Macroeconomics

We could fill this section with general market data again, but it doesn’t seem to make much sense at the moment. The facts and markets are not corresponding much at present and, consequently, the financial news and statistics are not very helpful in terms of general analysis of the markets and particularly the leather pipeline.

In the western world, poor economic figures, bankruptcies and deep structural crises are dominating the news. Unemployment is rising, in some areas more than in others, but the negative trend is still there and the outlook isn’t any better.

At the same time, commodity prices are rising and this normally indicates that the markets are expecting a recovery in terms of industrial production and private consumption. Oil has risen from around $40 at the beginning of the year to $70 now. Nickel prices have increased by 60% and aluminium prices have risen from $1,300 to about $1,600 per tonne. The list could go on. Since the fundamentals are not justifying this, it can only be the fear of inflation or simple speculation that is moving investors into commodities. The number of oil future calls held by hedge funds has risen by almost fivefold even though present physical stocks are still at pretty high levels.

We have all learnt from last year’s experience that speculation and futures markets can easily propel prices up but, if the real markets do not justify this increase, we have also learnt how the story can end. With the sharp gains in the commodity market, the US$ came under pressure and lost almost 10% of its value. Although there are other influences on the currency market, most of the movement can be directly linked to the rise in commodity prices. One should always be on high alert when market prices and fundamentals do not tally.

Market intelligence

The last two weeks brought similar activity to the activity we have seen in the past. The market continued to buy hides and prices were able to advance moderately further. The Chinese tanners continue to be the driving force behind the market. This is not really surprising seeing as more than 50% of global leather production is now located there. And China accounts for the same proportion of global purchasing activity.

However, in addition to the main market, we saw a significant rise in activity among European tanners. Those that complained most about the dreadful economic situation and those who have been underperforming for quite some time showed a much greater interest in hides and also bought quite a few. We can only scratch our heads over what made them change their minds. The only reasonable explanation is that they simply gave in and accepted the fact that, for some months now, other people in the world have had more courage and were readily investing in better quality raw materials regardless of how large or expensive they might be.

As a result, only a small increase was needed in order to replenish stocks and a lot of tanners in continental Europe have realised that the hides would not wait for them anymore. We wouldn't say that this additional demand has been really vast, or that it would stir the market up, but sometimes only a very small trigger is needed to bring about sharp movements. So, after a long period of depression, particularly for the hides used by and preferred by automotive tanners, we suddenly experienced the same battle for hides we had experienced for a long time before the crisis struck.

While tanners were still pretty relaxed at the beginning of the period and thought sellers’ resistance was no more than a bluff, they realised pretty quickly that the number of hides they expected to be waiting for them were not there. Quite the reverse; with the reduced slaughter and plenty of holidays, there were not enough hides to meet and satisfy short-term demand. Price negotiations with the abattoirs became pretty difficult in the end and prices for hides, particularly for males, circulating the European trade became pretty frightening. Some of the prices mentioned were higher at the abattoir door than a tanner would actually pay delivered.

Higher or lower

As we all know, when the market is moving it moves all across the board, as do the other categories. Dairy cows, for example were taken along and prices shot up at the abattoirs without any justification because the market had not really got any better and the currency market offered no help. The market realities are what they are, but the situation has been a nasty headache for quite a number of players. At present prices, calculations no longer fit and it is hard to decide which direction one would like prices to go.

The situation is simple for tanners who missed the low prices to replenish inventory. Prices must go down if they are to get a second chance. For raw material suppliers who sold their stocks in fear and prudence, down could also be the right direction. However, for the others, further price advances within a certain timeframe would be the best case scenario. This would protect stocks and give people the chance to take advantage of some of the decisions that have already been made.

However, it seems that those who were not willing to operate with a long-term view and missed opportunities are still trying to catch the train even if the ticket price is 20%, or more, higher than it was a few months ago.

Since the tanning industry has been buying top quality hides, some of the better demand and price increases are now spilling into the lower quality origins. This certainly does not mean that all the stocks that had built up have been absorbed, but some movement has been seen in regions such as Central and South America and prices have left the bottom already. All this has happened because of courage shown by the Asian tanners who bought cheap raw material even when leather orders were not, and possibly still are not, justifying this.

Looking at the US sales in recent weeks, business has been active there as well and the weekly number of sales easily continues to outpace slaughter. Shipments are also pretty decent and this is helping to deplete stocks and improving sellers’ moods and positions. Most US shippers are becoming more and more positive about the market by the day and are feeling more than comfortable about the summer and the near future.

Rebounds based on speculation

All the above is actually in conflict with the more cautious position we took in our last issue. The world and the markets are telling us that with rising prices the crisis in the leather industry is over and that the business outlook for the leather sector is fine. However, some of the arguments we used during the crisis that we have not reached the end of the leather industry have also proved to be true.

Demand for basic items such as shoes remains pretty stable and price reductions have been limited. The world still has the same population, or even a growing population, of consumers. Top quality products have not lost their fans either and reduced prices have also helped leather to regain some market share. The question that remains is whether all this is enough to justify the recent and sharp market turnaround that has propelled some markets up by double-digit figures. Monitoring the other commodity markets we are seeing a similar pattern. The oil and metal markets, in particular, have seen similar rebounds in recent months and pundits are scratching their heads as to whether this is really a sign that the global economy is recovering or whether it is largely based on speculation.

