Macroeconomics

The global economy took a breather last week after the sharp correction of the asset markets and a rebound – at least prices were settling.

However, one really can’t gain much confidence yet. More people are beginning to discuss market stabilities, with books published that are critical of the economies of the Western world and the spread between rich and poor. The major criticism derives from wealth creation related to asset price rises, ie non-productive gains in correlation to labour-related incomes.

The low-interest policy that many national banks are using to stimulate investment and consumption has led to rising asset prices and has not helped the income from labour or created more jobs in those countries in crisis. In many nations, the necessary reforms cannot be implemented either because of the ideology of the ruling parties or because people are demonstrating for improvements in the state rather than in the economy, which would benefit them.

This is a dangerous situation and you can read headlines in a number of leading international magazines that express the opinion that capitalism is at its end. This is certainly a question of position and interpretation, but the world is threatened by other problems, such as ISIS or the risk of further spread of Ebola.

Life is an endless cycle of changes, and decisions taken by politicians and bankers over the past years can certainly be discussed, but many of the intellectuals should not forget that, on average, the Western free-market system has offered a significantly better life than any other option.

Slowly, people are beginning to think about 2015. From our point of view, many of the fundamental problems have not been solved. This could catch up with us eventually. A new crisis is lurking around the corner and the most frightening fact that is that the global leaders don’t seem to have adequate measures in place.

This means more injections of cheap money into the markets and this money is not reaching the companies or the consumer. More bureaucracy and regulation and fewer reforms may please some voters, but will not help the economy.

With the general uncertainty, oil prices remained under pressure and the currency market has taken a temporary break before deciding where to go next.

Market intelligence

On the raw materials side, the core suppliers from the main supply regions continue to aggressively justify the market. In particular, in the US there are negative margins and lower kills but a continuous justification to oppose any serious weaker trend in prices. However, this cannot be applied to the entire market, just for the supply chains where the flexibility of the members is limited and we discussed this in previous reports.

The standard materials, which are in demand by industrial leather productions, can still hold prices, because tanners find it extremely difficult to handle a larger number of raw material supplies with unpredictable volumes and qualities.

While leather in the “good old days” was made by a tanner handling the most economic raw material he could lay his hands on, today the raw material supply enters the drums to meet computerised, standard processes. The bigger the tanneries are getting, the more final customers are setting technical targets. Tolerance in the production of raw material is fading, with leather production based on budgets and forecasts, while corporate policies and regulations have to be observed and it becomes almost impossible for a large tannery to use the best raw material and to create the best leather from a given hide or skin. This plays into the hands of the large industrial beef suppliers and producers of standard raw material. And they know it.

As long as raw material is generally in short supply this is dragging all raw material sources and supplies up in price, and the high demand for leather allows other producers to sell leather at prices that are close to the ‘big ones’. The day when this changes the spread between prices for leather and for raw materials will widen.

Generally, other smaller satellites of production - as long as they are not niche players - are suffering first from a decline in demand and feeling price pressure before the big players. There are quite a number in the trade who think that this is exactly what the big units are looking for, and they hope that this is when they can get rid of a good part of their competition.

Before the leather industry can discuss this it seems to be necessary first to get a picture of where we stand in the long-term cycles. This is what we have been discussing for some time and the key question is if leather demand has declined and if consumption of the material will be lower over the next seasons. The consequences would be the next question.

To get a picture of leather demand is not easy these days. You have an official and an unofficial conversation. The official one is pretty easy, with most companies reporting that demand might not be fantastic, but it is good enough to be called stable. Conclusion: Things might not be exciting, but they are steady and there is no indication of any serious imbalance between supply and demand.

The unofficial one is a bit different: The range of positions is getting much wider with a much more negative undertone.

Let’s begin with the companies that are plausibly explaining that their business is running well but are being cautious about the outlook. They say many of their customers are not happy with their sales and they can see that inventory at wholesale and retail level is rising. The customers, however, continue to believe that this is temporary and are still willing to take material on a steady level. The fear of the material producers and suppliers is that sales in the Christmas and Chinese New Year season might not meet expectations and this could lead to an abrupt stop to leather orders.

Those who are already feeling the pain are reporting what we save said for a while. Leather demand, after the sharp increase of prices over the past two seasons, has been fading and leather as a material has been substituted to a much larger extend than people had been hoping. Only a very strong winter season would offer a chance for a quick recovery in leather demand. We have to admit we did not find many who were too hopeful about this scenario.

