Macroeconomics

The financial markets continue to be trapped by the weak performance of the US economy and the uncertainties of the EU debt crisis. Although more and more countries in the EURO are getting approval from their governments for the EFSF boost, concerns regarding the long-term stability of the EURO are not fading.

The EURO and the system remain under attack from various directions and the situation continues to be very fragile.

The GDP data delivered by the USA was a bit better than expected, but the economy remains weak and the labour market problematic. Slowly but surely the problems of Western economies are starting to influence the situation in the emerging markets where falling exports start to worry industries and investors. Industrial production in China is starting to fade and the booming property sector is also sending negative signals. Empty apartment blocks which were not an issue of discussion for a long time are now starting to raise questions about the future of the real estate market.

One can already see how sensible the markets have become by the daily ups and downs of the stock markets and the commodity prices. Daily movements of 2-5% were pretty common, but the general trend remains down rather than up and the end of the third quarter looks back on one of the worst quarters in a long time.

Stock markets are down by large double digit figures and so are most commodity prices. Considering that both markets are trading expectations and the future, one has to be sceptical about the global growth in the quarters to come, and most experts and analysts are running to reduce their forecast now. Retail sales in Germany and the US are underperforming and leave growing concern about the economies. Also critical is rising inflation in the EURO zone (2.6 %) which is not making the life of the ECB any easier when it comes to interest rates.

However, the optimists have not disappeared and investors, for lack of an alternative, are fighting hard to stem against further declines. There are still a number of positive expectations circulating for commodities such as gold and oil. Despite the recent correction, one has the odd feeling that present prices are still not reflecting the realities of supply and demand and continue to be inflated by financial investments. In particular for gold many investors still play the ‘safe haven card’ and see the present decline just as correction and a good chance to buy. For them the USD 2.000 is only a milestone on the way up to USD 2.500 and oil prices are also expected to rebound due to the ‘endless’ hunger for energy of the emerging markets.

Well, sometimes one gets the impression that there is a lot of wishful thinking and whistling in the dark. One shouldn’t be overly concerned and depressed, but the other extreme could be pretty harmful as well. Looking at the charts and the daily price movements, one has the impression that the levels of USD 1.600 for gold and USD 100 for oil (Brent) are magic and aggressively defended by investors. If they break and follow the market fundamentals it could become a difficult time for those holding positions. Serious analysts in the physical markets see prices for oil realistically more close to USD 80 than 100. The EURO continues to suffer from the situation and ended the period at levels around 1.35 which is low versus the levels above 1.40 seen in the second quarter, but still far above the 1.18 level when it was started.

Market Intelligence

The leather pipeline is starting to run into difficulties. For quite a long time the market has been struggling to find a level of fair valuation, and a number of people have failed to understand the logics of hide valuation. On the supply side in particular, a great number of suppliers were impressed by the strong recovery of the market after the 2008 crash and the very positive results of many public companies using leather and selling products using leather, such as automobiles. This has encouraged many of them to believe that controlling supply is also authorizing to set the price levels.

The success of luxury brands, auto companies and their impressive profits has left the idea that if the product makes money, the materials should also get their fair share of the profit. That might be true in some cases, but the idea of the supply chain is not to share profits and/or losses equally, and so we got another nice example how inelastic and sensible prices in this supply chain are. It hasn’t got any better since the leather pipeline is more and more a producer-to-producer business.

Things have changed in the past years. Prices today are far more determined by plans, budgets and forecasts rather than day to day trading, and in the attempt to meet targets and fulfil forecasts the price side of the business, there has grown a static belief in reports and ‘benchmarks’. Today, this is how sales and purchasing departments define and justify their decisions. It is becoming critical when a rising number of independent observers feel that the information given and distributed is moving more and more away from the market realities.

Sometimes in the past months one has had the impression that the hide market was a bit like the economy and many players a bit like the politicians in the present crisis. For the sake of rescue and safety, blending of the truth is allowed. In the case of the global and European economy, politicians make the EURO citizen still believe that things can be sorted out without too much harm and cost for the individual. The policy is: Deliver the risk and the bad news in small chunks to avoid an immediate avalanche of consequences which could take things out of control and make the consequences more profound in the end.

In the hide market, a lot is oriented around the strong performers (automotive high quality and luxury accessories) and the business there is said to be representative for the entire situation. It is not. The leather market has become much more fragmented with rising wealth around the globe. Leather is not a material which has to be used for some products. It can be used, and if somebody favours the material then he or she is willing to pay any premium. This is however not representative for the entire use of the material. It cannot be repeated often enough, that where price is a dominant factor in the calculation, leather can be reduced or substituted.

Since most of the consumer products which are made from leather are actually very price sensitive, the price of the material qualifies or disqualifies to a great extent. In addition, it has never been a seasonal product. Most of the finished products made from leather are actually dependant on big retailers and brand names and their decisions for materials and prices covering the next seasons. This means decisions which are going to take effect only six to nine months after they have been taken. Since the raw material business is a very short term activity, many of the players are neither willing nor in the position to consider that in their day-to-day valuation of their product.

