Macroeconomics

The situation in general in the business and economical world is overshadowed by the tragedy in Japan and the difficult situation in Northern Africa and the other Arabian countries. The markets are presently still pretty undecided about what the consequences could and will be for the future.

Commodity prices have become pretty volatile. Commodities traded on the future market jumped up and down by more than the allowed daily limits and they are reflecting again the massive influence of speculators in these markets.

Energy is now going to become an even more important factor than in the past. As well as the problem of the nuclear plant in Japan and the military activities in Northern Africa, both of them are actually influencing the future enterprise for energy. While the disaster in Japan is questioning in many countries the use of nuclear power, there could be possible interruptions of oil supplies due to Western intervention in Libya driving crude oil prices much higher. Opinions are pretty controversial, but it is pretty likely that for a certain period of time energy supply and the prices will make the headlines. It is again the question of energy production, transportation and storage of energy what will be one of the major issues of economical and social discussions.

So far the financial markets are shrugging the problems off. It seems that the global financial community is taking the decision to ignore them rather than to deal with the problem and situation. Stock markets and commodity prices nosedived before recovering quickly again. After the deep crisis in 2008 it seems that the world and the people not directly touched by the catastrophe are not willing to accept another crisis and have taken the decision to ignore the possible consequences for the daily life of everyone.

In the meantime, financial speculators began trying to find the benefit of the situation and so they were investing into Japanese yen in the expectation that a lot of Japanese foreign investments have to be repatriated. That drove the value of the yen to new record levels and for the first time in more than a decade, organised financial intervention was executed to drive the value of the yen back. The interventions were so far successful, but it has to be seen if the speculators will try again.

As already stated, with stock markets turning around quickly, the oil price also bounced back after falling approximately $10 per barrel and so did also all other agri-commodities. The US dollar is losing value against the euro and went to levels close to 1.42 to the European currency. The European debt crisis is considered to be under control and the strength of the European currency is at the moment greatly related to investments from emerging markets into the high yielding euro bonds of countries like Spain and Portugal. With the dominating news from other parts of the world, the still unresolved problems in the euro zone are pushed into the background.

Market intelligence

The leather pipeline was pretty much uninfluenced by the catastrophe in Japan and problems in Northern Africa. Looking at the price trend of hides and skins over the past two weeks, one had the impression that these commodities are some of the few raw materials totally ignoring the situation and the consequences in the two different regions.

One fundamental reason why the leather pipeline did not show similar reactions than other raw material markets is the fact that no future markets or centralised stocks are used for this commodity. The market just follows the physical demand and supply.

And here little has changed (so far). The programs and budgets of the industry are made, the sales in the first two months of the year have been exceptionally good, and for global retailers and brand names, the tragedy in Japan seems to be local in not having any major impact on the global consumption of leather related products. Northern Africa has not got a great market share of consumer product consumption anyway.

This might be superficially true, but there are some possible consequences. The first is the great influence of Japanese consumers on the luxury markets. Japanese ladies will presently have other priorities rather than buying the latest fashion bag. This could even become true for some part of the Arabian world pretty soon too. Even if the Fukushima problem gets under control, daily life in Japan will be different for a while. Secondly, one should also think of other possible interruptions of the supply chain in the automotive industry. In the last few days, a number of manufacturing plants around the globe are slowing production down, because components from Japanese factories are missing. Although this might be substituted by other suppliers, it will take a while until this will be organised and handled.

The two sectors, luxury and automotive, are certainly not the biggest consumers in the leather pipeline, but for a long time now they have been the price clients. So it just has to be seen if any decline of luxury consumption or interruptions in the supply chain can and will be compensated by other markets.

For the rest, it is indeed true that the situation in Japan has had very little impact on supply and demand. The shoe business remains exceptionally good and there is hardly any reason why this should be negatively affected for the current season and production plans. The shelves and wholesale stocks are pretty well clear, budgets are running high and demand remains strong. The reports from the GDS shoe fair in Düsseldorf, Germany have been pretty positive again and despite the sharp rises for all kinds of components, retailers are ordering actively and remained totally optimistic for the rest of the year.

To meet all the demand and interest around the globe for leather shoes, beef consumption is still not enough and this makes the raw materials continuously more expensive. However, prices will certainly not reach levels which will make the breeding of cattle profitable just by the return of the by-product. Nonetheless, farmers will appreciate better returns and it will make their lives a little easier.

