Macroeconomics

During the period under review, the macroeconomic factors driving the world economy were very much to the fore, with the Iraq war and Sars outbreak centred in the Far East dominating the headlines.

Many people have made their predictions, but it seems at this stage almost impossible to know how long it will take before the Sars epidemic peaks and for Hong Kong and the other parts of Asia to get back to normal.  If the number of cases continues to rise at the present rate, then severe economic consequences can be expected.  In fact, consumer activity in Asia could be measurably reduced for some time.  The leather supply pipeline could also be disrupted by postponed trips for purchasing and inspections. However, remembering BSE, Foot and Mouth etc., it should be borne in mind that incidences such as these are nearly always temporary and mainly psychological in their causes.

In the short term, it would be reasonable to assume that non-Asian tanners and manufacturers will benefit from the situation as buyers and inspectors decide to give the Far East a wide berth.  Aside from Sars, a looming problem for many Asian economies is high energy costs. If the war does not come to a quick end and oil price do not fall quickly, consumer spending could be hit.   Higher energy costs could also prove a major problem for producers, many of whom have long term price commitments.  In fact, we could see a reversal of the current deflationary situation into one of inflation.

As ever these days, the general economic indicators were not particularly good as stock markets continued their ups and downs in sympathy with the daily war reports. Currency levels also remained steady with only a few major currencies showing any sign of wanting to break out of their current, narrow trading bands.

Consumer confidence in the USA fell again as the main index dropped 2.3 points to 62.8.  The manufacturing index for March meanwhile fell 4 points to 46.2, adding to the already gloomy outlook for industrial production in the country.

In the Euro Zone meanwhile, German business confidence declined in March by 1% while unemployment rose by 0.1 % to 8.7 % in February. Only the European car manufacturers were able to defend their export positions. Despite the war they were able to maintain production and sales at almost steady levels, the figures being given a lift by a surge in BMW sales.  As ever, uncertainty surrounding the future remained the main enemy of consumption.

Market  Intelligence

The previous weeks’ activity was again almost completely determined by economic uncertainty and the factors mentioned above.  Prices continued to trade within a very narrow range and any price movement that was seen tended to be downward.

At the current time, we can see two trends dominating the market. One is the psychological fall out from the war and Sars and the continuing gloomy outlook for the world economy.   The other is  the massive downward pressure on finished product price driven by high unemployment in Europe, a lack of consumer confidence in the USA, the endless economic problems in Japan and now the rising risk posed by Sars to the South East Asian economies.

In addition there is the growing perception that the availability of ‘easy money’ is in decline. The so-called New Economy, investments banking, business consulting etc. – in other words all of the things that were ‘hip’ in the business world in the late 1990s and which supposedly added value to products – all of these are now on the wane and being replaced by a new discount mentality – a sure sign that money is in short supply and that the outlook becoming more uncertain.

In short, saving money and spending less is now back in vogue – the obvious beneficiaries being the discount and larger retail chains that offer the latest fashions at discount prices.

This is squeezing more and more of the traditional and specialised retail shops out of the city centres or even out of business altogether. Volume and price have taken over at the expense of medium priced, good quality articles.  Of course, this trend has been at work in the garment market for some years and has latterly gained favour in the shoe and furniture markets.   Blinded by the savings, many of the bargain shoppers appear oblivious to the consequences, however.  Choice and quality will inevitably suffer as will the competence of sales staff, being preserved only in high end shops.

Evidence of this shift downmarket can be seen in the raw materials market and supply pipeline. The consolidation process which we have referred to in previous editions of Market Intelligence is gathering pace. But one cannot help but wonder where all the hides and leathers are disappearing to, if business is so bad as many claim.

Well, they don’t disappear.  They are simply being absorbed by the multinational players that are driving the trend towards vertical integration. A lot of hides, skins and leather are not appearing on the market any more simply because they are being vacuumed up by these businesses, almost at their point of source.

As these businesses become bigger and stronger, so their purchasing power can be expected to increase commensurately.  And with greater purchasing power comes the ability to control price levels better – at least in times like now when business is not so good and the market is in a state of equilibrium, or slight over supply.  Under these conditions, there is less opportunity for material to find its way into traders’ hands or inventories, let alone for speculative positions to be adopted.

