Macroeconomics

The financial markets have not been very active over the past fortnight. The G20 summit in Brisbane was probably the most important event and showed that the crisis in the Ukraine and Russian sanctions continues to be prominent. The representatives of the largest economies discussed how the global economy could be put back on track, but failed to reach a conclusion or come up with any new ideas.

For Russia, the decline of energy and metal prices is the biggest problem. Being one of the biggest exporters it might have been expected that commodity prices would rise – as they usually do – but they have fallen and there are many speculations as to why. Russia’s currency is also losing strength; the rouble has lost 20%-40% of its value. Russia is looking for new allies and to strengthen relations with potential partners such as China and Venezuela to protect sales and to stabilise prices.

The situation is weighing on many exporting countries, in particular those from Europe. There are some winners but the weak currency and the lack of foreign exchange in the private sector in Russia is causing problems. Falling raw material prices are not only hurting Russia but also countries such as Australia and Africa.

Falling commodity prices and record low interest rates increase the risk of deflation. Although this might be appreciated by consumers at first, it could cause problems later. Many take the past 20 years in Japan as an example and if consumers slow consumption in expectation of further price declines it could hit recovery in Europe, as well as the global economy, in 2015.

Although nobody talks openly about it, one get the impression that a large number of corporations are already taking decisions to curb production and to reconsider capacities and budgets for 2015.

The US dollar stopped the rise at levels around 1.25 against the euro. Oil prices began to settle, awaiting the meeting of the Organization of the Petroleum Exporting Countries in Vienna this week.

Market Intelligence

The risk of deflation and the fall of many leather-related commodity prices are difficult enough, but the leather pipeline has its own problems, too.

We have been warning about the long-term effects of inflated leather prices for a long time. The pricing strategy of the large hide producers and the speculation of semi-finished producers and traders have pushed leather prices ‘over the cliff’ and triggered new material strategies for many product manufacturers.

The end of the bull market cycle seen in the second quarter has also reduced the interest of traders, with many trying to wind stocks down. Either for market or cash-flow reasons, this has shifted the market balance. For the moment, supply is exceeding demand and production needs.

Tanners and leather users are seeing, for the first time in years, a serious chance to average their raw material cost down.

No matter if your order book is long or short, margins have been very tight if not negative and raw material costs too high with limited or no chances to adjust selling prices for leather. Consequently, only an adjustment of raw material cost can get calculations back to normal. In a market where supply is not the bottleneck anymore everyone is now searching for the ‘right price’ in relation to the timing for replenishment. This means waiting as long as possible and not paying more than the competition to get the best deal.

In times when the markets are falling, raw material supply and finance is tight we see the return of bad habits of the usual suspects. Older and more expensive contracts of raw materials and leather are either less respected or related to product quality of previous shipments. In short, this means either old contracts are not taken or only at renegotiated prices or some are trying to find quality arguments to get compensation or to step away from contractual commitments of unprofitable contracts.

This is creating more uncertainty. Perhaps some of the quality key suppliers can hold their sold positions with long-term contract buyers, but in general we know a good number of supply origins where the number of hides produced and the number of hides sold are not matching. One just has to check the offers, with people hoping to find the one out of a million who is attracted by their introductory offers. In the raw material market, when people look for new clients at ‘special prices’, you can rest assured that the market is not good.

However, what does all of this mean and what do we have to expect for the coming months? Firstly, we have to consider that we are being influenced by the upcoming holiday seasons. No matter where the raw material markets go in 2015 and how leather demand will develop in the short term, tanners need fewer hides and at least in Europe, tanners are covered into the New Year.
From our perspective, tanners in Asia are not overstocked. Looking at shipments and arrivals one has to assume that a few weeks of production still need to be covered. However, tanners are now aware of two facts: one, there is no shortage of raw material and so time is on their side. And two, leather prices have no room to go higher for some time. Demand is down and alternatives are attractive.

Those who believe the balance in the market has a chance to change quickly will, in our opinion, be disappointed. Flurries can happen, but the fundamentals would need major changes on the demand side to reverse the trend.

Many should not forget where we stand with raw material prices. The long term averages are still 10%-25% lower than the present price levels and so far very little has happened in terms of price corrections. In that respect, nobody could be surprised if one predicts that prices have still plenty of room to correct.

The biggest mistake might be, however – and this includes our position too – to generalise. Maybe we are going to see different or less pronounced trends. If one looks at the auto shows, there are many kinds of cars on display: big ones, luxury ones, small ones, hybrid, electro, but one they all have in common: far more attention to the interior and most have a leather interior.

The car industry still considers leather as being ‘the upgrade’ for any car. In addition, one has to recognise that design plays a far bigger role these days. While the seats 10 or 20 years ago were all pretty much same, today’s interior designers are playing with the ‘luxury material’ because of the look and to optimise cutting panels.

With the far lower leverage effect of material prices we have a reasonable potential that the decline of leather consumption in side leather and furniture upholstery can in the medium term be compensated by automotive use, which would prevent the raw material market from significant declines below the long-term averages.

However, car sales and leather businesses are both tricky to monitor because of the long supply chains, and in terms of the global economy, budgets and forecasts could easily be missed.

The raw materials dominated by the use in auto interiors are better-performing and more protected than the standard items.

The split market is quiet. In China, tanners are still complaining and suffering from the low prices for lime splits while the wet blue splits have settled and are seeing little movement. Although we do not think all the material produced has been shifted, the inventories are not seriously burdening anyone yet.

The skins business remains pretty mixed. The leather show in Istanbul did not deliver the positive news that so many had been waiting for. The situation in Russia and the Ukraine and the weak rouble are making business difficult. The upper and luxury end is still doing fine and top-of-the-range skins have even recovered well. However, as in many other sectors, this is just a small portion of the business and does not offer the necessary support to the general market.

For the coming weeks, almost until Christmas, we don’t see anything that could turn this market around. We are still happy to see an orderly retreat of prices and not a sharp correction. No matter what reports are stating, real market prices are already below the official quotes.

We hope the financial issues in China and other parts of the world will not become the nail in the coffin, because we believe that, independent of the market situation, many are still underestimating the tight finance of many players and banks.
So, we hope and believe in further and moderate declines which will be more pronounced in the expensive markets and less where currency and corrections have created a more competitive base.

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