The Leather Pipeline - 27.01.15
27/01/2015
Sometimes it is really difficult to fill this section, but with everything that has happened in the last two weeks we could almost have filled books.
It all began with the Swiss Central Bank wiping away the guarantee not to let the Swiss franc rise above the level of CHF1.20 against the euro. It came out of the blue for many because Swiss bankers are well known for keeping their word. It was not so surprising for others who knew how much the Swiss Central Bank had to spend in November and December 2014 to protect their currency against sharp revaluation against the euro. A revaluation of almost 20% is likely and is going to be a very hard hit for the export-oriented Swiss industry and also for the large numbers of tourists who now may think twice before booking a trip to the beautiful country in the mountains. One has to suppose that a bit of information was filtering through already concerning the European Central Bank’s (ECB) intentions on quantitative easing (QE).
Although long expected and already announced, the ECB has decided to go beyond expectations and published a whole QE programme in excess of expectations by quite a bit. The total amount of €1.2 trillion will be spent over a period of about 24 months to buy government and corporate bonds. It’s really a huge amount of money, in particular if one considers that even today nobody is really feeling any shortage of liquidity in the markets now.
The idea is to see more lending at cheap interest rates to companies, to depress the value of the euro to boost exports, to return to a moderate inflation around the desired 2% level and to guarantee cheap lending rates for the countries that are still burdened by huge budget deficits.
Countries in northern Europe are in the majority more than sceptical about the results and consequences such a programme will offer to their economies, while countries in the southern part of the union welcome it. The dividing line in Europe is possibly clearer than ever before these days. Any comparison with the QE programme in the US is not adequate as the preconditions are totally different. The only thing one can actually really say is if it doesn’t work out it’s going to be a very, very high burden for future generations.
At least one of the targets worked out rapidly with the euro continuing its descent, falling from Thursday morning to Friday evening by almost 3.5%. European citizens should be aware that they have become poorer since the euro lost its shine last summer and we have to expect parity to the dollar to be reached, as many of the experts are predicting. Fortunately our energy and other commodity prices are substantially lower too, so many European consumers are not yet really feeling any of the consequences of the substantial devaluation of the currency.
We are quite sure that this section will have quite a bit more to report in the weeks ahead.
Market Intelligence
The incidents of the past two weeks are a final step in the process of revaluation of different raw materials from different origins. Valuations have changed and the spread between the value of various origins has become wider.
Apart from the effects of the currency market, we have also to repeat the questionable price levels that are being published in offer letters and also market reports. It doesn’t require much work on the part of the intelligence services to figure out that the official published prices in many parts of the world have very little to do with the real prices in deals taking place week by week. The difference between the official price and the real price can easily be 10% or more. And this cannot be justified by the usual remarks about prices varying from supplier to supplier or being the result of different descriptions. What we actually mean is a real and serious difference between the public world and the real marketplace.
It is sellers’ policy to achieve higher returns and to lend a hand to some of their customers in their negotiations over finished leather prices. However, it doesn’t help to create a virtual reality and a parallel universe. It makes analysis and decisions more complicated for many people and provides no protection against the reality of economics, which sooner or later hit everyone.
The leather pipeline has now to deal with massive movement in the currency markets. This applies of course mostly to those who are dollar- or euro-related because this is actually the exchange rate that has made the strongest moves. It is fair to say that the recent Swiss franc movement was even bigger, but the trade within the leather pipeline between Swiss francs, euros and US dollars is negligible in terms of the entire global marketplace.
The Chinese, still today the biggest players in the leather pipeline, are not affected too much by currency rates, but being smart business people they are watching the situation and they know very well who is taking advantage and who is suffering. There are rumours, and we have to say only rumours, of Chinese customers asking European suppliers for a readjustment of prices to cover for currency variations. This is a very difficult request because many companies tend to hedge their currency exposure on every sale they are making. And even if they don’t do it they would definitely pretend to do so to safeguard and rescue windfall profits made by the currency movement. Raw material business is classically a very short-term, quick-trade operation and currency market adjustments are normally reflected in the material prices pretty quickly. Consequently there is very little logic and justification for such requests; in the next round of trade prices will reflect the changes anyway. It is probably more about the pain of losing and of seeing someone else gain, in other words jealousy more than anything else. This applies in the finished leather business too, even though the situation is a bit more complicated there because prices are fixed for a much longer period of time.
