Macroeconomics

A few changes have taken place in the global markets during the last two weeks. Trouble that started some weeks ago with the payments problems in Dubai continued and spilled over into Europe. Greece is also in deep trouble having been fiddling the budget statistics for years. Ireland, Portugal and Spain have been downgraded or are under special supervision from the international rating agencies. This has put pressure on the euro, which has declined by more than 3% during the past two weeks.

As if that was not enough, those who had been betting on the ever-rising euro also received better-than-expected economic data from the US. Retail sales and consumer confidence were better than expected and labour market news also looked promising. Consequently, there were rising concerns that the Fed could possibly end the low interest policy earlier than expected (potentially during the second half of 2010). These new market fundamentals forced many speculators to review their positions and to unwind some of their large short positions on the greenback to safeguard their 2009 profits.

The situation is as shaky for the euro now as it was brilliant up to a week ago. In the coming weeks, EU member states will have to decide whether to bail out Greece, whether the country can manage the situation itself, or whether it will have to leave the European community. Options one or two would be pretty dangerous for the euro; option one would certainly undermine confidence for a long time and would most likely send the euro pretty far down. While the euro has been a success so far, many have ignored the fact that it is still an artificial currency based on separate and independent nations that are linked only by agreements and contracts.

Commodities also lost a bit of their shine as a result. Selling or borrowing US$ and buying commodities has been the play of the market for the last nine months. This suddenly got a shot in the arm, and gold and oil prices fell for the first time in a long while. Gold lost almost $100 and oil lost about $5 per barrel. It will be interesting to see whether speculators will continue to unwind positions towards the end of the year, which could pile further pressure on the euro and on commodity prices. On the other hand, a technical reaction after the sharp moves would not come as a surprise either. In any case, we would not be surprised to see a lot of volatility before the end of the year.

Market intelligence

Activity in the leather pipeline is slowing down. The end of the year and the upcoming Lunar New Year in Asia are throwing their shadows ahead and most are busy planning for the break rather than actively managing current business and thinking about making major business decisions.

Consequently, sales and activity have been a bit mixed during the past couple of weeks. While some have already closed their books for the year, others were still busy making short-term decisions or even working on their longer-term 2010 strategies and searching for opportunities according to their outlook and budgets.

The general market continues to be impressed by the extended forward positions of most raw material suppliers around the globe. Also, they believe that, after the movements in Brazil, more abattoirs groups may invest deeper into the leather pipeline, and this is becoming more of a factor when it comes to making decisions.

It is interesting how frequently this option and situation is mentioned these days, particular by players in China. As an industry that is so dependent on raw material imports, one can understand the worries, but in our opinion these worries are definitely premature and should and cannot influence supply decisions for the next six months or so.

When packers turn tanners

Let’s make a quick excursion into the possibility of packers becoming tanners and what this would and could mean for the industry. This means considering how likely it is that more slaughterhouses will invest in leather production.

Well, the initial question is what does investment into leather production mean? There is a major difference between an investment into long-term preservation (wet blue) and leather production, and this is frequently mixed up. As long as abattoirs only decide to invest more into wet blue tanning in order to increase storage time and market flexibility, the level of concern in the industry should only be on medium alert level.

It is true that hides could be kept and stored for a longer period of time and could become less accessible to the tanning industry, but access to material is not limited at all and the intention of the slaughterhouses is not to keep hides longer than necessary; they are available for leather production. If there could be any complaint about an expansion of wet blue tanning, it is that beamhouse investments could become obsolete and individualised qualities might decline. However, this could happen anyway with the rising dominance of mass production.

If the interpretation of leather production is determined by the recent acquisitions of full-scale tanneries by packer groups, the situation is possibly a bit different, but only in the long run if further developments take place. Why? Well, for the moment, slaughterhouses have just bought what already existed. No additional leather production has been generated and no expansion of leather production has been achieved. So, in the worst of all cases, the tanneries will be supplied from the group’s raw material supply at their slaughterhouses. This means the quantities substituted will need other customers (tanners), so the only shift would happen on the “dance floor”. Tanners’ concerns that they would have less access to raw material and that prices will change are not valid in our opinion. It will simply mean new customer/supplier relations will need to be established.

The key question is whether the slaughterhouses will be successful in managing their new vertical investment and whether growth will eventually mean less raw material for the ‘free tanning industry’. For commodity productions there could be a number of benefits and savings in controlling the entire supply chain from the abattoir to finished leather but, as everyone in the industry knows, a lot of value can quickly be destroyed during leather production if any of the essential key factors in production and marketing are not well handled.