The logic of many raw material suppliers in the past year also has been that increasing populations, growing wealth and steady supply will lead to rising prices. This position was also supported by the general trend in the commodity markets and the fear of inflation and the general trend of investment into commodities. The trend was also supported by some speculating buyers who took a similar opinion and were willing to pour the necessary demand money into the market.

However, prices had gone too high and with alternative materials being more stable, reliable and cheaper, a higher number of substitutions took place than the potential growing demand was able to cover. Consequently prices in the third quarter were moderately declining and all ambitions of the producers to hold the market out were in vain. Most of them were just thinking that the declining demand was the result of the holiday period and the low season of the summer, but they had to know better in September when the month did not deliver them the uptick in demand to hold prices steady.

Another big problem of the current market situation is the unequally divided demand for the different quality segments. While the edges, the very high and very low end of the quality range always find their customers either by prestige or price, the average section is the critical one. As usual, average quality is not good enough to satisfy the demand and the top end of the range and it is far too expensive to be used in the low end, price sensible market section. As long as the price trend is up or at least steady the owners of the material are trying to hold on to it, because there is always the hope to cover the cost. As long as cash flow allows and interest rates are low, people are quite comfortable to bet on the chance to get compensated for the product in the end.

This situation does not only apply to raw material people, but much more to tanners and manufacturers along the supply chain. This makes the lives of upholstery and automotive tanners extremely complicated, because they’re cutting patterns from much less flexibility to use such material up. Consequently we hear a lot of rumours of people seeing the finished material sitting in the warehouses of traders and tanners waiting for customers or an adequate use. They become more and more of a pain. The big question is, what is the correct valuation of the material? Producers who are ending their fiscal year at the end of December already see the threat for the valuation coming up and decisions have to be taken of whether the stocks should be liquidated at the prices they can obtain (subject to finding a buyer) or if they should be kept with the risk that they need to be evaluated for the balance sheet. Difficult decision.

Despite this, we have been warning that this market could become strongly influenced by financial issues. Cash flow is always a problem in this business and in particular when prices are high and turnover is slowing down. This has been exactly the situation during the summer and the rumour about the larger failure of the leather trade in one of the shoe centres in China did not come as a surprise. The fact is that one of the large leather trading operations in China has failed and left a lot of unpaid invoices. What this means to the business nobody really knows, because such issues are definitely handled differently in China than in other parts of the world, but one thing is definitely for sure: it is not going to make things easier and many may have forgotten that the tax evasion in China already had negative consequences on the trade during the summer.

Money is a growing matter of concern not only in China. Also in Europe a lot of people of the trade are reporting that payments are no longer coming in as fast and as punctual as they had done before. Obtaining the necessary credit insurance covers and to receive payments in time is becoming increasingly difficult and confirms that finances these days are for some companies a headache. We all know that it needs very little for bad things to happen and financial problems occur.

Maybe many people had good arguments to be more positive than we were and are. Certainly the number of rich people globally has increased and the demand for luxury products has been and will be pretty strong. It is no question that the rich are also willing and in the position to buy more automobiles as well. This is however not the case for the majority of consumers in general and in particular for leather too. Apart from the psychological influence of purchasing decisions, the price is still one of the most influential factors to decide for a product and this hasn’t been too good for leather since the peak prices.

We don’t expect that sellers in a strike of philanthropy will reduce their prices to rescue the global demand and use of leather. What we are concerned about is the fact that justified and necessary adjustments are hindered and ignored, that price adjustments in a rising market are quickly implemented while downward corrections are avoided by too many interested parties with long term consequences. Maybe some tried to learn from the oil industry, but energy and leather are really two totally different issues.

The split market has also started to feel some of the pain. Like for good hides, high quality splits and specialties are still in good demand and the food industry also asks for more suitable splits for their productions. That keeps at least the lime split market in Europe on safe ground, as well as the extra heavy splits and specialities for suedes, for example.

The skin market is also starting to face headwinds. Some double face skins are still in good demand, but as in all other market segments, the more standard items are also facing pressure and tanners become more careful regarding the future. For skins there is a remarkable decline of supply from many supply origins which is supporting the price situation. However, splits cannot just walk away from the general price problem. We would not be surprised if the pressure on skins prices will also start to mount from November onwards.

For the coming weeks we expect reduced activity. Next week the Chinese take a break for almost the full week and the rest of the market is possibly now waiting for the Bologna fair when leather buyers for side leathers and many of the trade are gathering again for the next show prior to the winter production season. Other than that there is little change in the fundamentals. Automotive premium production continues to run at high levels and will not reduce demand, the same applies for the high end luxury leathergoods. For shoes in general and in particular for upholstery, one has to far less optimistic and since these segments are still accounting for the majority of leather production, we continue to believe that the volume and standard market would need extremely good news to stem against the corrections we consider to be necessary to bring leather back to be used in the volume needed to absorb hides and skins at the price levels we still trade at today.

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