Macroeconomics

There is little substantial news to report. The EU debt crisis still dominates the headlines and the failure in the US to find an agreement between the big political blocks to solve the budget problem in the USA was not able to change the focus of the media and interest of the economic markets.

The big problem is that there is simply no progress. The countries with the biggest problems are now falling back into something like recession and growth is just not strong enough to provide any serious hope for an improvement in the situation. There is just one exception and that is Germany, were the business climate and consumer spending is rising.

The discrepancy in the EURO zone is also one of the fundamental problems. While most members favour EURO Bonds to take advantage of the strong countries to lower their interest rates, Germany is predominantly against this idea. Apart from the fact that Germany doesn’t want to pay more interest, the consequences of the idea are also not sellable to the German tax payer, who has little intention of covering the budget deficits of other member states. In addition they hold a strong argument, believing that easing the pressure to bring the deficits in order would be counterproductive.

Whatever the final solution is going to be, we are now dealing with the same or similar problem for months and no progress. This makes the financial markets and also the public increasingly nervous. The problem needs to be solved eventually, but one finds it difficult to see any serious solution. How can government debts finally be erased? Is there any realistic chance to make public administration more efficient? Will politicians ever be able to manage countries and budgets with clear long term visions, and can the political success in the Western World ever be disconnected by extensive spending and insufficient administrations? Well, there are some positive examples, but the hope should not be too high.

Under these circumstances, and along with expectations for a slowdown in China, asset markets are falling. Only the oil price is holding up in view of the winter heating season and the expected demand for heating oil. Gold is pretty steady but the forecasted run above USD 2,000 per bullion hasn’t taken place yet.

In the currency market the EURO has lost further ground. Not really a surprise in view of the debt crisis, but basically the currency is still holding pretty well. However, Portugal has been downgraded to junk and let’s see for how long the EU currency can still defend itself against possible attacks and receive confidence from the markets. A sharp drop would certainly force politicians to make quick and painful decisions.

Oil as a commodity is holding its price pretty well. Despite all the negative news for the global economy, barrel prices are still far higher than they were a while ago. The winter ahead and steady demand from the main producing markets hold prices higher than one would expect under the present conditions. One gets the impression that this is one of the last commodities the investors still like to play with. One wouldn’t be surprised if oil prices also drop sooner or later.

Market Intelligence

There are sometimes such periods when no news is happening and nothing changes. At the moment we are in such a period and everything said and written about the leather pipeline is still valid. Reading through the previous issue, it could just be carbon copied and used again. The reason is that we are in a swing of a trend and a situation which has no reason to change anything and it would need something serious and new from the political or macro economical scene to trigger any motivation for the players in the pipeline to take new or confirm their present attitudes.

Without any important news it seems that the year 2011, or the Year of the Rabbit, is already finished for the majority of the members of the pipeline. With all the uncertainties ahead hardly anyone is really willing to take any forward decisions and most are happy to just finish the present year without taking any additional risk. With the raw material markets still in defensive mode and declining it is not really seen as a threat just to sit tight and let time pass until the next year opens its doors and decisions are taken.

Talking to tanners, most of them are reporting a pretty lacklustre time from their buyers, the leather manufacturers. The situation in the European upholstery industry is described as dreadful and this is also reflected by the very quiet and slow business activity in Northern Italy. Most suppliers of standard European dairy cows have to make sure that enough salting and warehousing capacities are ready to handle the hides which are no longer taken by the regular Italian tanners. Apart from the order problems, the VAT regulations where VAT on imports from countries outside the EU also has to be paid immediately upon import and clearance has had a serious impact on cash flow. All in all the situation in Italy in volume leather production is not described as good.

Suppliers to Asia – in particular to China – are also not too happy. Confirmed stories about cancellations of more expensive contracts are circulating, but sometimes one gets the impression that the story is not completely told. In many cases it seems there is still a second story behind it all which is not told. There might now be a showdown between buyers and sellers who were still having an open discussion about quality issues in the first half of 2011 when hides seemed to be short and prices rising forever. It is no secret that a number of shippers back then were bending the descriptions, weights and origins to their benefit and were not too prepared to discuss issues with the clients. For many it is now time to hit back and the story of revenge never stops.

Having said that, we also have to mention that a number of sellers are not complaining and are reporting a regular income of letters of credit. They do not see any negative influences as a consequence of the sharp correction of prices in the past weeks. Well, in the end, bad news and good news are both having their effects and at the moment we are at a time where the bad news is more readily taken and absorbed than any good ones.

This might also be the danger in the end. Yes, we are presently in a correction mode. Yes, the outlook isn’t too good, yes, leather has been substituted as a consequence of prices, yes, we have a financial crisis on a corporate as well as on a government level, but weren’t things worse at the beginning of 2009?

It is true that we are still far away from the prices levels seen then, but it had only reached the levels and was followed by the extreme sharp rebound, because many were just driven by emotions and not by the facts. High volatility is the last thing one needs in the leather pipeline and so it needs a serious evaluation of the situation and the risk. The tanning capacities are still the same, global population is still rising, there is no serious antipathy against leather as a material and on the supply side very little has changed. So, we just need to rebalance the market and correct the mistakes of the past. This is actually just a matter of a fair valuation of leather and an adequate level of the raw material according to its quality and value. It is actually dramatic and totally irrational that in the time of the internet, raw material producers and suppliers still do not have a serious clue about the value of their raw material and actually don’t bother to analyse the supply chain to figure out when the boundaries are passed. The additional revenues made in periods of overvaluation is just and only borrowed and is paid back when the prices swing back.

In summer when it was obvious that prices had gone too high, the big suppliers were not at all willing to consider price adjustments and many preferred to stock up in raw or to park material in wet-blue instead of adjusting.

Since then they have had to run to secure sales and prices and can’t catch the market anymore. If leather demand is killed it needs at least a season to restore it and in the meantime the overhanging stocks from the high period need to be cleared and weighed on prices.

However, from a long-term perspective it is more important if the leather as a material is in danger or if we have a real chance to regain enough production and sales to stabilise the market again. For this, the question has to be answered where the adequate price levels and the bandwidth of the prices ranges should be set and a longer term balance can be achieved.

To establish anything stable we first need to bring the present market into balance and at the moment we are still in no man’s land. Hides and skins are not inviting for anyone to own them and for present production and calculations we are just about reaching a workable level. Suppliers are still not comfortable with their position and tanners are not yet considering present price levels to be attractive enough to absorb the inventories at the beginning of the supply chain.

The split market now faces a lot of pressure. Specialty items can still be placed as in the hide market too, but with falling hide prices splits cannot escape from the price problem. The split market has a foundation which is more solid, because of the alternative use in the collagen and gelatine segment.

The skin market is also in difficulties at least in the nappa segment. Fine wool and double face skins can still profit from the general shortage of material. The nappa market has come almost to a standstill. Many stories about contract cancellations for skins in China are heard and seem to be true. This has brought a lot of uncertainty into the supply side and with the shipping interruption to Asia, for the coming weeks no serious price level can be mentioned, but things definitely do not look good.

For the coming weeks we do not believe that the market mood will get much better. Certainly there are some strong hands already monitoring the situation carefully and if they would get any hint that prices could see any turnaround we believe in a strong round of buying. However, this seems still to be too early and most likely will tanners also try to fix new and safe price levels for leather for the first quarter 2012. Once that is in the pocket we will also know what price level will seriously attract them. We still believe that another slide of 5-10% would regain a lot of confidence and raw material sales would run much smoother again.

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