The Leather Pipeline - 28.11.17
28/11/2017
We are increasingly impressed by how little the financial markets are being affected by general politics. The global economy is expanding, interest rates are low and the end of the ‘easy money’ money policy is still far away. The markets, as well as the politicians and bankers, are very comfortable with the way things are.
The conflict in Ukraine, the threat of war on the Korean peninsula and the increasing number of egocentric leaders around the globe: it appears nothing can stop people or corporations believing in better times ahead.
In China, President Xi and his Communist Party have built their power up to levels possibly never before seen. In Germany, the Merkel era could come to an end, which would have a massive impact on Europe. Brexit is a never-ending story, Venezuela, one of the biggest oil producers, is essentially bankrupt, and the conflict continues on the Arabian Peninsula. In the US, President Trump has so far failed to deliver on many of his promises.
There have been times when just a small part of the above would have prompted a serious reaction from the financial markets and scared CEOs around the globe. People would have been reluctant to spend due to the uncertainty over what was going to happen, and a generally depressive mood would have dominated. All this is history; today, the release of a new smartphone or the latest luxury sneaker is deemed more important than what the state of politics could mean for the future.
Perhaps it is a good thing that there are no clouds in the sky, at least for the moment. Why bother worrying about something that we can’t change? Indeed, of the warnings have so far failed and the longer this situation lasts, the less willing anyone will be to deal with any kind of risk.
In the meantime, the financial markets are already beginning to wind down for the year. Very little is happening. Stock markets continue to trade in a marginally weaker range, but earnings, low interest rates and positive forecasts are keeping them steady. The number of voices talking about a potential end of the cycle is rising, however.
Oil and gold prices are rising. It is no surprise that Russia is taking the lead in organising oil production cuts. Gold is an indicator for ‘safe haven’ activities, which could explain the recent firmer trend. Nonetheless, in the past two years the price of gold has taken a nosedive between the end of the year and the middle of the first quarter of the next year. It will be interesting to see if this happens for the third year in a row.
The US dollar is weakening but it is still trading in the same very narrow range as it has been for a while. With no news about the Federal Reserve’s policy or about the long-awaited tax reform, only the end of year position trading can rock the value of the greenback.
Market Intelligence
This time of the year is traditionally one of the most active for leather production. The winter quarters are a period when global leather production is pretty high, only interrupted by the Christmas season in Europe and the Chinese New Year holidays in Asia.
In general, this year is not much different. What is different is the level of production. Automotive and accessory (leathergoods) leathers continue to perform well, but garment, shoe and glove leather are lagging a long way behind.
The leather pipeline continues to discuss what will happen next and a number of people are beginning to seriously analyse the general market situation. In this report, we have been warning for a long time that the declining consumption of leather cannot be ignored while the production of hides and skins remains stable. Although there are regional differences, the general supply of raw hides and skins has not declined and there are some people who believe that the numbers have actually increased.
The problem is that we don’t have completely reliable statistics for total global production. From what is known, the assumption that global slaughter is not declining has to be accepted. This comes despite the anti-beef campaigning that has been taking place in the Western world for some time now. In very simple terms, supply is the same or larger, while demand has been and might still be shrinking.
Analysts are mainly concentrating on the production of leather products; this is definitely important, but it is only part of the problem in the leather pipeline. Consumption of leather in the shoe industry is definitely down. All of the statistics confirm that the production and sales of leather shoes are in decline and that this has been the case for several seasons. It doesn’t really matter by how many percent because one hide or one square foot of leather too much in the market tilts the balance of the scale.
Challenges for China
We consider the reduction in production capacity in China to be an even bigger factor. It is shrinking because the government is closing down factories, mostly in the north of the country, where production was traditionally dominated by upholstery or bag leather tanners. This comes at the same time as the decline in demand for shoe leather. What has happened is pretty simple; producers in the north have shifted into other regions and have found enough empty drums due to the decline in shoe leather production.
All of this is contributing to a rising production cost for leather in China. This has been killing the low-price sector. With enough man-made materials available at more attractive prices, as well as the lower cost of producing them, there has been no reason to actively search for cheaper destinations, which is usually the reaction of the leather pipeline.
Once a location became too expensive to manufacture leather in, the players just moved on to a cheaper area. This is no longer the case because the demand for finished products is being easily met with non-leather material. All this directly correlates with the decline in oil prices, which has made alternative materials very competitive in price.
Mainstream struggles
The situation is now being taken much more seriously. A number of players have begun to realise that a serious analysis and business forecast is now necessary to understand and manage the business outlook. This is going hand-in-hand with the usual games, ‘fake news’ and market camouflage that was, is and always will be part of the game.
A number of our sources are now pointing out that raw material has become significantly cheaper. At the same time, the price of oil, the main base for several artificial competitors, has almost doubled from its previous lows. This is definitely true, and it can be considered some good news. We were warning of the risks long before raw material prices began their descent and the fall in demand for leather took place. It is not our aim to simply be right. What we are doing is throwing arguments into the ring with the intention of helping our readers come to their own conclusions.