As far as activity in the leather pipeline is concerned, one issue is the long break the Chinese intend to take for their New Year holiday this year. Most people are advising that they are either totally closed for four weeks or will just work with emergency staff at the beginning of February and at the end of February. No matter what, it’s clear the activity in leather production in China will be significantly lower around the holiday break this year than ever before.
However, with the amount of hand-to-mouth purchasing the tanneries have been doing for quite some time, it did not come as a surprise that the export sales numbers in the United States were significantly boosted in the past week, and despite all their problems, European suppliers were not totally unhappy either with a number of sales there were able to generate in January in the direction of Asia. However, there was also plenty of material around that needed to be moved and it would be surprising if it has all been cleaned up.
What is far more interesting for the coming month is if Asian tanners have now bought enough material to cover quite a bit of time after their holiday already. If everything they will need right away is already on the ocean, the large contracts they have agreed will satisfy the needs of the tanning industry there for quite a while and there is a fair chance that we will see a longer period of very low activity in the raw material markets for a little while.
Apart from the currency market, the strike at the West Coast ports in the US is causing a bit of a shift in market activities. Some buyers in Asia are afraid that they might not get the volume required in time from the US and have focused a bit more on other origins such as Europe. It’s not a very difficult decision these days because European hides in combination with a firmer US dollar look quite attractive in price. We have spoken to a number of suppliers of good reputation in Europe and almost every one confirmed that they have been positively surprised by the amount of interest from China in male hides; there has been quite a bit of surplus in production since mid-November and normally these hides are too expensive for the Asian markets.
We have mentioned already that the prices, in particular from the US, that are published are actually not the ones obtained in the majority of sales. We have been able to verify that much of the large quantities recently sold was promoted aggressively by substantial discounts on the asking price. However, prices are always brought back into line with what the international market levels are and what a serious valuation of the material can actually justify.
As far as the leather business is concerned one cannot be too happy. In the end you see what you want to see and you report what you want the public to know. However, also here we have been able to discuss things with a number of pundits who confirm that leather buyers have become very, very cautious about new contracts and leather orders. Not that anyone can draw any final conclusion, because it is not yet clear if these are just precautionary decisions in view of the turmoil on the financial markets, or a precaution to reduce inventory as a defence strategy in view of the various crises around the globe.
From the global perspective we have to deal with a slowdown in many markets. China is barely steady, Russia and the Ukraine are pretty poor, the rest of Europe is flat at best, some of the emerging markets are under-performing, declining commodity prices are affecting consumer spending in previously strong performing regions and so we are left with just the US as an area of better growth and rising consumption. Fortunately, the US economy is, with almost 300 million consumers, consumption-driven, so that is an important support. However, large organisations like the International Monetary Fund are revising their outlook for the global economy on the downside.
The medium term outlook is not so promising, except possibly in the automotive industry. However, even here plans still need to be confirmed. At least the low interest rates will be of assistance to finance car sales in 2015 and it’s possible the ECB decision will have a positive effect on the lagging EU car market.
With the macro data not really laying a positive base for 2015, we had better look at the short-term variations and we should keep our eyes open for any short-term changes that might become more important. The leather pipeline is certainly less full at the beginning of this year than it was a year ago and this makes it far more sensitive to short-term changes, for better or for worse.
The split market remains pretty quiet and most markets report slow activity and falling prices. In particular in Asia activity is slow. It is not a particularly good sign for leather demand in general that the split market is not showing much sign of recovery.
The skin market seem to have hit bottom, or is certainly on a very low plateau if we talk about mainstream and average-quality skins. Some sales to china for nappa skins have stabilised the market a bit and several producers and suppliers believe they see a bit of light at the end of the tunnel. However, it is still uncertain if this is real demand for leather or just some production buying with limited risk with a reasonable revenue for the wool. In Europe, at least, buying the largest skins with the longest wool is an attraction for some players. However, we still fail to sense a real return of business.
The coming weeks will be a bit problematic. We think that the leather pipeline will need some days if not weeks to digest the new parameters in the currency markets and we still don’t know if we have to expect more turmoil and surprises over the coming weeks.
In addition we will see China and some other parts of Asia closing down for the Chinese New Year holidays in mid-February. This will definitely take some demand out of the market and in many ways it is becoming obvious that the production industry in China is quite happy to reach the shore and to have a good excuse to close factories for an extended period. This can only be broken with an unexpected uptick in finished leather demand. Otherwise one has to expect a continuation of the orderly fall in prices.
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