The Leather Pipeline - 19.08.14
19/08/2014
We are in the peak holiday season and normally activity and news from the markets are reduced and all activities are postponed until the return of the main players at the end of August. This year is a bit different because the crises in the Ukraine and the Middle East are having an ongoing effect on the markets.
The general situation remains pretty uncertain. While in Iraq military action is already taking place, the situation in the Ukraine remains unclear. Russia and the West are pretty careful about any movement, because they are clear that military conflict could possibly spread very quickly and involve the big players much faster than anybody could imagine. However, daily information from the east of the Ukraine shows that something could happen any minute.
These kinds of global security problems are weighing heavily on the stock markets and stock prices change by the minute, with every recovery being reversed whenever negative information is published. At the moment it is less the sanctions imposed, but much more the military situation that is affecting the markets.
What is surprising is the reaction of the energy market. With the conflict between Russia and the West and the military action in Iraq added to conflict in Libya everyone would have expected that the price for oil would rocket up. However, quite reverse: the price of oil is substantially declining and every rebound in prices is answered by another substantial drop. This can only be explained if financial investors are pulling investments out of commodities to be flexible and are no longer hoping for speculative gains from investments in the futures markets. It proves once again that many markets today are just run by speculators’ money and possibly also manipulation. The physical supply and demand situation in the energy sector has, for a long time, never justified the prices we have seen. However, these markets remain extremely volatile and an overnight change of direction would not surprise anyone.
In the meantime it is good news for consumers, because energy bills are substantially declining and the price of petrol at the pump is coming down. For the winter season in the Northern hemisphere it will also be a relief to fill up oil tanks at prices that are on average significantly lower than those of previous years. Falling energy prices are also keeping inflation under control and, as usual, many are already discussing the potential of deflation.
The EU is delivering no good news on economic growth. Italy’s economy is shrinking, France has got serious problems and cannot manage the negative budget, Germany saw exports and industrial orders falling, so quite a number of countries are worried that the crisis could be back and the recovery is facing a quick end. It is definitely far too early to know for sure, but the writing is on the wall and as usual it is advisable to be a bit cautious and not to start celebrating too early as many in Europe have already done.
As a consequence the value of the euro has remained under pressure and except for a moderate recovery at the end of last week we see the downward trend continuing; there is a decent chance that the price of the European currency could face additional pressure if the conflict in the Ukraine is not ended soon and the economic situation fails to normalise. One wouldn’t be surprised if the rest of 2014 were a pretty bumpy road for the euro.
Market Intelligence
August is really not the time to expect too much from the leather pipeline. In the northern hemisphere most of the factories are closed and they are still a very important driving force. However, we are getting close to the end of the holiday season and in particular in Asia people are beginning to think about what kind of decisions they have to make for the rest of the year.
In Asia we still see regular and growing demand for consumer products; the region is far less affected by global tensions than we are in Europe in particular. In the Far East most countries and societies are running a more business-as-usual policy. This is good news because it is keeping consumption and production at a reasonably stable level.
If there is any concern mentioned in daily conversations it is the money side. Almost everyone is confirming that the financial resources that were available until the first quarter of this year are no longer available today. Banks, in particular in China, are controlling the financial resources of customers with much more care and the government there is very active in controlling and avoiding the grey capital market for finances.
The unclear trend of prices poses another important question. Traditionally investors and people with financial resources are willing to offer short-term loans to medium and small enterprises if they can make a decent profit of a couple of percent for a short-term (up to three-month financing period). There are no safe and reliable collaterals in this kind of business and it is generally based on personal relations. However, with a sharp correction in the market due to the problems in Hebei province and tight controls from the Chinese government these kinds of short-term loan are not so easy to get any more. Investors are much more cautious because they know very well if the raw material markets are declining the possibility of repayment declines too.
This is not public information, but the situation has brought a lot of the big international traders back into the play. Traditionally some big names have been willing to finance tanneries in Asia with open credit or pretty loose terms as far as payment is concerned. This is actually where they make their margin and one has the impression that in the past six or eight weeks more business between the hide and skin producers and the trading houses has been done rather than between the producer and the industrial customer direct. This is just an impression; not many are openly talking about it for obvious reasons but we believe that there is quite a bit of truth in the situation and it would also explain part of the moderate recovery of prices we have seen in the past weeks.
The stable or firm market is offering much more security and putting not only the producer but also the trade in a much more comfortable position versus the industry. However, this is also creating a pretty decent risk because if the general leather business in the next months is not as positive as many believe there could be a pretty sobering period to follow.
For the moment everybody is still optimistic about a strong performance of the leather market in the last quarter of 2014. Except in the automotive industry, where the order books are still pretty full, nothing is certain these days. From the automotive side we cannot trace any risk, because with their long-term budgeting none of the big brands will risk the forecasts and budgets already published and many of the big car companies have already given their target numbers for the entire year 2014. Whatever they do in 2015, for this year they will just fulfil their predictions. These predictions are high and productions will run almost full with leather demand remaining high accordingly.
