 50% in the third quarter compared with the same period a year ago; however, there has been a moderate seasonal rebound in recent weeks. The situation has not been good since the second quarter and things are likely to remain pretty difficult for the time being. Car upholstery tanners who, on the whole, continued to produce close to normal levels over the summer have now had to cut production drastically. They are facing complete uncertainty about the automotive industry’s production plans for the next six months.

Car manufacturers’ expectations are running low. European car sales in September fell by an incredible 18% and the US is expecting the lowest number of sales for 15 years. Sales in other markets have not been good recently either and we must expect to see negative growth in terms of global car sales in 2008. Inventories of unsold cars are rising almost everywhere and manufacturers have no choice other than to cut production. However, they do not know how much they should cut it by or for how long. Not only is the financial crisis keeping buyers away from the showrooms, high energy prices earlier this year have made consumers think twice before buying a new vehicle.

So far, most European manufacturers have decided to take a long Christmas break this year if they have not already stopped production. Those areas where the supply chain has not already been hit will definitely jam towards the end of the year and, as already discussed in our last issue, there are not many alternatives for raw materials or for the tanners. Options for flexible labour contracts will end quickly and lay-offs will happen sooner rather than later, both in the automotive industry and among its suppliers. So, automotive tanners are presently more involved in adjusting their overheads and discussing downsizing strategies rather than planning for a better future.

Negotiations break down

For side leather tanners the situation is different. There is a big difference between expectations and the real situation. The mood among shoe tanners is more or less as negative as the mood elsewhere, but most of the tanneries supplying big brands have confirmed that their order books are still pretty decent and that there is little to worry about in the coming weeks. However, this is only half the story. While the order situation remains pretty stable, shoe manufacturers are trying to take advantage of the general problems and falling raw material prices. Most of the people we spoke to were complaining bitterly about strict inspections and a number of clients are trying to blackmail them for a renegotiation of existing contracts or other systems to lower the average price of existing contracts. It is a real shame to see that morals and principles are going down the drain all over these days.

As far as trading and prices are concerned, prices for bovine hides remained under decent pressure. However, the situation is completely different depending on the market. Suppliers that have been aiming sales toward Europe, and especially Italy, are facing the biggest headwinds.

A number of suppliers from the southern hemisphere claim they are still facing big trouble in getting their existing contracts accepted. Many are having trouble obtaining payments for shipments that are either on the way or have already arrived, particularly at the original price levels. So the market prices for these kinds of material are today being made on-the-spot, even for shipments that have already arrived in the ports. With sufficient material now available it is becoming increasingly difficult for shippers to discuss new programmes and shipments for the months to come. Promptly available material is by far sufficient to cover what tanners anticipate they will need for the foreseeable future. So there is still a lot of talk about market prices, and those that were writing reports with price lists are struggling to find realistic levels to publish. Price ranges are pretty wide and it is almost impossible to find anything reliable as far as prices are concerned when you consider that market activity and trading is probably far from any levels that could be called representative.

China seeks better raw materials

The situation in Asia is somewhat different. Demand for leather is still reasonable, particularly in China and especially for shoe leathers. The recent decline in raw material prices and the problem of rising production costs in China have set a certain new trend in this market. Better raw materials are increasingly being sold because Chinese tanners are trying to upgrade their leather production. Higher costs mean higher prices and this can only be met with better raw materials and quality. By consequence, we were able to speak to quite a number of European suppliers who are admitting to the general problems, but still confirm steady demand for their products from China. With the massive rise of the US dollar versus the euro, calculations for shippers from Europe are still reasonable when they are selling into the Orient on a US dollar basis.

What is good for one is bad for the other; European suppliers suffered in the second quarter when the dollar was low and US suppliers are now suffering with the dollar being significantly better. The US market is moderately sliding and we get the impression that big sellers from the US are trying to keep the market at a higher level than it actually should be. This is definitely related to the fact that many of the big shippers are still holding large contracts and higher prices and don't want to endanger them by accepting a falling market. However, if there are no significant changes in the currency market and taking into account the negative outlook for European sales, there is likely to be a fair amount of pressure for quite some time. We shouldn’t be surprised if US prices see a significant drop in the near future and, if this happens, it could trigger a new downward price spiral.

Dealing with tax fraud

Last but not least, the Italian market produced some other interesting news on Friday. Officials have been picking up on tax fraud, which has been going on in Italy for a long time, as we have mentioned before. We must not forget that, with the volume the Italian market still has, the influence on prices has been inflationary. VAT fraud has given participating players a 20% margin. With major official intervention and a number of arrests, it is now fairly certain this kind of fraudulent business activity will stop and this is likely to cause further casualties in the market. However, it is always good when this kind of business activity, which manipulates the markets on top of all the other problems, is stopped. This should help genuine businesses to run properly and successfully again.

The splits market did not see much of a change. Wet blue splits are still struggling from the generally poor condition of the leather business and they are likely to continue to be under massive pressure considering that low quality hides can be bought at extremely attractive levels these days. This should keep split values under very, very tight control. The situation for lime splits is a bit different. Reduced soaks, combined with the seasonal high level of interest, will definitely make lime split sales more attractive for quite some time.

Nappa starts to suffer

The skins market is now also starting to face more headwinds. With wool prices also coming under pressure, the nappa business is not looking as promising as it was some weeks ago. Activity has started to slow down and we should not be surprised if skin prices also retreat at some time or another. Chinese activity has also started a moderate decline and this could, in the end, bring a number of suppliers under increasing pressure. With calfskin prices becoming more attractive, the substitution of high quality calf leather for goat and sheep will also decline.

We cannot be optimistic about the weeks to come. Emotions and psychology will still control the market entirely and it doesn’t seem we will be able to loosen the tight grip of the financial crisis any time soon. Having clients that are not only taking product, but are also in the position to pay for it, will probably be the most important issue.

However, further price pressure on raw materials will improve the situation of tanners in general. The same number of hides can be bought for the same amount of money, and the calculations and margins of successfully running businesses will improve further. We must never forget that business activity never falls to zero, and it happens even less in terms of the basics which, to a certain extent, include shoes. One thing that is important to remember is that the more difficult life becomes, the more important the small pleasures in life become, and one of these pleasures is fashion.