Macroeconomics

The situation in the financial markets continues to be pretty quiet and we believe it could be time for some movers and shakers again.

There is no real indication that the markets are worried about anything, but a number of issues have not been sorted out yet. Whether it's the crisis in Greece, the budget problems in Italy, Spain or Portugal, the housing market in the US, or even China's boom, there are plenty of issues that could potentially lead to another upset.

The markets do not seem to be worried at the moment and in general the players are convinced the global economy is slowly but surely getting back on track. Job market indicators in markets such as the US and Germany are showing stabilisation at least, if not even improvement. Manufacturers’ order books continue to fill up and if freight rates are a reliable indicator for the global trade, things are indeed on their way up again. Exporters from Europe and the US are complaining about not getting enough containers on the vessels to move their product on time and in the desired quantities.

However, the warning voices should not be ignored either. The housing market in the US does not seem to be on safe ground with the Case-Shiller index having been on the decline for some months. More and more people are unable to make their payments and the US government is thinking about another bailout programme to prevent another market crash.

Even for China, where everything seems to be just fantastic, more and more people are becoming really worried about the housing market. Banks, in particular,  are believed to have seen far too much property built and empty apartment complexes can be seen all over the country. It seems the Chinese government is taking notice of the situation and the purchase of multiple properties is having to be covered with far more collateral and cash injections.

The easy money policy has created a tremendous boom in investment and consumption and has presented the impression that the global crisis has left China totally untouched. Since every action is completely in the hands of the government, which has massive financial resources to spend, it is hard to predict how China would handle a bubble situation in the country. Nevertheless, many feel economic risks are rising.

The financial markets have been pretty stable and neither the currency nor the commodity markets delivered any major changes. The US dollar remained within its trading ranges, interest rates remain low and the stock markets, in the main, continued their steady to firmer trend.

The price of oil has stuck at around the $80 mark and most consumers are complaining about rising product prices, which do not reflect the market realities. Oil companies will be happy about having pretty reasonable margins.

Market intelligence

When more proof was needed about how large the Asian tanners’ order books are and how optimistic many of them are about the future, the visit to the Asia Pacific Leather Fair (APLF) in Hong Kong delivered it. Having been at Lineapelle in Bologna just two weeks ago to get an impression about the situation in Europe, the show in Hong Kong was very revealing about the market conditions in Asia.

Bologna confirmed the positive situation in terms of demand for shoes and leathergoods, and Hong Kong delivered the same news for Asia. In Bologna the European tanners were really suffering as a result of raw material prices, and the Chinese tanners were not happy about the present market trend either, although they were not complaining nearly as much as their colleagues in Europe.

However, the show in Hong Kong is not only for Chinese tanners, it is also a marketplace for many other Asian countries. There was a significant presence from India, Pakistan and Thailand as well as countries such as Korea, which still has an impressive presence. Tanners from these countries are also feeling the pain of rising raw material prices. Those who still have to book raw material against existing leather orders are counting their losses and those who need to discuss business for next season with their customers are afraid the present raw material prices will make negotiations not only difficult, but in some cases even impossible.

Part of the show contained stands that were showing the latest developments in artificial leather. As much as we are linked to the product and as much we are trying to promote and to support the leather industry, one has to admit that the copies have reached an impressive quality level. There is still nothing better than the original, but considering that leather still has price limits in the commodity section, it would not surprise anyone if more artificial product is seen on the market in the coming seasons.

The boot boost 

Talking to numerous people, it became pretty evident that demand for ladies’ boots, in particular, has boosted total demand for leather by such an amount that it probably had the most significant impact on the current raw material shortage. For higher quality productions we even believe present order books cannot be supplied in the materials that were originally ordered. A number of shoe buyers and tanners have been discussing the options. With this already proving problematic and with the knowledge boots will be high and will be at the top of the shopping list for next season, it is pretty clear that a number of designers and purchasing managers will have to redo their homework and discuss with their suppliers how realistically product can be delivered in the quality and at the price people are looking for.

