Macroeconomics

The financial markets have mainly been driven by the weak performance of the US economy. The problems Irish banks are facing and the strikes in many countries have pretty much been ignored. The markets believe that Europe can deal with the problems. What a change from the situation of just a few months ago!

Indeed, the actions and precautions being taken are impressive, but the impact of the crisis is certainly not over for Europe yet. Germany seems to be making the best progress, with its labour market recovering quickly, private consumption picking up and budget problems not developing as badly as many had expected. Most other EU countries, however, are still dealing with deep structural problems and there is still no guarantee that Europe isn’t already over the cliff.

For the moment everything is different and the market sentiment has changed. In the first half the ‘experts’ were convinced that the US would recover much more quickly than the EU, that interest rates in the States would rise more rapidly and that the Euro zone would break into pieces because of its many different economies, cultures and politics. The euro was considered to be an endangered species and back then it was only a matter of weeks before it would have reached parity with the US$. We tend to forget things very quickly, but this was only about six months ago.

Today everything is said to be different. The US is believed to be losing its global leadership status, the Fed is printing US$ and will flood the economy with cheap US$ forever, the labour market and property market remain weak and the political scene in the country is turning away from change in favour of old methods. Now it is the US$ that is descending, and we wouldn’t be surprised to hear the experts saying very soon that we should be preparing for new record lows.

We are only mentioning this to show how useless any kind of media coverage is these days. We can no longer expect systematic and analytic explanation; it is more and more about the interest of speculative money or, more accurately, the excessive liquidity in the markets that set the new trends. It’s worth remembering that it is not the physical supply and demand for money, interest, commodities and currencies that is setting the prices, but the virtual money set in red or black in the form of ‘investments’. So it doesn’t matter what the trend is, so long as we have one and can ride the waves, finding ourselves almost back where we were before it all happened in 2008.

So, the same people who were doing down the euro are now doing the same to the US$. Over the last three weeks it has been declining at almost exactly three cents per week. It looks pretty planned at the moment and devaluing the greenback and buying commodities is something we have seen before. The expectation we had towards the end of the summer that volatility would sharply increase proved to be right. For the moment the ‘big money’ is still in devaluing the US$ and any potential threat to the euro is being ignored. For those who are not part of the US$ zone it will be necessary to keep an eye out to see how long the devaluation policy of the US investors will continue. After the sharp decline there is at least a chance for a rebound; if only for the sake of profit making.

The other main subject to discuss is the US decision to threaten China with a trade war. The intention to implement trade sanctions and import duties on various goods that are made in China have attracted strong support. Again this is more about domestic political affairs than presenting a really impressive move.

Before jobs return, consumers (and not only those in the US) could miss out on a number of products at affordable prices. It makes sense to start by analysing which products can be made, and at what cost, in order to meet demand.  A lot of people are pretty happy with what they are getting at the current prices, despite what they say.  Anyway, this is still a long way off and at the moment the US government and other interested parties are pretty happy to see their currency weakening again.

Market intelligence

The past two weeks delivered rather more excitement than we really expected. Possibly less in US$ areas, but in Europe the failure of a tanner in Scandinavia, which we reported in our last issue, was the trigger for a market change. With another automotive leather supplier in Austria failing last Friday, the market for heavy bulls, which have been trading far above their real value for some time, got a shot in the arm and corrected by 5-10% in a matter of hours.

Prior to the summer holidays we indicated that the high raw material price levels and the sharp and quick rise of prices will stretch the financial resources of many tanners, particularly in Europe. This was another example that the European hide market hasn’t really matured and that sellers are still trying to test the limits and to go beyond them rather than carefully managing the values and returns.

The writing has been on the wall for quite some time and proof that tanners have been stretched for margins and cash flow has been available. In the end, some had to burn their fingers before everyone realised that strong demand doesn’t mean raw material prices can be overstretched. There is still not enough trust within the industry to prevent the consequences we are seeing.

Although it is not really the big players that are failing, and in the long term the influence on demand will not be remarkable because the leather will still be needed, the beef industry needs to understand that adequate prices for finished leather have to be achieved in order to justify raw material price levels. Leather prices are far less flexible than raw material prices. For a short period exaggerations can and need to be managed, but moves that are too fast, too high and too long-lasting cannot be sustained. Ignorance about the economic realities might not affect everyone to the same extent or at the same time, but the market realities impact on everyone sooner or later.

With the sharp decline of the US$ against many raw material origins, the global price structure for hides has changed again. The biggest change can be seen for European and Australian hides, which have become far less competitive. Meanwhile, since US prices have more or less stopped advancing they have become increasingly competitive. Tanners, however, did not consider US material prices to be particularly cheap. The $80 barrier for US premium steers has remained a pretty strong obstacle for the market and tanners have not been willing to pay more because of the margin problems they have.

