Macroeconomics

Most of the news about the global economy published in the media continues to be pretty negative. Governments and financial institutions are still fighting the global financial crisis and have still not managed to find the tools needed to successfully combat it. The problems are too deep-rooted, while the tools that have been applied so far are not good enough to have any positive results.

The key problem continues to be financial stability. The discussions about ‘bad banks’ are ongoing in many countries. This could be an appropriate decision in terms of centralising all the private banks’ bad loans in order to lift the burden from financial institutions and enable them to return to their core business of financing the economy. However, the decision is not that simple, because setting up ‘bad banks’ would basically mean nationalising all the losses while all the profits had been privatised in the past. This is not likely to go down well with the average taxpayer.

Nevertheless, the longer one thinks about the present situation, the more obvious it becomes that there will be no solution to the problem until the mystery of all the potential losses—which are still hanging above the financial system—is clarified and the world gets a clear picture of just how much trouble the banks and speculators have actually caused. Uncertainty is now the biggest problem and it is weighing on demand, on corporate decisions and on governments that are unable to work out how great the financial burden they will have to carry on their shoulders for the years to come really is.

Under these circumstances, it is very difficult to understand why the leading nations are taking such a long time to discuss global decisions. It seems the best solution would be for all banks to be forced to open their books to a central intelligence unit which would try to evaluate how many counter risks actually exist and how many could be balanced. We must not forget that the vast majority of today’s problems are related to derivates and there is a fair chance of bursting the bubble if we can find out what kind of risks have been taken on. The system that blew up the bubble could be deflated in the same way it has been pumped up. However, in order to do this, all the cards would need to be laid on the table and the brains behind the constructions would be responsible for dismantling the constructions.

Breaking down the actual losses that have occurred, particularly in the real estate markets, they are far lower than the amounts people are talking about. The real problem is that we are losing too much time as the clock relating to the products and derivatives continues to tick. They are basically behaving like a time bomb through which an explosion could come at any time. Unless there is a solution to this problem, we will not regain any security or confidence and, without this, we will be unable to prevent the global economy from imploding.

In the meantime, many GNPs shrank (e.g. the USA’s by 3.8%) during the last quarter, while companies were reporting huge losses and unemployment has been rising all over the world. The automotive industry is still the hardest hit and is spreading its problems to suppliers and to associated industries. Commodity prices are slowly stabilising and the US$ continues to trade in the ranges established at the start of 2009.

Market intelligence

The leather pipeline has not seen much good news in the past two weeks either. Because of the holidays in Asia, activity was significantly reduced. Those hoping for an increase in activity during the last week have largely been disappointed. The tanners that returned this week did not really come back in the mood for buying and this does not come as a major surprise, as it is unlikely that anyone received large finished leather orders.

Despite the situation in the raw material markets, the most interesting focus now is the consumption of finished leather products. Looking at the dominating sectors such as automotive, upholstery and footwear, the situation for leathergoods has more or less remained the same. Everyone is following the dramatic decline in automotive production and there is really very little hope left for the production year 2009 in the automotive industry. As a result, leather supply is also declining sharply and what happened in the last quarter of 2008 is continuing into 2009. Even the manufacturers who were still reporting reasonably steady sales are now reporting declines and cuts in production volume.

With the production cycle as it is in this industry, and with stocks sitting almost everywhere in the world, it is pretty unlikely that even higher sales would actually increase production in the first half of 2009. The only thing that could help would be a higher volume of leather in smaller cars that are still selling in many countries. However, knowing the decision processes and the time it takes for new components to be approved for production, it is more than unlikely that this will actually materialise in the near future. Taking everything into consideration, production cuts that are currently ranging from anywhere between 50% and 70% are likely to remain the same for some time.

