Macroeconomics

The world is starting to wind down as the year, which has brought such a dramatic mixture of situations and emotions, draws to a close. It will definitely leave a deep footprint in the history books. Other years have left big impressions, the last one being the tragic events of 9/11 in 2001, but since then there have been few periods that have been filled with such extremes or have affected almost everyone across the globe.

Apart from the presidential elections in the USA and growing instability in the Middle East, we have also had the conflict between Russia and Georgia, the recent riots in Thailand, terrorist attacks in Mumbai and ongoing suffering in Africa. Modern piracy along the coast of Somalia, where large ships are being hijacked by well-equipped bandits is also challenging the global civil community. We see a lot of this as a result of the rising imbalance between the rich and poor around the world and some people are using religion as a cover for physical attacks and riots that are mainly in their own interests.

The western world makes it easy for these people by not living or protecting its own values, ethical standards and morals. Many individuals made huge profits through exploitation before the collapse of the financial world, but are now refusing to take responsibility. And the system is not strong enough to provide compensation; the led cannot be blamed if leaders fail, and we will all end up paying in the end. We can only hope that our societies are now strong enough to correct failures rather than paving the way for new ones.

The year has presented two faces. One with a smiling façade of growth and rising consumption accompanied by excesses in the commodity markets, and the other with the correction of the same sending the financial markets into chaos, triggering the credit crunch and seeing the commodity markets go into freefall after the previous exuberance.

We know today that most of the present problems are related to the greed of making money through investment rather than by adding value. This has mainly been powered by cheap money pumped into the markets for years, particularly by the Fed in the US. This is a problem we are still seeing with all the packages and rescue programmes being implemented by governments in the attempt to create or save jobs and to boost consumption.

In our opinion, the world would be well advised not to make the same mistakes ever again. Pumping endless money into saturated markets, making people shop for goods they don’t actually need, and creating asset bubbles that eventually burst because they have no real counter value cannot be the right way to create a world of stability and wealth. We need new definitions to describe what quality of life is and how personal wealth is actually measured. The driving force must be the fundamental need for jobs everywhere so that everyone has the chance to provide for their own needs by working for it. This should come through necessary consumption rather than through people’s overspending. The value of goods and services must be watched carefully and those still trying to make money by inflating assets to questionable values must be controlled and sanctioned by the system.

The biggest problem is that investments have become almost completely disconnected from the question of what kind of added value they generate. Banks were busy investing for the sake of investing rather than lending for the sake of starting businesses and/or growing them. There is no need to speak about the investing strategies of hedge funds and private equity companies. Investors and banks are too distanced from their original business concepts and markets as well as from their customers. They have finally lost their fundamental economic function in the money cycle. This is bad and must be changed. They are already starting to fail again by tightening credit supplies despite the fact that the bail-out was specifically introduced to prevent this.

The US$ has fallen from the 1.25-1.30 range to almost 1.34 in the last two weeks. The yen is, at present, considered a safe haven and is trading at very firm levels. Interest rates have been cut again and oil prices are bouncing at around $40 per barrel. Product prices for petrol and heating oil continue to fall subject to tax influences and are helping families budget.

Market intelligence

The last three months have been a bloodbath for everyone and 2008 will probably end with a very negative feeling. So far, no one has taken advantage of the situation and it is difficult to see how anyone could be a winner from what has happened. Maybe at a later stage the strong players will consider the losses as a trigger for a major shake-up in the market and that this might have laid the base for a better future, but it will take a long time for this to really be appreciated.

Even if the markets settle now the victims have not all been counted yet. So far, we haven’t seen too many major consequences and the 2008 accounts are still balancing. Depending on the results and on the reactions from banks, company owners and managers in 2009, a line can finally be drawn and the consequences can be analysed. Realistically, we will still have to expect a lot of restructuring, including closures, mergers and alterations to existing structures. We still expect a lot of this, so even if the markets calm down it will not mean that times are going to be easier or that the bad news will fade.

