Macroeconomics

The global situation is becoming pretty tricky now. While China, India and some other emerging markets are fighting with inflation, in the rest of the world the recovery is stable. There might be an exception in Germany, where people are already talking about a boom. Growth rates are high and private consumption is also gaining pace in the meantime.

However, a lot reminds one of the situation in 2008. With the exception of the massive national debt which has increased by so much since the crisis, many other things are looking pretty much the same. Raw material and commodity prices have reached high levels again, inflation is becoming a very problematic issue again, but at the same time global investors and politicians are still claiming that things are on track.

The gold price is training around $1400, silver is well over $34 in the oil price has reached levels of more than $100 per barrel, with prices at gas stations shooting up too. As optimistic as people may be, energy costs for companies and private households are rising drastically and those living in the northern hemisphere have been facing a reasonably cold winter again. The bill for the heating oil is still going to come. Food prices are increasing as well and nobody can tell us that this is a healthy and stable economical environment.

Political unrest continues to spread in the Muslim world. It is not easy for Western politicians to handle the situation and to quickly drop their counterparts which they have considered, to guarantee stability in the region. The media and politicians are welcoming the changes and claim that they appreciate the changes to democracy. In theory this might be true, but there is definitely no guarantee that the countries will just shift into anything like a Western-style democracy and that internal stability will be granted. It would be more than a surprise if a peaceful and successful change in all the countries in northern Africa and possibly also around the Arabian Peninsula could be achieved straight away.

With a global dependency on oil, any threat to the supply by widening unrest would become a serious problem for peace and the global economy. We cannot know how politicians are dealing with the subject at the moment behind the curtains, but we can only hope that not just the political changes can be achieved reasonably peacefully, but also the installation of new political and administrational structures will be successful and not violent or unrestful.

Over the past two weeks the currency market had no clear direction. The impression that the European debt crisis would ease made the euro stronger and the unrest in North Africa supported the dollar again with its safe haven status.

In the end the USD traded versus the euro in a range of 1.34-1.38 and was just bouncing up and down.

The EU is now planning to install the general economic government, but generally it seems it’s going to be a toothless tiger. Little to decide, but more cost and bureaucracy meant their financial community was not too impressed by what has been decided.

Market intelligence

The development of the pipeline and the raw material market over the past two weeks was just an extension of what we have seen in the previous period.

Tanners in Asia returned from their holidays with the hope that raw material prices would have reacted to their absence. However they quickly realised that the forward positions of the producers and sellers were good enough to maintain their price ideas and left enough courage to increase asking levels even further.

The driving force remained the automotive industry. Strong demand for leather kept buyers active in the market and they had little choice but to follow the ambitious price ideas of the slaughter industry. This was of course still supported by the reasonably low kill which we have seen all over central Europe for some weeks. Certainly it depends a lot on transportation cost and payment terms, as some were claiming.

As usual the big figures were also a great psychological barrier. Consequently, tanners are now fighting hard to not let the market pass on to the next euro levels. Most likely it will be decided next month whether we are stepping into a new period in new ranges of high valuations. We see a similar pattern in the US, where the triple digit levels are already well in sight.

Well, will we really get that far? Will raw material prices for the leather pipeline follow to the extent of other commodities such as metals, cotton etc? There is no question that leather producers are mostly operating at a loss at the moment and the normal reflex also remains; this has to be resolved by falling raw material prices.

There is quite a bit to say about this. Fundamentally it is always a question of added value along the production and retail chain. If we look at the price development of veal skins over the past years, this may give us an indication for a different perspective on the problem and how it was handled in the past.

Prices for veal skins have become relatively more expensive over the years, because of their exceptional quality and the tremendous success of luxury leathergoods. Although the big brand names are not very famous for sharing their success with their suppliers, some of it is reflecting in the raw material price today. Many may argue that the reflection is still not big enough, and prices are difficult to negotiate but so far the solution has always been found. The material is so prestigious and such an important part of the final product and its image, but the price for leather is not the obstacle for the total calculation.

For normal cattle hide the situation is certainly a bit different. However, in this field we have also seen little niches which are acting in the same pattern that we see for veal skins. There are some selected hide regions which are so high in quality or so specific in their characteristics, that they have found their own individual valuation. They look pretty expensive in relative terms, but still obtain their prices on absolute levels.