European males have been out of the price range since early summer because of the lower seasonal kill, strong demand from the automotive industry and the dependency of many on fresh hides due to quality and effluent issues. We already considered the gap to be about 10% and this expanded to 15-20% before the market started to realise what was happening. Although the market has not really established new levels, we got the impression during the last couple of weeks that something like a half-way correction has already taken place. A lot will now depend on the currency market, the development of the US packer market and the results of the trade shows that are taking place in the coming weeks.

Lower quality standards

It seems, however, that leather prices will not be able to solve the whole problem. From what we are hearing, some increases have been achieved, but not enough to compensate for the raw material price levels. There is still no problem in terms of leather demand and from China we are even getting positive news about order intakes. The industry solution today is to downgrade leather quality and to use cheaper raw material qualities. Many cheaper raw material origins are reporting increasing demand and the normal supply markets are sensing more inquiry for lower-grade material.

Demand from China, in particular, is reflecting this trend. Local demand remains high and consumers are shopping. The moderate appreciation of the RMB against the US$ is helping import prices and is also stimulating prices for domestic hides. The situation is less attractive for the industries that are mainly involved in exporting. As they are getting far less competitive, production has been heading to other cheaper countries for some time.

The strong performance in terms of domestic consumption, however, is not helping with the price problem for raw material. The spenders in China are either wealthy and prestigious, looking for expensive luxury items, or are low-income shoppers looking for cheap goods. Even the so-called ‘middle class’ is not buying ‘middle price’ items. Either they are also bargain hunters or selective luxury shoppers. Consequently, demand for top-quality raw materials and low-priced items is still pretty strong, while the average-quality items continue to struggle with demand for volume and value.

This fundamental problem hasn’t been resolved for a long time. None of the discussions and complaints have helped; they certainly haven’t had any influence on the suppliers from Europe. Nobody can foresee the currency movement, but the situation is obvious even without the currency variations. The butchers have no responsibility for the economic success of the leather pipeline, but in their own interest a certain recognition of industry feedback would help them to manage the volatility and long-term safety of their by-product. After a long period of over-valuation, the market seems to be entering a correction phase. Traditionally, a long period of overvaluation is often corrected with a period of undervaluation until a safe base is re-established.

This way of looking at things is not popular with everyone. It is the old conflict between those who want and need market movements and believe they can beat the market and those who are interested in stability and security. In the industrialised world where information is not only available, but also reasonably easy to get, a fair price analysis can be made for a season. The industrial players (packers and integrated tanning industries) overseas are already well ahead in this subject, but in Europe the market is still too fragmented in terms of quality level and supplier so it is currently missing the necessary discipline and organisation to manage this professionally.

Change ahead

The split market has also lost a bit of steam. The high level of production isn’t making the distribution of splits as easy as it was leading up to the summer. Even the good demand from the collagen side is failing to make things really easy. However, if the leather industry is now seriously focusing on more economical products and the food industry performs according to the long-term cycles, this situation should be a temporary one rather than a real threat.

The skins market is still in good shape. Rising prices for wool and seemingly good demand for leather garments and ladies’ shoes are supporting the interest for skins. Fine wool skins, in particular, are still enjoying good demand, but interest for skins that are suitable for nappa production are also outstripping supply. The price problem is the same as for cattle hides. Skins were undervalued for a long time and were an attractive alternative for bovine material wherever they could be used. With the recent rise in prices they are now reaching their limits. Fashion and temporary shortages may allow prices to inflate, but we could run into a similar problem to the bovine market.

In the coming weeks we think we will reach a pretty important junction. The Lineapelle fair in Bologna might set new directions. For the moment it seems that the tanners becoming more confident that they are finally in a position to influence the market with their problems of profitability. This might apply more for tanners in the tanning centres in Europe, but the Chinese tanning industry is not happy either.

Government restrictions and effluent controls are adding to the concerns in China. While Chinese tanners are aggressively looking for cheaper raw material alternatives to meet the demand for leather and to make a profit, many European tanners will now be busy testing the market and checking how desperate sellers really are to distribute their hides. One must not forget that fresh, chilled hides play a much more important role and that one hide too many can create the same problem as one hide too few.

The coming weeks will, at least in Europe, be dominated by anxiety. Abattoir prices need to be fixed, the Bologna fair is approaching and the currency market is adding to the trouble. The US market could possibly benefit from the situation as it is now more attractive in terms of price and has been less volatile for a while. We think that the period of adjustment and correction is not finished yet and it may still take some time for the market to sort itself out. We just hope credit insurers and banks do not create any more financial problems going forward.

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