At the end of the week, we could already see some problems with one of the top names in the Swedish tanning industry announcing that they will have to stop operations because of the drastic situation their main customers in the car industry are facing. Although the company will attempt to continue operations after a major restructuring, it will not be the same as before. Adapting the size and production capacity according to the market realities is essential and this means that production and labour force will decline to levels that are hopefully still workable.

Automotive problems continue

As the automotive industry is probably the hardest hit at present, questions are being raised about other players in the industry. Most of the larger, well-established companies are pretty sound financially after decades of good, profitable times, but failures in the industry and financial losses for their suppliers could mean big trouble even for past winners. Large production cuts, stock write-downs and restructuring costs could be a tremendous challenge in 2009 even for the largest and strongest.

The biggest problem is definitely the uncertain outlook in the car industry. The future of the big three in the US is still unclear and even if the US government puts a bailout programme in place it will not mean a return to business as usual. There is no question that production numbers will fall sharply and mergers seem inevitable. Even then no one knows what the consequences will be and whether the companies will be strong enough to develop new models quickly enough to allow them to survive in the market. At the same time, all competitors are facing similar problems and they will not wait until the US companies are fit for the market again before making decisions.

This does not mean that manufacturers outside the US will prosper. Many other brands have been through pretty rough times and even in Germany it is not certain that all of the premium car manufacturers will be able to handle the situation successfully. The price of mobility seems to be being redefined by the consumer these days and even the sharply falling petrol prices which had been one of the triggers of the problem have not stimulated demand in recent months. There is no question that individual mobility will still be one of the consumer’s main desires, but the questions are just how much the consumer is willing to spend and what are his or her actual needs? Spending is not only a question of the price of a car, but also how often it needs to be replaced.

Leasing and financing has boosted production and sales. For as long as people were willing to exchange their vehicles every two to four years and the market was able to absorb all the second-hand cars, everything was fine, and manufacturers were able to increase production year by year. The sharply rising demand for cars in the emerging markets added to the endless optimism and none of the manufacturers considered that this would come to an end. With the global just-in-time production driven to perfection, the supply chain has become like a super tanker on the ocean. Stopping it quickly in an orderly way is an impossible task. So what has happened is rather like a mass collision on a foggy motorway. At present, no one knows if the last one has already been found or whether the accident has been thoroughly secured to prevent further crashes.

The biggest problem, however, is that no one knows how many victims there are yet or how long it will take to clean up the scene and get the traffic moving again. At the moment it seems investigations will take quite a bit of time and it might be a while before the road block is cleared.

The situation in the upholstery market is a bit different. Here we are confronted with declining demand because of the crisis in many property markets, as well as a general reluctance to spend and terrible quality policies. Leather furniture has been destroyed as a product by a never-ending downward spiral of quality and price. Only the highest end has been able to escape and even the luxury market is now unable to maintain reasonable sales levels. With all the capacity built in recent years it seems some restructuring is required.

Some hope remains

We remain much more positive about the shoe and accessories markets where the fundamentals are completely different. We have already gone through these arguments a number of times but we think they are important enough to be repeated in order to prevent people thinking no products are going to be bought any more and that reductions are the same across the board.

We do not share the general opinion that consumers will cut back on all expenses at the same time and to the same extent. We may have hiccups but in the long term the number of consumers remains the same. Furthermore, demand is driven not only by the need to purchase footwear, but also by the wish to do so for fashion reasons. So it will all hinge on whether shoe designers can create fashion and designs that appeal to consumers in these difficult times. After the sharp reductions in raw material prices, calculations can no longer be excuses for poor quality and style. Perhaps some retailers and brands will have to reconsider their marketing and distribution costs as the simple price for a pair of shoes at the factory door cannot be the obstacle anymore. At this stage it is also worth mentioning that transportation costs are well down with freight charges falling back to levels seen two years ago.