Our theory of the ‘survival of the fittest’ in the leather pipeline which we discussed in previous issues seems to gain more reality. We tried to explain that not only the logic of supply and demand applies to prices, but also the capability of market players to handle the economics. We hear numerous stories and messages where people report that an increasing number of tanneries have surrendered in the competition for raw material. Firstly, upholstery tanners were not able to convince their buyers to pay adequate prices for leather, and now more side leather tanners feel that they can’t compete anymore with their leather revenues in the battle for premium raw materials with the automotive tanners.

Many are trying to look for alternative and cheaper raw materials, only to find that they are not available at any reasonable price or volume either. Consequently, the phrase ‘cutting production’ has become popular recently and to be honest it is the only option for bringing the raw material market back into balance. This has also been the subject of our reports in the past. The market is entirely dependent on physical supply, which is as limited and restricted to beef consumption as the hide and skin market, and has no other option than to reduce the demand to get back into balance. Supply cannot solve the problem and if there are not enough stocks parked along the pipeline, there is nothing that can change the situation other than the decline in consumption.

We originally thought that financial restrictions would be the trigger for a change in the market trend, but so far there have been no real financial issues yet. However profitability has become such a big problem that we hear of more and more companies working on except strategies from full capacity production. With insufficient leather prices it makes no sense to produce more, only to lose them all.

As rough as it may sound, we knew already that all the existing tanning capacities around the globe had never been used in the past to the full hundred percent, because of a lack of orders. With a strong performance from the emerging markets and the massive recovery after the 2008 crash, tanners today could fill all the drums with their existing and expected order books, but they cannot secure the raw material needed.

This can also nicely be seen by the fact that demand is shifting. A lot of the well-established manufacturers are either producing at capacity limits or – for the reasons stated above – trying to turn leather orders down. Their leather buyers are consequently trying to find new suppliers and if it’s not for the reason of volume, it is for the reason of price. In their attempts, they visit and consider suppliers which have desperately tried in the past to find access to premium customers, but have never been successful. They are shocked with these new chances, but the new business opportunities will fail due to the inability to buy adequate raw material. The tanneries from the second line can hardly understand, and this creates great frustration.

However, with these tanneries suddenly now showing up, the suppliers get the impression that leather demand is far better than what they thought. This has had a logical effect on prices too and was supporting the raw material levels. As good as the demand for leather and the related raw materials is, it looks even better than it actually is from the daily market perspective due to these circumstances.

This leads to the question which is now raised in endless conversations. Can this go on, and if so, for how long? The answer to the question for the first part is, yes it can. The answer to the second part is, absolutely no idea, but not before supply and demand are back in balance. Since the past two weeks have not been enough to change to a lower gear in the industries, it might need more clear signals from consumer demand to let companies reconsider their budgets and production plans.

In the meantime, the game of the ‘survival of the fittest’ will just continue and spread its effects eventually.

The split market continues to follow its function to be a balancing factor for the hide and skin market. Demand rises with every leather manufacturer considering splits as a possible alternative to grains. Consequently, the split demand is also good and prices continue to display strength.

The skin market is also extremely firm. With more seasonality playing a role in the markets, some of the trends are even more pronounced than in the bovine section. The shortage of wool, and the steep rise in price is supportive of the prices of all skins carrying good quality wool. Skins suitable for the UGG style boots or for lining in general are pushed by the fashion and tanners in need for the lightweight double face qualities. With the season of the kill of the suitable material not really started in the Northern Hemisphere, it is however spilling oil into the price fire.

What shall we now expect and predict for the next two weeks to come? Well, again, not much. First of all we wish the people in Japan all the very best and hope that the tragedy is not going to have any bad follow-up. The same applies for the innocent people in Libya, Yemen, Bahrain and any other country where military action and riots are threatening lives. Let’s hope that they can quickly return to safe and peaceful life. Also that they can afford all the other necessities a human being needs to live an adequate life.

The question of what the leather pipeline does in the coming weeks is indeed an issue of minor importance under these circumstances.

Let us believe that most of the market activity will be put on hold until the trade gathers in Hong Kong next week. Sellers will remain reasonably optimistic with all their stocks pretty well clear, and will not see any particular reason why they should listen to the complaints of their buyers. We hope that the APLF will bring the market corrections they have been seeking for a long time. We should find a bit of transparency during the event and from the discussions many suppliers are going to have around the fair.

We will certainly share our investigations, findings, feelings and insight with our readers in our next issue.

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