A lot of experts who have their feet on the ground and are looking more into the physical markets are as sceptical as we are. The downward trend in the global economy has slowed down, but the actual numbers from many countries are still frightening and the outlook for the rest of 2009 is still not good. Even the figures for 2010 show almost no signs that a decent recovery in the first part of the year is realistic. World Bank estimates that the global economy will shrink by 3% are not encouraging either. This still leaves us wondering why the markets have recovered so well and why this has been reflected in the hide market.

There is no question that our concerns about seeing lots of easy money returning based on speculation is becoming a reality. Most of the money invested in the oil market, for example, has come from hedge funds. Some physical buying of metals by the Chinese has caused a market increase, but speculative money also jumped on the bandwagon eventually and pushed things forward.

However, we should never forget that most of the markets are still based on the futures markets, where you can jump in and out whenever you want. The hide market is still based on physical volumes and the more than 200 million hides produced every year around the globe still need to be stored somewhere along the pipeline. There is also no question that a lot of the hides that have been stranded in the hands of the producers since the crisis last autumn have now moved up the leather pipeline. But will they all be absorbed by the consumer in the coming season(s)? With the data we have today it is unlikely. There is absolutely no sign that global consumption is in a position to buy the number of leather products that can be produced from the hides bought in the last three months. A lot has just been bought for inventory replenishment and it is now up to the consumer to buy the finished products.

No European tanners are reporting an increase in demand and orders at the moment. There are even rumours about tanneries starting to resell some of their stocks. There were some, although not many, who still had enough cash to buy when prices were low and one would expect them to hold onto their stocks. However, the opposite is happening. Many warehouses are pretty full and, particularly from Italy, we are hearing that some would readily resell their stocks because they are not expecting leather orders to be good enough to cover raw material inventories. Europe is a headache even if it no longer plays the role it used to play. Missing orders are one part of the game, but restricted financial resources and the tremendous reductions in credit covers are hindering the trade.

All eyes on China

Consequently, the importance of continued growth in the Asian markets and the assumption that the Chinese market is already controlling more than 50% of the global supply is not far from the truth. It is a big country and there is enough space and capacity for raw materials to disappear from the market. However, it is also creating big risks because it is still so far from being transparent for suppliers.

After a while, raw hides, wet blue and crust need to find a buyer. The leather pipeline is famous for its harmonium effect where suction is created when there is demand, but jams appear when it stops and material pushes backwards again. Hardly anyone expects this and most are always pointing towards low price levels. This reduces the risk but not the possibilities. Today, half the cash could finance the number of hides it could exactly a year ago and this is more comfortable considering that those who have bought since the beginning of the year are disposing of low-risk stocks because the valuation is still low and risk free. This will not develop any high-risk potential for the market soon, but neither is it any guarantee that buyers will continue to support the market and be ready takers when prices rise assuming consumer demand does not deliver the positive news expected.

We know the positive trend has to come mainly from the Chinese market as well as relying on raw materials. The western world and the former Eastern bloc are not giving us any indications that consumption will return to the same level any time soon. So a lot will depend on whether the Chinese economy continues to perform well and whether Chinese consumers will compensate for reductions in the rest of the world. For the time being the Chinese are very confident it will. If our concerns about commodity prices are not justified, maybe some of the raw material producing countries will join in as well.

The Chinese government’s current self-consciousness and its forecasts that economic growth will return to 7% or more in the second half of 2009 at least explain why the Chinese industry is not shy about investing in raw materials.

Mixed results for splits and skins

The splits market has also seen signs of further improvement and in most shoe and fashion shows designers are showing more suede than one would expect considering the grain leather prices. Prices for better quality splits suitable for suede production are now higher than prices for full substance hides. This can’t last long, but it is a reflection of the lower splits output and improved demand. With the indications we saw back in April when suede and Nubuk returned in Bologna, it seems little will change in this fashion-driven situation.

The skin market is not really benefiting from the situation in the hide market yet. Despite the gains we have seen in the market for dairy cows, lamb nappa is not yet being seen as a more attractive alternative. The main reason for this is that the cows haven’t been bought from garment tanners, but have mainly found homes in tanneries making bag leather and, in smaller volumes, for upholstery leather. Skins for linings are still experiencing a better situation, but the market for skins as a whole hasn’t really seen any remarkable increases in inquiries. There are one or two isolated trades for new-season lambs to report, but we cannot find any skin suppliers who are saying that demand is really making anyone happy yet.

In the coming weeks we will sit in the audience and watch. With the general enthusiasm that has spilled into the market there might still be some after-effects from the changes seen in recent weeks. Sellers, particularly packers and abattoirs in the US and Europe, believe they have regained full control of the market and their sold forward positions will allow them to take a pretty rigid position on price in the near future. Consequently, the market is now on safe ground and a firm footing. The top end of the quality range is well cleared now with most of the global inquiries for hides having been for top quality material. Suppliers of this high-quality product will do anything now to protect their ‘baby’.

However, the world has more hides to offer and they haven’t really benefited from the recent market rises. We would even say that the levels we have reached for premium hides in the meantime make the medium, lower end of the quality scale more attractive again. With the number of hides of these origins still available, it should make buyers think twice if they are willing to pay even higher prices for the better-quality end. To cut a long story short, prices might oscillate and sellers will not allow them to go down at the moment, but we would be more than surprised if buyers are willing to allow the market to advance even further. We will continue to watch the market risks rather than the opportunities.

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