This is a pretty generalised view and you could find exceptions, but for the general picture we think, after almost four months of intense investigation, that this is a pretty fair description of the situation at the end of October.

What scares us most is the fact that we are almost in the middle of the last quarter of the year. This is traditionally the time when most tanneries are active, running at very high if not full production and, under normal conditions, disposing of a clear and well-filled order book for the months to come.

However, if you talk of the main tanning centres in Europe and Asia, you find hardly anyone who would say production is running at full capacity. Tanneries are holding limited inventory, the raw material procurement is hand-to-mouth and we were able to speak to only a few people who could confirm that they have a clear picture about their production for the long term.

On the raw materials side, timing is also becoming an issue. The Christmas holidays in Europe will most likely close factories for two weeks or, if orders do not get substantially better, maybe even three. The Chinese New Year will cover most of the first half of February 2015. In Europe, where kills are high, the majority of hides are in fresh, chilled state, and normal shipping time due to slow steaming has reached almost 40 days to Asia. This means there is a have a fair risk of a congestion of shipments around December for six weeks.

If raw material prices were low we would not consider this to be a serious problem. However, nobody knows how suppliers are going to react when they are confronted with this.

On the other side of the Atlantic, the raw material supply base might see this from a different perspective, expecting the kill to decline even further. However, independent of the good performance of the standard and preferred raw material grades, we do not have the impression that the lower-end production has seen a fantastic clearance since early summer. If there is any confidence in the official statistics, even the reduced raw material production has not found enough buyers to absorb it. This would confirm leather demand for this season is indeed significantly lower than it was a year ago.

We might also draw our readers’ attention to the fact that many of the wet blue traders in Asia, who had been so busy, have become very quiet since spring. Many have been reported to hold very high stocks and they were keen to liquidate rather than to replenish. They factored heavily in the raw material pipeline and without them, it seems unlikely that the full-scale tanning industry is in the position to clean the entire raw material market up.

The split market is showing pretty much the same performance we have seen since the end of the summer. The lime split market in China is still under serious pressure; prices for lime splits are seeing further declines. For the rest, in particular good-quality wet blue splits, the situation seems to have stabilised and the market is, for the moment, in balance. Shipments and productions have resumed and if leather production and wet blue traders are running on a lower production level, the pressure on split prices should fade and the market should be set for more stability.

There is not much new in the skin market. High-quality raw materials have had a pretty good seasonal clearance; Spanish top quality skins have even recognised a rebound in prices. The same applies to some other top-quality ovine raw materials.

Standard products are still not having an easy time. However, prices have come down so much that you are finding more and more producers willing to buy. Ovine leather has become extremely attractive in price and producers with money are aware that cheap raw material has never been a mistake in this business. Consequently, we have heard of a number of sizeable contracts at pretty low prices and even the Chinese have returned to the market, keen not to miss opportunities.

Supply is definitely still good enough, because there are pretty decent backlogs in the pipeline. However, many of these stocks, in particular in Europe, are of questionable quality, because they had to be stored all through the summer and not every supplier is using the necessary cold store warehouses that would prevent deterioration. However, it seems to us that the skin market has gone through the worst for the time being and maybe the cheap price are finally substituting even some of the bovine leathers and are adding to the impression that demand for bovine leather is less than a year ago.

For the coming weeks we would be very surprised if any of the pressure on the market is lifted. We are not of the impression that there are many leather orders stuck in the pipeline.

The kill in the US might not be good but the increase in Europe and in other places seems to have compensated. What concerns us however is the spreads between raw materials. We are also hearing of a decent volume of semi-finished product that is looking for customers. This applies for wet blue in the Americas, but also in Europe where people talk about sudden and surprising offers for wet blue and wet white hides which nobody expected to be available. This means we have a wide range between the standard products and the others, ovine and bovine and between the average prices of wet blue selections which are quietly offered in the market.

For tanners with a reasonable order book and production flexibility, profitable opportunities are begin to build. For those who have to stick to what they always buy, the situation is more difficult. They will continue to meet solid resistance of their suppliers to make bigger concessions on prices. We are approaching a new junction in this market and we are excited to see what is going to happen. Whatever it’s going to be, we will let you know.

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