Macroeconomics

Like everything else, almost everyone in the financial community is on holiday. They are taking a rest to prepare for the battles ahead. Consequently, not much is happening. Even if any economic news was being published at the moment there are not enough players around to convert it into something sensible.

The US$ has totally reversed the trends we saw during the second quarter and is now losing its value against the euro almost daily; or better said, the euro is gaining its strength back. There is no longer any mention of the great worries about a European debt crisis. It seems like concerns about the euro breaking apart, countries needing to be bailed out using emergency measures and the risk of a domino effect dragging others behind it was just a bad dream.

We are hearing nothing anymore about the US$ being a safe haven, and everything that was going for it has now been turned against the greenback. Nothing is new about the lagging recovery of the economy, the fading shine of the president, the high cost of the wars, the stagnant labour market, but the thing that is now making the headlines is the value of the currency. On the other hand, people are using the recovery in Europe, led by German exports and the superficial success in fighting the debt crisis, as the main argument for the recovery of the euro, which is now rising as quickly as it was falling before. The recovery has already exceeded 10%, bringing the exchange rate back to almost 1.33 on Friday.

From an outsider’s point of view, these movements appear to be based on speculation. The same people who were predicting the impending parity a few weeks ago are now celebrating the recovery and predicting the endless tumble of the US$. There is no question that, as usual, most of it is about trying to make money from speculations and trends.

European politicians are celebrating their rescue of the euro, but what they are totally overlooking is the fact that the currency was never really in danger and the devaluation was possibly one of the biggest pieces of luck they had during the recent crisis. The currency adjustment, in combination with the strong performance of economies in Asia, was what really brought about the rescue and the favourable exchange rate enabled European companies to not only secure orders, but also to generate favourable margins.

The other commodity markets gained some momentum in response to the weaker US$. Oil was able to leave the long trading range of US$70-80 per barrel and traded at around US$82. With the global economy stabilising, gold is losing a bit of its security and has stopped its rise for the moment. Some agro commodities rose in response to weather problems and we could see further gains later in the year as some of the dry, hot weather over the summer could create shortages not only for animal feed and general foodstuffs, but also for bioenergy plants.

Market intelligence

This issue will once again be strongly influenced by the holiday season. For the coming two weeks the majority of the industry will be on vacation and will be following the leather pipeline through their smartphones and Wi-Fi hotspots rather than from their desks. They won’t be doing too much, so they will be well recovered for the challenges ahead.

The last two weeks were pretty much a repeat of the previous two. Trade was reasonably light, but was still enough to clean productions for most origins. What is impressive is that the product flow has remained totally intact. Looking at the weekly sales numbers and reports, it is pretty obvious that at least the raw materials for medium and higher qualities are well cleaned up. Despite all the complaints about prices, tanners are still buying what they assume they will need. In combination with the results and forecasts from the shoe, leathergoods and automotive industries, budgets are more likely to be inflated than deflated for the coming seasons and this means that the pipeline continues to ask for steady, if not increased, volumes.

Even during the summer period so far there has been no real decline in orders and raw material requirements. Manufacturers have no choice other than to follow their order books and the indications they are getting from their clients. Since retail and brands had a better-than-expected clearing of inventories in 2009-10 and since results have been extremely positive for almost every company related to leather products, almost all budgets and sales forecasts have been upgraded. In this respect, it doesn’t matter that most of the increases came from the markets in Asia. In the end, it’s the numbers that count.

Upholstery leather segment suffers

The situation for leather upholstery is a lot less stable. While in 2009 the real estate boom in China supported the recovery in this market, the situation has cooled significantly since the first quarter of 2010 and although property developers in China are still as busy as before, the volume of business has already slowed and warning voices about a collapse in the property market are rising quickly. We can see how concerned the government in China by their stress tests for banks, which suggested property prices would fall by 50-60%. The question is how much these stress tests and numbers are worth in a economy that is still totally run and controlled by the single-party government in Beijing.

Looking at the business and talking to ‘insiders’ in China, the general consensus is that the property market is cooling much faster than the available statistics are allowing the public to believe. It seems government measurements to restrict credits to slow the market down and to stop further speculation are definitely working. For leather upholstery producers it means that a lot of excessive demand is also being removed from the market and this is the only section where leather demand has really come down.

It never stops, however, so the problem is not hitting everyone at the same time or to the same extent. The established names in the industry are still fairly busy and seem to be able to limit declines in production. Those who have been hardest hit are the small operators, who mainly work for the domestic market in China and use the cheapest production environments in the country. Much stricter pollution controls have also made their lives more complicated and have increased production costs. Companies have either had to relocate productions, which means set-up costs and increased transportation costs, or have had to find new ‘deals’ with the authorities, which also means there is more money involved. This is all happening during a period of falling demand.

Easy money

Apart from these problems, which in China are traditionally quickly resolved when money can be made, we would like to draw the reader’s attention again to a subject we have raised in a former issue. A lot of finance for industries such as tanning in China is actually a by-product of the cheap money supplied to other industries, which had far more access to credit than they actually needed.

A lot of this cheap liquidity was redirected by owners and management teams to other businesses or ‘friends’ where the profits allowed a decent margin for both the tanner and the business handing over the unused credit. This was easy money to make and with the cheap raw material prices of 2009, strong demand and healthy margins, it was a fantastic deal for all of them, particularly for the guy who made money simply by offering his unused financial resources.

With the present raw material price levels, government restrictions and falling demand, margins have disappeared, risk has substantially increased and the money-making machine is more than stuttering, for tanners operating within the domestic upholstery market at least. It remains to be seen whether there is still credit that needs to be repaid.

We can definitely see that demand for upholstery-related hides has fallen and there are few indications that things will improve apart from a possible seasonal improvement after September. Apart from the declining demand in China, the furniture markets in Europe and the US aren’t too positive. It seems leather furniture is becoming more and more a niche product at the moment and there is little indication that it will be in fashion again soon. Maybe a smart product placement in a blockbuster film would be helpful.

So far, a lot of the hides that have become available because of this decline in the upholstery market have been absorbed by other segments, but it seems it is becoming increasingly difficult for lower-quality hides to find homes if they are no longer needed for the upholstery market. Despite robust demand, it is mainly for better-quality materials at the moment.

Darker days

The split market is also in the summer doldrums. It seems that niches are still doing reasonably well, but the mainstream products have been hit by the summer break.

Skins are also finding rising resistance with the exception of top-quality nappa material, the final skins that are suitable for double-face and some goatskins that are used for ladies’ shoes. Other skins are finding it more difficult to sustain their performance, mainly because of price resistance for tannery wool in China. This important part of the calculation for tanners in China is not performing the way it was until recently.

On top of this, we are in the summer season in Europe and neither production nor the temperatures are inviting Chinese tanners to be active in this market. The upcoming Ramadan season with its increased slaughter of lamb and sheep will also increase the availability of skins, which will also play a role in the market analysis for tanners at the moment.

In the coming weeks we don’t foresee any major influences that could change the market. We follow the concerns of some European voices, who believe that the stronger euro has not yet been reflected in prices at abattoir doors in Europe. The euro has gained about 10% since mid-June and prices have hardly reacted at all.

This might be explained by competition, changes within the structure of the beef industry in some countries, the low kill and comfortable sales positions, but at the end the real value of hides counts. The fact is that selling prices today are not reflecting the abattoirs prices, and sooner or later the gap has to close. Without sharp gains in alternative supplies the EU market is ready for a correction. In US$, however, the market still looks pretty solid and it is hard to believe there will be any major triggers before the All China Leather Exhibition in Shanghai (September 1-3).

Share this story: