The financial markets were pretty quiet over the past two weeks. While the European Central bank is already reacting against inflation, the American FED is continuing its policy of easy and cheap money. Interest rates in Europe rose by a quarter of a percent and the indications are clear that further tightening is going to take place if prices continue to rise.

Inflation continues to be a serious issue around the world. Prices all over for the basics of life such as food and energy continue to rise sharply and quickly. Inflation rates, depending on the reliability of the statistics, have reached levels between two and 10% around the globe.

The threats to global stability are still in place. The situation in Libya is not yet under control, and one cannot see any end to the nuclear drama in Japan. The debt crisis in Europe is not easing and Greek, Portugese and Irish yields are climbing again. Greece is still the most problematic issue and one can hardly see how a complete refinancing programme can be avoided.

At the same time, the emerging markets continue to run their course under the lead of China. China was again reporting massive growth of industrial production and the foreign currency reserves have in the meantime exceeded the 3 trillion level. China continues to desperately seek investment opportunities abroad and, besides looking at access for raw material resources, more and more corporate investments are taking place. Further purchases of government bonds are also reported.

In the USA further moderate economical recovery is recognised, but the USA is also facing a huge budget deficit, like many other of the ‘old economies’. The Obama administration is trying to handle the problem with budget cuts and tax rises for the wealthy; a lethal therapy for the Republicans, who have announced massive opposition. With the present balance of the political power in the USA it seems pretty likely that Obama is going to have a tough time. However, his opponents will have to answer the question of how the budget deficit is going to be handled eventually.

Countries like Japan, most of Europe and definitely the USA are facing big financial problems and are losing room to manoeuvre. It seems that governments and people don’t fully realise that there are difficult economical and social problems down the road.

The financial community is still playing the card of inflation. Precious metals are still at record levels, industrial metals are still high and oil trades around the USD 120,00 level, which is a worry for the industry as well as for private households, where energy and food bills will absorb more purchasing power if prices are not going to adjust.

Market intelligence

The market has turned into the correction mood. Tanners have shifted into a ‘wait and see’ position. Most of them seem to have enough raw material to lean back for a moment and check if either the selling price for leather can be moved higher or the price of the raw material can be dragged lower to get back into a positive margin.

Since we are entering the lower production season, the stocks can be stretched a bit and one can already see from the export sales statistics from the USA, that the big hunger for raw hides we had seen until February has faded.

Hides have just become too expensive to attract either tanners to purchase against their existing orders or traders/speculators to buy for the sake of trading profits in expectation of higher prices. Sellers who had been spoiled for so long by the endless road of rising prices since 2009 wanted to check the limits and now they know where they are – at least for the moment, in the present market conditions. In addition to the decline of producer interest, we also have to deal with the stocks of traders which have an increasing desire to liquidate them at a profit, and even some tanners who are not in desperate need anymore for more product and are trying to grab some cash and lock some profits in by selling arrivals on their domestic market.

The aggregation of all the above has changed the tone of the market and the trend of prices. Most of the global supply origins have either steadied or even turned the direction and a lot of prices have already eased from the peaks. As we said in our previous report, we do not believe in a market collapse, but the correction of even 10 or so more per cent would not be surprised considering how far prices have risen in the past year.

For those markets which are not operating in US dollar terms, the currency development is also extremely important. Against the Euro for example, the US dollar has lost approximately 10% since January 2011 which has made hides from Europe another 10% more expensive just for currency reasons. This hasn’t, however, reflected yet at all in the prices in Europe. So the correction potential not only in the old world, but also in Australia or New Zealand is possibly even higher just for currency issues.

Many people don’t like to hear that and this does not only apply to butchers and sellers. Tanners have been fighting so hard for higher leather prices, but the sudden and extended decline of raw material levels would make their positions tough and their buyers extremely complicated. Sellers tend to protect their position for too long and buyers generally miss the sensibility to feed the market with enough business to let it slide instead of preparing the sudden fall. It is, as always, the mixture between greed and fear, the ever repeating attempt to do everything right, to beat the market and to be better than the next door competitor.

For the moment the market isn’t sure if we are at the beginning of such a situation or if we are already deep into the same.

Fundamentally one has to believe that with the strong demand for leather we are just in a normal market consolidation. Rising population and the rising number of consumers in total around the globe, two years of strong recovery and a good clearance of wholesale and retail stocks don’t deliver a lot of arguments for any reason for a fundamental correction of the valuation of raw material prices.

It is pretty obvious, that the market has not found a fair balance yet between raw material and leather prices, but also in the valuation of leather as such in relation to the potential leather substitutes after the sharp rise of prices and demand since mid-2009. Since the market rules still work we see presently a reflection of the above, for example:

• Short supply chains for fresh male hides for the automotive industry are still showing the least reaction

• Luxury items are also still relying on strong demand and dispose of the largest added value potential in their value-added chain

• US hides are also more attractive in view of the currency situation and more US hides find homes in Europe to substitute expensive, local material

• Commodity upholstery related hides are the weakest performers as their price rise has never been really been actually been reflected in the finished product market

• Sheep and lambskins still suffer from the reduced herd and kill and face on the other side a sharp rebound of demand due to fashion reasons in the past years

• Financial strains are forcing a number of tanneries to manage their inventories even tighter, sometimes triggering re-sales of inventories to keep cash positions intact

• Traders and speculators are starting to cautiously liquidate their positions, since they feel that the chance for more profits is fading and the risk for missing the same is rising. Consequently there are also no real net buyers in the market at the moment

So, in the end everything is perfect market order. There is no way that a commodity market without trading futures can ever remain in the status of imbalance for a long time. Sooner or later the balance is always achieved and this is the way we are going at the moment. We still have a few open questions to be answered and one of them is how much leather buyers are going to pay for leather in the next season. For us, this is the one and only determining parameter where the raw material prices are going to go.

Over the past years we had a lot of speculative buying in the market too and manufacturers as well as speculators consider raw hides and skins to be a good investment. This has added to the physical demand of the industry and possibly manipulated the balance of real demand and supply.

What has to be watched carefully now is, in our opinion the, one and only real risk to the situation. National debt could become a similar threat to the financial stability. It is the simple logic that global growth cannot be strong enough to allow the government to balance its budgets just by growth. The growth needed would require such a big amount of raw materials, but it’s hard to believe that this can be met. It has to be either budget cuts or the rise of taxes; neither of which are really favourable for private consumption or investments.

This might not be a very popular opinion in the business community, and if we are realistic it will actually soon require innovation, in particular in the energy sector, to help the world out of this fundamental problem. In particular the emerging markets with their rising wealth will in the shorter term not have much mercy with the old economies. At the same time had the governments of the old economies presently have very little room to manoeuvre after they spent all the money to bail out the private banks in 2008.

Generally one has to expect that the gap between the rich and the poor is going to rise further, which is good news for the luxury sector and bad news for commodity products and the less wealthy in many parts of the world. As such, leather seems now to be at the junction of whether it’s going to become a luxury item based on natural raw materials in general, or if most of it is going to remain just material for the production of consumer products in general. This leaves out, of course, the existing small segment of luxury brands and accessories.

This is definitely not something which can be sorted out very quickly, but rather it is a trend which has to be watched with great care. However, as surprising as the collapse of the banking system in 2008 was, any major trouble in the financial system caused by the problem of national debt could arise as quickly again. One thing is for sure: there will be again no bell ringing before it happens.

The split market continues to be in a similar situation as the hide market. Demand is fine and even somewhat supported by the demand for more economical items in response to the high price level for hides. However, we are also dealing with the season and in the summer the need for product will fade. Anyway, with production levels falling for hides, the supply of splits does and so the market seems to be on safe ground.

The skin market is still untouched by the situation in the bovine sector. Too many problems on the supply side hold skin prices firm and one can hardly believe what kind of prices are quoted today for a number of items. In the forefront are the skins from Australia or the Southern hemisphere in general. With a severe supply problem, one can quote whatever one wants. Some smaller buyers cannot get any supply anymore and will either have to shut down, find alternatives (hardly possible) or switch to other finished products and articles to keep production alive. Fine wool skins, to quality nappa skins and skins suitable for double face are in short supply and buyers are running around trying to secure raw material for the coming months. Many hope now for the seasonal lamb kill in Europe to ease some of the supply problem; let’s see whether that will help. Generally we now face in the skins market the same problem as in the bovine sector. Raw materials are just too expensive and need to be adjusted and supply and demand will need to be brought back into balance.

For the coming weeks we cannot expect anything else than the continuation of the correction and adjustments of the markets. The market for hides for the side leather and automotive production is still reasonably well supported and the correction potential is not too large for the short term. Hides for the upholstery sector face more headwinds and might also risk larger adjustments needs. However, since the order books of the tanneries are still reasonable well-filled, only the upcoming summer break in Europe will have a negative impact on demand. So, we are convinced of further price adjustments, but it seems that it will not come easy, with sellers defending and the surplus of material to force sellers to deeper price cuts. However, this indication for a slide rather than a fall might suit everybody.

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