Upholstery drama continues

There are also very few positive indications from the upholstery sector. The only question mark that still remains continues to be domestic consumption in China. No other markets have yet delivered any indication that the present crisis will lead consumers to buy more for their homes as they save on holidays and cars. Within the main markets for consumption in Europe and the US, consumers are not currently willing to spend on ‘big ticket’ items. We are also seeing a lot of real estate projects in Russia and the Middle East being put on hold. Many of these were set to become luxury apartments or office space. We have seen a lot of free spending in these parts of the world in recent years so it was hoped there would be some good news for leather in terms of interior design. Also, these projects, which many people already had on their agenda, have not been put on hold in the production plans of tanneries, particularly in the medium and higher end, and mainly in Europe.

As a result, the drama in the European upholstery tanning industry continues. More and more worrying news, particularly from Italy, is being reported. If the general decline in leather orders is not enough to weigh on the industry in Northern Italy, we are also hearing that the Italian justice system is now aggressively prosecuting VAT fraud, which we have been complaining about since last year. A number of tanneries are also trying to walk away from their financial obligations by seeking legal protection and by trying to negotiate with their creditors for minimal payments on the original amounts. This would not be particularly worrying or attract the attention of the Italian justice system if, in a number of cases, the money was being taken out of the company to refinance a new operation after a successful negotiation. This is nothing new in the trade, especially in Italy, but it has become increasingly common again in the last year or so.

Italian newspapers have reported that invoices worth €300 million are under investigation and prosecutors believe that at least €60 million of VAT has been avoided through false companies that have been founded solely for this purpose. This explains some of the success seen in the Caribbean industry in recent years and why capacity has never been reduced, and why we have not seen more bankruptcies from this area. A number of companies have obviously been running with an advantage of more than 10% on raw material purchases for quite a while. Not only is this illegal, but it must also have been a tremendous burden for those that have been following the rules.

These investigations are obviously paralysing the market in Italy on top of generally difficult trading conditions. Capacity adjustments are inevitable and are killing many contract operations that accounted for a large portion of the production capacity in that region. We were finally able to find out where all these overcapacities, which many of us have already been feeling for quite a long time and that had supported the raw material markets in a rather artificial way, came from.

More dishonoured contracts

Leather orders haven't really picked up for upholstery tanners and further trouble is being reported on raw material contracts. Everyone must still remember the dramatic and large numbers of renegotiations for existing contracts between last September and November. Most people, particularly suppliers, thought the trouble would be over, but we are now hearing that, yet again, huge quantities that have mainly been shipped from overseas origins have been refused by buyers and, without a further substantial price reduction, they were not willing to honour their contracts.

These problems, which are not limited to Italy, have actually triggered a new discussion about business morals. It is very questionable whether the attitude that ‘if I have to lose money or you have to lose money, it is better that you lose the money’ can actually be accepted. A number of people have started forums and discussions as to whether there is a chance of returning to normal commercial relations. First of all, it does not help those that have already gone through the drama and, second, it is a question of what kind of legal tools one actually has to solve the immediate commercial troubles when the container is stuck in the port, when the demurrage charges are rising and when there is no action from the buyer. We cannot see any serious legal way of handling the dispute in any reasonable period of time in any of the problematic destinations.

It seems that the only realistic way of reducing the problem and of threatening clients that are planning to work in this way would be to publish the case of those that think they can walk away from their commercial responsibilities. Of course, this not only applies to buyers who are not accepting the prices, but also to sellers who, in the current market environment, are trying to take advantage in the same way. However, since the trade no longer really disposes of an accepted institution that could handle such issues from a neutral position, it will not be easy to set anything up soon. It would definitely only work if it is accepted by almost everyone involved in the global trade. In any case, the trade would be well advised to try to find some a solution to this problem so that the ‘bad boys’ are eliminated as quickly as possible. Blackmail should not be accepted as a trade practice.

Shaking off the pessimism

The remaining sector to discuss is shoes and leathergoods. Here the market environment is definitely much better and few deny that the business outlook for 2009 is fairly similar to previous years. We may not see the massive growth projected for many companies, but there is also no reason to believe that sales volumes and consumption will be significantly lower than in previous years.

