Like the rest of the world, the sight of Iraqis pounding the toppled statue of Saddam Hussein last week with their shoes transfixed me. Unlike the rest of the world, however, my thoughts quickly turned to the original 12-member

Dow Jones Industrial Average

and one of its constituents, U.S. Leather (preferred), an issue dissolved in 1952.

Yes, the preferred stock of a leather company ranked as an industrial titan back in May 1896. Now we have issues such as

Intel

(INTC) - Get Report

. What, are you going to whack a statue with a Pentium?

Before we get going, a sincere and serious warning to more sensitive readers is in order. Commodities are not pretty. Nowhere is this more true than in the animal and animal products markets. The memorable advertising line "rich Corinthian leather" masks some things most of us prefer to keep out of mind.

McDonald's

(MCD) - Get Report

breaks even on its hamburgers and depends on selling (freedom?) fries, and

Coca-Cola

(CCE)

for its profit margin.

Ford

(F) - Get Report

and

General Motors

(GM) - Get Report

have the same setup: They make no money on sedans and depend on financing, which must be a tough business with 0% interest rates. And let's not start on

Hewlett-Packard's

(HPQ) - Get Report

profit margins for ink-jet cartridges and laser toner. Not even

Gillette

(G) - Get Report

has it so good with giving away razors to sell blades.

So it is with the economics of a slaughterhouse. You break even on meat for direct sale and make your money on hides and offal. Hides are tanned into leather, and, at last observation, I am wearing leather shoes and a leather belt and I am carrying a leather wallet and attach¿ case. Offal encompasses items such as cheek meat, head meat, blood meal and bone meal, edible tallow for making those freedom fries, bleachable tallow for soap, hearts, livers, tails, tongues, lips, inedible lungs (there are edible lungs?) and for our friends in old Europe, tripe.

At present, the total byproduct value of a 1,200-pound steer is $8.10. That same steer's value per 100 pounds as boxed beef, the cutout value, is just under $135. For a typical 750-900 pound cutout, the byproducts represent between 0.65%-0.80% of the cutout value before all of the packer's costs are netted.

The Good, the Bad and the Ugly

Source: Bloomberg

A Postponable Nondurable

Shoes, as Imelda Marcos would no doubt attest, can be accumulated in any quantity. As with goods such as wine, olive oil or luxury cars, they'll let you pay as much for a pair of shoes as it takes for you to feel good about the purchase.

But if shoes or other leather goods such as sofas and chairs, coats and belts can be accumulated, their purchase can be postponed as well.

You might think that the shipments and inventories of leather goods might track the growth of the population, plus or minus some adjustment for national income levels.

But these two series have some definite trends. Inventories of leather goods fell by 27% between November 1998 and May 2002, and the latter phases of the inventory reduction resemble the chart of a market crash.

In fact, the odd combination of inventories falling along with shipments suggests that less leather was being produced and consumed.

Getting Your Hide Tanned

Source: Bloomberg

If there ever was a wealth effect from the bull market, it manifested itself in big homes and huge SUVs, not in collections of wingtips, oxfords, loafers, pumps, flats, cowboy boots and stiletto heels. The opposite does not hold, however. The crash in leather coincided with the worst phases of the bear market, and that suggests people were economizing feet first.

Price Cycle Puzzle

The long-term price histories of many basic materials industries have patterns consistent with and explained by investment cycles in that industry. Not so for hides and leather. The two oil shocks not related to either war with Iraq produced faster producer price increases in hides and leather than for general producer prices. Tanning, to the best of my knowledge, is not a particularly energy-intensive industry, and while I could joke that higher gasoline prices force people to walk more and wear their shoes out, I do not think that is at all demonstrable. This simply may be one of the better examples ever of spurious correlation in economic data.

A Little Bit of Sole

Source: Bloomberg

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In an Oil Rush, Sell Shoes

Leather prices by themselves, as is the case for so many other basic commodities, are a relatively small component of their final goods' price. The two largest U.S. footwear stocks,

Nike

(NKE) - Get Report

and

Reebok

(RBK)

, which together account for 82% of the weight in the seven-member S&P footwear index, are famous for athletic shoes, not for classic leather shoes.

The remaining five firms in the index are

Timberland

(TBL)

,

Wolverine World Wide

(WWW) - Get Report

,

Brown Shoe

(BWS)

,

K-Swiss

(KSWS)

and

Stride Rite

(SRR)

. Much of the manufacturing in the footwear industry occurs in China, Indonesia and other low-labor-cost locales, and marketing expenses eat up much of the remaining cost structure for these firms.

Still, footwear is going to be around for as long as we have feet, and that is something for those who fancy themselves long-term investors to consider. Over the past five years, the S&P footwear index has outperformed the

S&P 500

by 38% on a total return basis, recession or no recession, higher or lower leather prices.

The late Armand Hammer of

Occidental Petroleum

(OXY) - Get Report

loved to tell the story of how he persuaded Lenin to give him the pencil franchise in the new Soviet Union. His logic was that the Bolsheviks would want to emphasize education and that students would need pencils.

The same logic might apply in Iraq. Oil and construction firms have high political profiles and long payback periods on their investments. Nike can get in, plaster a few swooshes on all those newly empty billboards, sell a few shoes and have a limited downside on exposed capital equipment. Besides, it has spokesmen like Tiger Woods, while

Halliburton

(HAL) - Get Report

has Vice President Dick Cheney.

Howard L. Simons is a special academic adviser at Nasdaq Liffe Markets, a professor of finance at the Illinois Institute of Technology, a trading consultant and the author of

The Dynamic Option Selection System. Under no circumstances does the information in this column represent a recommendation to buy or sell securities. The views expressed in this article are those of Howard Simons and not necessarily those of NQLX. As a matter of policy, NQLX disclaims the private publication of materials by its employees. While Simons cannot provide investment advice or recommendations, he invites you to send your feedback to

Howard Simons.

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