The key players are now effectively setting the price levels and as long as the market doesn’t experience severe supply shortages like those brought about by the cattle disease epidemics of 2001, raw material prices have little chance of breaking out on the upside.  At the same time, the pattern of purchasing (large volumes at fixed prices) appears to be reducing the level of risk for the supplier. With quantities agreed in advance, there is little, if any, room for any alternative sales opportunities.

This is the situation that has been in place for at least the last six months, putting the squeeze on smaller companies, either because they no longer fit comfortably in the market, size or price-wise, or simply because they have allowed too much distance to come between themselves and the key buyers.   And the situation is continually becoming more unfavourable for them as the big players strive to grow their respective market shares.

Indeed, it would appear that the big companies are now getting things all their own way, with a number of factors counting strongly in their favour.  These include the reasonable balance on the supply side deriving from the stumbling world economy and the continuing downward price pressure on finished product prices that supports large, low cost and integrated operations.  And the process is far from finished, given the fragmented nature of the global leather industry.

But the times of raw material shortages and high prices are not yet completely forgotten. We can still remember a time not too long ago when the various parts of the leather pipeline were in conflict with each other price-wise, in order to secure their supplies. It will be interesting therefore to see what happens when the world economy begins to pick up again and the demand for leather with it.  When this occurs, the combatants will be that much bigger – something that will certainly not be very good for the flexibility and stability of the system. As ever, Market Intelligence will have an eye on this.

This process of consolidation is not just being seen in the tanning and leather industries. It is also taking place in the meat industry. What has been normal in the USA for years is now slowly but surely taking place in the rest of the world, and in particular in Europe. Considering that the largest five or six beef producers in America now control more than 70% of the market, then it becomes all the more easy to see what might happen in Europe in the near future – especially in view of changing agricultural policies in Brussels.

Europe obviously won’t follow the US model exactly, but there is a lot of room for change in the beef sector and this will surely happen, with the hide and skin industry following close behind. The temporary shut down of John Ronan’s in Ireland resulting from fierce competition from the  abattoirs together with difficult market environment and might well be the pattern of things to come. Many have been predicting changes similar to those already seen in the USA for some time, but it seems that the pace of change is now changing up a gear.

As already stated, prices have eased moderately and the markets are now entirely under control of the buyers. As strong as the downward pressure on finished product prices is, however, it is surprising that prices of raw materials remain at such high and stable levels.   This is most likely because inventories are not particularly well stocked and with the business concentrating on fewer people who are taking higher volumes, the market is not exactly awash with unsold hides.  Looking at the profits of many companies (see previous editions of Market Intelligence) the need for further reductions is in any case questionable. 

In terms of individual hide and skin types, whereas hide prices are slightly weak with good volumes, splits have been able to hold their levels and still generate strong interest.  The interest for skins is more mixed, with strong demand for low priced nappas and very little in the higher quality productions. The Turkish and Russian markets would appear to be bearing the brunt of the fallout from the war with Iraq, with decisions being postponed again and again.

Many will also miss the insight that APLF in Hong Kong would have provided by bringing the trade together in one place. However, there are good reasons why the next few weeks are unlikely to give rise to anything new.

We will continue keep a closer watch on the supply side than the demand. We are now entering  the second quarter, which is traditionally the one with the sharpest reductions in demand and leather production. Given the war and Sars situation, one cannot expect much from the demand side. However, everyone would appear to be in agreement that inventories are low.

In Europe the kill will soon start reducing while average weights are likewise expected to decline. The wider world situation notwithstanding, this could quickly lead to the creation of supply bottlenecks in specific grades. This has been seen countless times before and there is no reason to doubt that it could happen again.

Quite the opposite situation prevails in the USA and southern hemisphere. Here higher kills should enable lower levels of demand in the second quarter to be met without any problem.  

So, in summary and assuming normal conditions, history can be expected to repeat itself with levels of supply increasing and demand easing seasonally in April/May. Buyers therefore have a fair chance of maintaining control of the market for a while longer.

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