Often in the cycle the decisions in the pipeline are in severe conflict with each other. At this point we will see whether top management figures are smart enough to compromise over the various steps. It will take a wise person to overlook the whole project and to manage the individuals.

However, for the short term we do not believe there will be any substantial impact on raw material supplies for the tanning industry other than the general decline of beef production in many parts of the world. It might be that only a small number of tanners and abattoirs have to handle the shift from supplier/customer to competitor relations.

Recovery in progress

However, in a way, all the above has had an influence on recent market movements. The hide market all over the world is firm and prices are on their way back to pre-crisis levels. However, a lot of pundits and experienced members of the industry continue to scratch their heads and many of them still think that it is all too good to be true, that global leather production and consumer goods demand do not justify the extent of the recovery.

Many still believe that we are, at best, back to 80% in relation to where we were, which would mean raw materials are overvalued today. However, we know that it is not that simple. Raw material prices are never a 1:1 reflection of production and finished product demand. Stocks move and can be parked along the pipeline and individual raw material inventory positions and valuations play an important role. In 2009, low raw material prices invited those who had the courage and money to take advantage of the situation and to buy more than they needed. Stocks that had been held and stocked in producers’ hands at the beginning of the year have been keenly absorbed by speculators and producers.

It is also true that leather demand must have been much better than the 80% that we also believed in for a long time. Other than that, the keen purchasing in the last quarter cannot be explained and, if the reports that the majority of tanners are no longer benefiting from cheaper stocks are true, it means they experienced better sales than the sales statistics of the Western world showed. Of course, this is subject to there being no large stocks of finished leathers and leathergoods sitting in the warehouses.

So, we can assume that we are back at the starting blocks for 2010 and leather now has to find adequate prices to fit the current raw material levels or demand will fall, which will impact on prices. The first quarter might be too early to tell us the real story, but towards April we might see the realities again. There are good arguments that leather prices will not follow as quickly as they should and tanners’ problems with profitability could dampen demand again and cause strong headwinds for the price trend. As usual, hide producers will acknowledge this only when it is late or too late in their normal attempts to defend their returns for as long as possible. Only rising stocks and falling sales will cause them to change their policies and positions.

The wind-down

Trading has slowed down during the last couple of weeks. Despite some latecomers and isolated spots of demand and replenishment, for example in the car industry, excitement is fading in line with the production breaks in the West due to the Christmas season and the upcoming interruption in Asia for the Lunar New Year holidays.

There is no reflection of this in terms of pricing, because of the low stocks and decent forward positions for packers, processors and traders. So, everybody will be taking it easy until the New Year starts in January, or maybe even beyond. In some cases prices even went a bit higher, but prices level are rather coincidental and depend on individual trade rather than showing a trend. Tanners’ appetite for high-priced hides is fading, at least until they are justified by higher leather prices. And those will be only negotiated once the first quarter of 2010 gets underway.

The splits market was not very active for the same reasons we stated for hides. Non-leather demand for splits is in its high season, but alternative products are falling in price and this is keeping the sector under tight control. Suede is still a strong factor, but the holiday feeling can also be sensed.

The skins market was the only one that really showed some positive news. Chinese buyers are travelling all over Europe and are finding that, with better leather orders in hand, fewer skins are available or, more accurately, fewer of the skins they are really looking for. So demand and prices jumped up.

Lamb nappa was one of the few remaining cheap items and skins prices never really took part in the sharp recovery seen for hides. Being the only cheap product they attracted a lot of tanners and designers and the order books were filling quickly. We mentioned a while ago that it was only a matter of time before this would happen. Chinese tanners like to buy during the winter season, so sellers were happy to see them coming after such a long period of absence.

In the coming weeks—and this is the last issue of the Market Intelligence report for 2009—we believe the market will wind down even further. Only a few can be expected to take an active part in market activity. Isolated trades will determine price for the rest of the year and we wouldn’t call any of them a direction.

Early in 2010 we will know more, because then the tanning industry outside China will have to reveal its needs for the first quarter. The Chinese will have to decide by mid January how to plan for the time after their holidays. If demand doesn’t fade, supplies will still be pretty restricted and the response to this would be higher prices.

However, the higher prices go from now, the harder, in our eyes, the inevitable correction will be. Business is not based on wishful thinking, but it would be nice for the markets and prices to take a break now and avoid any major variations, which would be bad for everyone.

Happy Christmas!

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