What we cannot avoid is the bad mood that is spread around the globe. As a result, retailers and brands are feeling completely uncertain about their positions and are unsure how their individual businesses will develop over the next few seasons. This is the exact opposite of what we saw about a year ago when everyone was optimistic and believed growth would occur, which was as wrong as everyone now believing that they are going to be hit hard and that there will be a massive sales decline. The result is straightforward and we have already known this for a while. Orders are postponed, decisions are not made and manufacturers sit and wait, which pushes semi-finished and raw materials back into the pipeline.

The fair in India was reasonably well attended and a few new faces, particularly in terms of suppliers, were seen. Speaking to shoe buyers and tanners, no one was particularly negative about their business outlooks. Most people agreed with the situation we described above and everyone is expecting business to be pretty steady in 2009. However, when it comes to orders, it was pretty much the same, and orders that should have already been placed for the winter season are now expected to be placed later in February, or even in March.

The situation for leathergoods is a bit mixed. The mood here, in general, is quite positive, but several top names in the luxury sector have now finally announced that they will cut their forecasts for 2009 quite significantly.

We may see a shift in consumption as far as price levels are concerned, but the view that consumers are looking to cheer themselves up by buying a few small ticket items seems to contain some truth. People might not be buying $2,000 bags, but with $500 they can buy beautiful, high-quality products. This does not really change much for the industry, because the leather for the total units sold has to be made and this, at the moment, is certainly the most important issue.

Unexplained increase in demand

There have been a lot of rumours surrounding the splits market and demand has significantly improved, although we fail to see any reason for this. Although some people were saying this could mean a return to suede ladies’ shoe production, we haven't seen evidence of this so far. With the present prices for hides, they could not see any logic in increased demand for splits if it is not triggered by fashion.

It is certainly true that splits production has been substantially reduced. Considering that world leather production in the last three months has fallen by approximately 30%, with lime split production suffering the most, one could relate the improved sentiment to the reduced supply. However, we remain rather sceptical, because there were huge stocks of splits available and we cannot see how they could have already been absorbed by the market.

In the gelatine and collagen market, where there have been shortages at least in Europe in recent months, we expect more supply to become available from low-quality hides, which before being rendered could actually be converted at a lower cost for this purpose. Tests are definitely being run and, if it's economically viable, the supply will definitely increase later this year.

The skins market is still pretty much in the same doldrums as the hide market. There are still some bright spots for goats and hair sheep types which are now being used as a substitute for calf leathers, particularly for ladies’ shoes and, in some cases, for bag leathers. The situation is pretty dramatic for standard lambs and sheep, and prices in many countries have reached levels where the cost of processing is higher than the actual return. The production of skins is definitely outpacing demand. With the lamb and sheep population gradually declining in many countries, the only stimulation we can expect in the short term would come from the wool market, if the textile industry is not experiencing similar problems to those seen in the leather industry.

Mixed forecast

Our outlook for the next two week remains cautiously pessimistic. It appears that it will be a few more weeks before the shoe industry has everything clear for its productions. We remain rather optimistic for this business and expect hides that are mainly used for this kind of production to be reasonably safe as far as price developments are concerned.

On the contrary, we remain pretty pessimistic about the situation in the upholstery industry. Unless domestic demand in China compensates for the massive declines in consumption from other parts of the world, we cannot see that the present raw material production can be absorbed. The kill will gradually decline and more and more hides will not enter the leather pipeline for simple cost and price reasons. This will certainly deflate pressure from the supply side of the market. However, there are still significant stocks around the globe at all levels.

While the normal production season for upholstery leathers will only continue for another few months, only a round of massive speculative buying could absorb the stocks that are around. With the present state of the financial markets, not many will buy the hides and store them in whatever state for better times to come. However, on a timeframe of longer than six months, hides may not be a bad investment. There is not only good reason to believe that one day it will be rewarded by the leather business, but it might also be that the investments in raw materials or physical goods could, in part, also be a wise decision in terms of protecting against further potential risks in the financial markets.

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