For other sectors the situation remains uncertain. The luxury market is still talking about growth, however the anti-corruption policy in China is making its mark on consumption levels, while tourism shopping from China is still good but far from the growth rates many were expecting. Even if it is flat versus 2013, business is still pretty good and leather demand for luxury products will be too.
What has to be watched carefully is how the big brands deal with the record prices for leather they are going to have to pay. There are many rumours, and some of them already confirmed, that the High Street brands are putting a stop on prices and some of them are seriously experimenting with cheaper alternatives. The fair in Paris in September will offer more information about what this market segment is going to do for the coming seasons.
This leaves us still with the bread-and-butter business and this means commodity furniture and regular shoes. Here the situation remains pretty unclear. Under normal conditions one would expect the business to remain reasonably stable with no big variations. It’s interesting however that neither the closure of a large part of the tanning industry in China has had any serious effect on the supply of leather and secondly that the split market is not showing the recovery one would have expected after a slump in the second quarter.
Why is the situation in the split market is so strange? Well, with the record price levels for hides, splits in particular in shoes had been considered an attractive alternative at a cheaper price. Shoes made from split and shoes made from full-grain leather have been selling at the same price. That split prices had been inflated and exaggerated was clear and it was just a speculative bubble which made everybody happy. Tanners were obtaining more money for this byproduct and the rising price for splits was supporting the hide market, which was good for many at the first steps of the supply chain. However, with a sharp correction of price, in many cases by about 30% to 40% from the record levels we saw in March and April, splits should have become reasonably attractive again, in particular when we consider that hide prices have only corrected by 5% to 10% and have even recovered since then. So, why is nobody really reporting increasing demand for splits while many are still struggling to move their production, even at the prices that are mentioned as ‘the market’ today?
We would say that it still a bit too early, but by mid-September at the latest, when most of the shoe factories and tanners will have made decisions on their programmes and materials, we must see a strong rebound in split demand if the leather business remains reasonably stable versus a year ago. If we don’t see a return in demand for this cheaper material, we will become seriously worried about the performance of the market in general.
Another issue that needs to be monitored in the coming six or eight weeks is the situation in Hebei province in China, where a lot of wastewater treatment plants are presently being built to meet regulations and will be ready for production to begin again from mid-October. If this is true, tanners in the region will need to replenish their inventories and pipeline and the general level of demand for raw material will increase in the last quarter. We have heard rumours but cannot confirm these developments as fact. At this stage very few tanners and importers from this region are active in the market and what they are buying is being shipped to other provinces for tanning. So at this moment there is no real indication of a strong recovery of production in Hebei province. Not even the big players in the sheepskin business are reporting any change in the activity of their customers and partners in China.
On the pipeline for hides, there is very little to give a clear indication of what we can expect for the rest of the year. Two weeks from now the All China Leather Exhibition will take place in Shanghai, with the Lineapelle and Le Cuir shows taking place in Milan and Paris in the weeks that follow. Traditionally, until the end of September, the leather pipeline deals with a lot of expectation but very little fact and usually it’s only in October that we can really see what producers are planning. Let’s hope for more clarity on the political scene by then too, and let’s hope it is more positive.
As already indicated above, the split market has not really become more positive. There are a few voices saying that in China some split tanners are slowly returning to more regular production levels, but many of them have been running at 50% or below for quite a while and have had to struggle to digest the expensive material arriving in the second quarter. Let’s hope these first rumours of a normalising situation are true and that we will be able to form in Shanghai a better picture of what the situation in the split market is going to be. The situation for lime splits in Asia remains problematic.
Nothing serious is happening in the skin market either. All skins used for wool-on products are still selling reasonably steadily. Tanners and buyers are buying hand to mouth and some of the strong hands are willing to invest money in raw material because they know very well that the prices are on the low side and it has never been wrong to build up a little bit of inventory with prices on the low side of the trading range rather than to wait. The situation for fellmongering skins hasn’t improved at all. Nappa garment business is still pretty poor; the devaluation of the rouble is weighing on exports to Russia and there has been no strong breakthrough in fashion. In mass consumer products there are so many synthetic substitutes today and these are much cheaper and consequently easier to sell. It would require a serious return of a ‘real leather’ fashion to boost demand for skins for nappa leather again.
It would not be very serious or honest to make price and market predictions for the coming two weeks. The general environment is clear. Suppliers have been doing their utmost to pave the way ahead for after the summer holiday period, doing everything possible to push prices higher and to play the supply card. If this is successful, it will be dictated by demand. You may temporarily support prices by supply, but in the end, leather has to be manufactured and sold and consumer products have to be made, and if the orders are not good enough it will be reflected in orders and prices for leather. This is nothing new and as we mentioned above possibly 30% of the market, automotive and luxury, is in a strong position. The rest is simple speculation and inventory management. We will know later in the autumn if this is still enough to get by.
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