When this discussion is extended to the hides suitable for the premium automotive industry we see a similar situation. The only difference we have is that automotive manufacturers are not willing to share their success with their suppliers. It is indeed pretty difficult to explain to the butcher or the farmer why a superior leather interior can cost up to EUR10,000 and the raw material required would not cost more than a maximum of 3-5% of the price. Excuses about cost and profit do not apply, because in today’s world it is pretty easy to analyse added value, production cost and prices.

The industry is still ignoring the fact that their business is based on a specific by-product which is sometimes more and in this case less substitutable. It is however, still a by-product and to grow in volume can consequently only mean to pay higher prices to obtain more material from competing segments which use the raw material for other products and have either less returns or more workable alternatives. In any case, it is wise and necessary to check how the suppliers are doing; otherwise it could be pretty expensive when cars can’t be manufactured because the leather isn’t delivered. Some may remember the situation last summer. Ultimately, we are back where we were some years ago and what was only interrupted after the 2008 crash.

If the premium automotive manufacturers want a steady influx of leather of a superior quality they have to build a price shelter around this material, so that the majority of the material ends up in the drums of the leather manufacturer. In case the demand for the premium cars is so strong that the total volumes can’t be met, the price for a premium leather interior has to be increased by so much that the demand shrinks and the total gross margins remain the same – in a perfect world. It must also be accepted however, that more demand for leather interiors, extended sales plans and ambitious budgets are not generating more adequate raw materials.

The situation in veal skins and a high-quality mail material is pretty specific. Since they are reasonably limited markets and have specific high prices and products, the situation and analysis is much easier than for the more standard and commodity qualities.

For leather made from more economical raw materials many other factors apply. There is far more influence on the consumption per production unit, and many more options or substitutes offer significantly increased flexibility to deal with price variations. What speaks for leather at this moment is the rising risk of inflation and the rapidly increasing price for oil. Many leather alternatives are still based on oil-related materials and their price would consequently also increase substantially if the price for oil was boosted by the political unrest in the producing countries. In the short-term, nobody will realise that because prices for PU, microfibres or any other artificial products are fixed already, so it’s for a longer period of time. Traditionally it takes between six to nine months until the price of oil is actually reflected.

Under these conditions the defence line for more commodity style leather is definitely much stiffer and those lower in price in the market find it extremely complicated to digest and understand. But for the moment new prices and quality relations are established for all materials. This applies in particular for agents where the quality and the use of the material is widespread.

With the rising price problems, the split market continues to benefit from the situation. Splits are considered more and more as an alternative to expensive grains and, as expected, with every season change more splits will make their way into leather production. Consequently, prices for splits are steady and in many cases they continue to rise.

The skin market remains sheltered and supported by the situation in the bovine section. Prices have lost a bit of dynamism and steam, but the market continues to be firm. Skins which offer a decent return of wool prices are, in particular, still stable and rising. In Europe the industry is already starting to become concerned about the next season of new season double face lambs. The demand for lining in the garment remains very strong and tanners are more than concerned that they will be able to obtain the quantities of raw material they require to fulfil the orders that have been indicated by their customers. Spring, when the lambs will be produced, could become pretty tricky and we have already seen this market overshooting a number of times. Let’s hope the market is going to cool off before the season starts to prevent from all the related problems.

The coming weeks could become pretty tricky. The resistance of the leather industry to deal with ever rising prices is growing. The uncertainties about the situation in northern Africa will also play a very important role. More and more national banks are admitting that interest rates will have to rise to fight inflation. Energy prices, food prices and other basics also seem to become more expensive for the rest of 2011. Rising raw material prices could be a support for the raw material market, but rising energy prices and interest rates are also a tremendous threat. As long as the big retailers and brand names are still fully optimistic about their sales and continue to indicate strong demand to the manufacturers, there is very little chance for any relief on raw material prices.

However, we believe that financials in this business are extremely important, and the market could get pretty volatile if first payments do not come in on-time anymore. Sellers of raw material would then rather sell a little cheaper. In the end it’s the classical game of ‘the survival of the fittest’.

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