As a result, players along the supply chain of automotive leather and luxury handbags should have come to a different conclusion to producers of commodity leather and standard finished products. Looking at the market share in the entire global leather market, one can see that more people are being hit by the negative changes in the mainstream than our taking benefit from the great stability and fantastic performance of the smaller sectors. Those who are dealing with the highly competitive majority of the market should try and learn from the successful minority.
This is leading us to discussion about the short- and medium-term outlook for the leather pipeline.
Good news for US hides
Over the past two weeks the US raw material market has started to swim against the tide with prices stabilising. This has worked pretty well on paper. Due to the usual playing with numbers it was possible to send a message that the balance between supply and demand has tipped in favour of the raw material suppliers.
We will not return to the argument about the reliability of this message or the tools that are used to achieve the desired effect. It might be better to look at the main facts before coming to a general conclusion.
There is no question that US hides have been the most attractive alternative for the industrial leather making industry in recent months. This has been proven by the fact that these hides have significantly increased their share of the main leather producing markets around the world.
Improved sales have made many US hide suppliers feel much more comfortable, which has led them to the joint conclusion that it might be time to send the equivalent message to the markets in the form of higher asking prices.
When we look at the calendar we can assume that consumer product production is going to remain fairly high. The global economy continues to expand and so does personal consumption. We are currently still living in the best of all worlds. People spend money, interest rates are low, there is no concern about political risk or regional tension, corporate earnings are good, and labour markets are either strong or improving. If it wasn’t for the discussion about the materials, we would be living in the best of all worlds for the leather pipeline. It will hopefully last forever, but from the general fundamentals it is hard to believe that it can get any better for our industry.
Accentuate the positives
Taking these conditions into account, it should be easy to see why we are trying so hard to promote the positive things about leather. From the simple fact sheet, it seems we must simply hope for a serious rise in oil prices to make alternative materials more expensive. This should not be the only argument in favour of stimulating interest in leather. For the time being, the industry continues to defend itself instead of joining forces and making efforts to promote leather.
If one follows the media and publications at the moment, one gets the impression that the leather pipeline is just focusing on defence strategies against all kinds of direct and indirect attacks. The industry is once again fighting back against a reputation that it is based on a chain of cruelty and poor labour conditions, and is ruining the environment. In reality, this is not true, but as long as the industry is taking every subject up and is continuously defending itself, the public is left with the impression that the picture is not far away from reality.
Things can certainly be improved and there are some dark spots here and there. However, in general, the industry has made significant progress, and nobody should be ashamed to be part of it. There is definitely no reason to hide away in the face of alternative materials. We strongly believe that less effort should be spent on the negative reports and that more emphasis should be placed on promoting the positive aspects of the leather industry.
Same story for splits and skins
Not much is happening in the split market. It is almost impossible to find a home for low grade splits. The mass market, where these sorts of material have typically been used, has basically turned its back on leather. Gloves, insoles and other cheap products have turned towards artificial materials too. The supply and demand balance for gelatine and collagen is not helping the situation. High quality and specialties continue to do well while the rest are in the doldrums.
It is also Groundhog Day in the skins market. The market conditions for speciality items, especially for high-quality double-face, high-quality shoe linings and decoration, are still decent. The very poor conditions in the nappa garment market limit the outlet for the rest. Those kinds of skins continue to be very cheap. There is no indication, however, that the industry is willing to take advantage of these prices and use a natural resource the improve the general quality of their products.
A look ahead
There are just over four weeks left until the end of the calendar year. We have come to the conclusion that the leather pipeline had made its plans pretty early. This means production will continue to be steady until the Christmas break. Very few surprises can be expected. We understand that the industry in China is going to close down quite early for the Chinese New Year break. A number of our sources are reporting that they are already being told that raw materials arrivals at the end of January are not desired.
The serious situation of pollution control in China will make production very dependent on the weather. Dry weather conditions, mainly in the north of country, will have a very negative and immediate effect on the production of leather. Factories will be closed at very short notice. The leather industry might not be the main driver of energy consumption and air pollution, but it is one of the immediate victims. Under these conditions, it is extremely difficult for the factories to plan their production. This is not good news for the industry because potential or existing clients have to be prepared for supply interruptions. This is not really helping the present reputation of leather.
The focus of interest in the raw material markets is shifting from the Americas to Europe. Over the summer and into the autumn, the kill in the US was high and producers were struggling to clear their production. This problem is now affecting Europe. Many European hides are not very competitive at the moment. The material that cannot be placed into the regular customer base locally has to compete with origins, in particular in Asia, and is quickly running into trouble.
Without an improvement in leather demand, several origins around the globe can only increase their sales potential by being extremely aggressive with prices and trying to regain the market share they lost over the summer. Another option, and one which several people are taking at the moment, is to store the material. They are hoping that beef production will fall next year, meaning less supply. If this is combined with stable demand in the first quarter of 2018, the problem could be solved. However, Europeans should not be too optimistic about their price trends until the end of the year. It seems that not too many price changes can be expected in the rest of 2017. In fact, European suppliers should probably be prepared for further adjustments on the downside.
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