Apart from fashion, the main driving force behind the market trend is still domestic consumption in China, and tanners and manufacturers were all reporting the same story. They believe export business is simply a production filler, and that obtainable prices in the domestic market are significantly better than the levels their export customers are willing to pay. This is not surprising considering the situation in the European and US markets, where nobody is seriously considering price rises or inflation. The consumption boom in mainland China seems to be continuing and most Chinese visitors are not expecting any serious downturn this year.

As we mentioned in the macroeconomic section, a number of voices from outside the trade are seriously worried about the situation in China. The consumption boom has been driven by the government’s cash injections, the sharp gains in the stock and housing markets, and last but not least by higher disposable income caused by rising wages, mainly in the coastal regions. While wages are probably the most solid element, falling asset prices would certainly have a severe effect on private consumption and we don't need to look back too far to give examples of this in other parts of the world.

In the end, nothing could dampen the positive mood of the exhibitors and visitors. Not even the news that a larger Korean tanner has been in financial difficulties raised eyebrows. Quite the reverse, in fact. Suppliers were happy to resell available stock and outstanding contracts at a better price and nobody took the failure as an indication of any serious problem in the tanning industry.

Highs and lows

The show was another confirmation that it is the upholstery tanners who are suffering most from the present market conditions. Except for domestic business in China, demand seems to be insufficient, not to mention the negative margins most producers are experiencing in the meantime.

In automotive the news was pretty conflicting. While on one side growth in the Chinese automotive market will definitely persist in 2010 (+10-15% according to the forecast), most other markets are just stabilising and will mainly produce rather flat conditions. Most of the growth is coming from the medium to low end, which is not too leather friendly. The optimists see the luxury market being strong because of China’s import of expensive cars. However, the pessimists are expecting growth in the medium to low end for leather manufacturers in China, which will not have much positive effect for traditional automotive leather producers in Western Europe and the US.

The market news was conflicting too. While some were pretending to know that the well-known, top-quality producers will cut their production of premium leathers, others are only seeing this with isolated producers, not for general production. Since the advised actions to reduce production are expected to take place pretty soon, we will have a better idea about the reality in the near future.

So, let’s try to put together what we feel we already know:

• Chinese consumers have been the main driver behind the market recovery following the crisis. There are strong indications that will be the case for some time to come. Manufacturers are claiming a much better margin situation in the domestic market than for export contracts.

• The fashion for high ladies’ boots has substantially increased leather demand in the shoe industry. A large number of boots, many of them high, has been ordered for the next winter season. Because of the abundant supply of quality raw materials in 2009 at attractive price levels, demand has exceeded supply of the required raw materials, which is causing serious problems for a number of producers. They simply cannot get the materials they need to fulfil their orders. This has resulted in attempts to renegotiate in a number of cases. Others are trying to spend more money for raw materials in a bid to protect their orders, customers and business, even where this means making a loss.

• Luxury brands are still enjoying good sales growth in the Orient and are competing through their manufacturing base for premium quality raw materials.

• Western consumer markets are stabilising at best, but are showing little growth potential. By consequence, retailers are not willing to raise prices for retail products.

• Despite the generally flat conditions in the West, the extremely cold winter has emptied stocks and retailers have been readily replenishing stocks for the coming season, with stiff price targets.

• Upholstery leather is currently the real loser. While China is still performing well as a result of the booming housing market, the trend in the West is the opposite. Prices and flat sales for leather upholstery are putting producers under increasing pressure. Those who can’t expand their export businesses are facing severe problems—in terms of price and volume.

• Car upholstery is facing strong demand for medium and lower selections because of the strong growth of car sales in the Chinese market. Sales for the mainland are expected to show double-digit increases in 2010 and 2011.

• Premium brands are also optimistic, but they are more dependent on sales in the West. Car makers are optimistic, but demand is currently being driven by model changes rather than by rising demand or by higher income to spend on prestigious cars. So, at present, activity is centred around replenishing or filling the pipeline rather than a real indication of improving sales conditions.