We are certainly still experiencing hard times and there is very little indication that this period will be over any time soon. However, the leather pipeline has always been, and is still today, a frontrunner in cycles and market developments. Market reactions have already happened and raw material prices have fallen to historical lows. When the pipeline and the industry have successfully digested the pain of declining orders and prices the base is laid for a better future. Price is no longer an obstacle and further price reductions will not stimulate demand.

In the past two weeks we have seen a bit of confidence returning and a lot of our sources reported increasing demand for raw material and finally large sales at the end of the period. This has lifted a bit of the pressure off the market, but it would need to be repeated in order to make sure that more of the raw material stocks are starting to move. What nobody knows yet is whether volume purchases are happening solely to secure cheap raw material or whether they are actually covered by leather orders. With the holiday season in front of us it may be a while until we actually find out.

Outlook for splits and skins remains bleak

The splits market experienced a few flurries of interest. This is mainly fashion-related and we do not think it is, as yet, a change for the better. It must be an exiting time for selected producers of suede who are able to maintain their price levels for the sake of quality as they are able to buy full hides at a price that allows them to use the split and keep the grain. This is what we are hearing many people are starting to do.

However, total consumption is probably not enough to support the splits market as a whole. In Europe, the sharp fall in hide production and, consequently, the offer of lime splits has created a pretty firm market for splits used in the gelatine industry. Taking the cheapest European raw material into calculation and using the best prices for collagen splits obtainable in the market, the investment of tanners into the product they are actually looking for—the grain—is absolutely minimal. The pessimist will argue again and say that this kind of mathematical equation will not generate the necessary positive cash flow to run a tannery. They are right, but it is another proof that raw material costs are not hindering leather sales and that, with good quality products, enough market should be traceable.

In the skins market, sheep and lamb skins continue to suffer from the weak performance in the retail market. Where it applies, declines in wool revenues are also having a negative impact. Chinese sources are reporting that one of the key centres of fellmongering in the Hebei province remains almost idle and has never really recovered from the shutdown during the Olympics. Consequently, prices for sheep and lamp skins are also under severe pressure globally. The situation for goats is a bit better. Demand for suede and fashion influences are still supporting this product and, as prices have never been particularly high, the pressure on goats remains limited.

What is to come?

It might already be time to look ahead into 2009. Despite our continuous attempts not to be entirely downbeat about the leather pipeline, we have to admit that the coming months will remain pretty tricky. The fact is that the drama of the last quarter 2008 has led to massive congestion in the supply chain. In addition, most companies are now downsizing their budgets and sales plans for 2009 are too pessimistic by far. Only speculative positions are levelling the imbalance between the physical supply of raw material and projected demand.

In addition, the necessary restructuring of leather businesses will create a number of victims in the near future. The logic is very simple. If everyone wants to survive, the demand for raw material cannot be as bad as the market is reflecting it at the moment. If it is, a number of productions will close down in the near future and the existing production capacity will need to be refilled. Then we would have to expect a tremendous rebound in raw material demand. This seems, at least at the moment, rather unlikely.

A more plausible outcome would be an adjustment of production capacity to the real market levels which we do not consider to be as bad as current forecasts, but are still well below the levels of 2007 and 2008. This is why existing production capacities are being shut down. Normally everyone would see this as an argument for an ongoing descent in raw material prices; however, we think that the worst is behind us. The sharp decline was the result of a classic avalanche of expectation and the dramatic reactions of retail markets, as we have described before.

So everyone has been busy getting rid of stocks in order to increase cash flow and to minimise risks. This had nothing to do with any rational decisions. However, where the same budget can now buy double or triple the number of hides, the risk is minimised and will be spread more evenly throughout the supply chain. Everyone is now willing to take more risks than before, according to cash flow of course. We recommend once again that people value stocks less by the amount and more by the number of pieces. Those that believe their business will not end up as one of the victims will lay a healthy base for the future in the present market cycle.

We hope all our readers have been able to handle the market horrors of 2008, that they are able to make plans for 2009, and that they don’t forget that every crisis is the start of a resurgence.

We wish you a very happy Christmas and a prosperous and healthy New Year.

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