• Beef consumption and, consequently, cattle slaughter has been down for a while. Apart from in China, beef consumption is down, largely because of price. The cheaper alternatives such as pork and poultry are seeing a much better sales performance. There is hardly any indication that this will change in the near future, although it may hit production in the various markets differently. However, countries that are in a position to produce beef at cheaper prices will obviously perform significantly better, while others (Europe and the US) could possibly lose further ground with consumers still being extremely price conscious.

• Short-term shipping is becoming more and more problematic. Empty containers and freight space on vessels are increasingly difficult to find when it comes to exports to Asia. It takes a month or even six weeks before material can be moved. Shipping lines are happy to push rates rather than bringing equipment back to the market and many containers and ships are still parked around. Since it will take at least four to six before any market-changing decisions are made, it will be the end of May at least before anything changes. No announcements have been made for the time after that yet.

What to expect

So, getting into spring now—and are many hoping for some relief from the raw material market—we have to accept that manufacturers and retailers (mainly Chinese) have been too optimistic about raw material supply. The offer of leather products expanded too much after the crisis and the Chinese preference for luxury has outpaced supply. Towards the end of the production season a serious shortage of high-quality hides and skins has been the consequence. A number of ‘weaker’ suppliers will struggle to fulfil their orders in time and at the contracted quality level. The next few months will most likely be a struggle for many and for their buyers too.

There are many who believe this is only the start to an era of extra high prices for raw materials. We believe it is premature to be sure about this. While the outlook for the luxury segment remains good with the noveau riche in Asia continuing to spend and bonuses in the financial sector booming again, the mass consumer market remains pretty price-sensitive and the current prices for raw materials and leather will not leave the Chinese consumer untouched.

As a result, action will be taken in the coming seasons. In the shoe industry, the winter season will soon be finished and this will eventually slow down demand. Rather than making seven-to-nine square-foot consumption of over-knee boots, people can make a fair amount of sandals and sneakers. Redesigning to use less leather, using lower qualities and substitutes is also being discussed. Some or all of these will be the result.

It would take an enormous rise in shoe sales to compensate. Tanners don’t like to hear that, but there is still no such thing as free lunch in this business. Even if leather prices rise by the amount needed, the supply of raw materials is not sufficient to support the present production and demand levels. More money still cannot not buy (or make) more hides.

So anyone who is still short on material for the current season and needs a quick supply of specific goods will face difficulties, and when these problems are resolved the situation could become tricky. Everything will depend on the way retailers and manufacturers respond to the present conditions. This could be lower leather consumption, changes in the product mix or the ‘let’s close our eyes and we will be the last man standing’ approach. It seems it will still be a while before conclusions are drawn and the period before that will be difficult for everyone in the leather pipeline.

Good news for splits and skins

The split market is becoming more popular again with the firm and undersupplied hide market. More and more people are searching for cheaper alternatives and split it being used wherever it can be. So the market is firming as well and more product is becoming available because the leather industry is becoming competitive again for many splits that had been shifted into the collagen and gelatine productions. The market is also firming up, but not at the speed seen for cattle hides.

Skins are also taking full advantage of the present situation. On one side lamb nappa has made a certain comeback in garment fashion and on the other side skins have increasingly become a substitute for ladies’ shoes and leathergoods. Prices for skins have been jumping up since December and received another push around the time of APLF. Buyers are already desperately searching for new season lambs in Europe, and that means double face and lining demand is expected to be good. The production of new season lambs, however, is just starting and most suppliers are reluctant to offer volume yet. Nevertheless, the first prices to be heard were impressive and we had to go back quite a long time to find equivalent levels.

We believe that the coming weeks will possibly be determined by business done with those in desperate need of material to cover pending orders. Sellers will take chances, but we also believe trading volume will decline. This will be prompted by reduced availability, but also by declining demand. The market is getting more concerned and more players are having to pull out on a daily basis. The most important information will be the decisions made for the time after the summer break. For the coming weeks supply will continue to command the market.

Share this story: