The Leather Pipeline - 16.09.14
16/09/2014
The financial markets remain in the tight grip of tensions between East and West, reflected by the Ukraine crisis. It remains a series of ups and downs and it is hard to believe that the position taken by both sides can actually lead to a quick end or solution.
Russia’s president, Vladimir Putin, caught the West unprepared for what has happened. It is a mystery that the US National Security Agency can spy on almost everyone, supposedly for the sake of security, but fails to realise when such a coup is part of the planning of one of the biggest political powers in the world. One has to imagine that the annexation of the eastern part of Ukraine with the participation of Russian services must have been planned for a pretty long time.
Anyway, despite ceasefire agreements that are constantly broken and sanctions it doesn’t seem that diplomacy is making much progress in solving the problem.
Some days the focus of interest shifts to the Middle East where the Islamic State is making further progress and controls more territory. Being well equipped and well supported, the situation for its opponents remains very difficult and the world is shocked by the cruelty. The situation is dragging the US and the West back into conflict there and, as is already usual in the region, new and awkward alliances are being made and arms delivered. Nobody knows how and where they are finally going to be used and history tells us that what you have delivered to your ally today becomes quickly a weapon directed at you by a new or old enemy later. However, there not many options and the western World has very little chance other than to fight hard before the new power is established and gains control. We know from experience in Afghanistan and Iraq that you may have short-term wins, but a long-term stability is still not in sight.
Europe is suffering most from the situation. The recovery in many countries after the financial crisis has never been strong and the necessary reforms not put in place. In particular in France and Italy the turnaround has not been achieved. The Ukraine crisis is now making business for many even more difficult and the monetary policy of the European Central Bank (ECB) remains questionable. In the past, more and cheaper money hasn’t helped without reforms and one fails to understand why more of the medication should do nothing more than ease a few symptoms without curing the causes.
The financial markets are noticing and a lot of the enthusiasm for the euro has quickly faded since July. The currency has suffered a serious correction and fell to levels well below $1.30 in the past weeks. This is nothing really special yet, because the exchange rate is still well above the long-term average.
The fall in the currency is also part of ECB policy. Making imports more expensive helps address the risk of deflation and makes exports cheaper and more attractive so it could help business for many companies in the euro zone.
Oil prices are sliding too, to the surprise of many. Crises and conflicts in various countries should send prices the other way, but one can see that this logic does not always apply.
Market Intelligence
Two important fairs (ACLE and Lineapelle) are behind us and a handful of top-quality producers have still to manage one more this week in Paris. Two totally different fairs in two different continents should have offered the necessary insight to say what we can expect from and for the leather pipeline in the next six months.
It began in Shanghai, where the international raw material suppliers tried to meet their Chinese customers. Many of them had already been touring around Asia and tried to complete their impressions during the three days of ACLE. This was not as easy as one would have thought. Most overseas visitors came with great expectations after the summer break and remembering the extraordinary performance they experienced in 2013. This year a good number of suppliers left the show reasonably disappointed.
The number of visitors was less and the ones who were there as potential buyers were pretty cautious in their supply picks. Origins that had come to the fair with higher prices and ambitious ideas were mostly left aside and origins that had been a bit more cautious were in the position to benefit from the sudden rise in the value of the US dollar and were able to benefit. The Americas had issues with asking prices and we got the impression that only limited business was booked. It was a bit different for the Europeans, who had currency on their side and the more US suppliers talked the market higher, the easier it got for the Europeans to sell what they had. This included a number of grades that are normally pretty difficult to place in the Far East.
While dairy cows are such a standard article that it did not need much to attract the regular customer base the situation was a bit different for the medium-weight males. All summer long a number of suppliers were complaining that this type of material was not generating enough interest from Asia despite the attractive price spread between them and their US alternatives. However, with higher asking prices from America and the additional 2%-3% gain of the dollar on the second day of the show, many buyers could not resist and grabbed what was on offer. This made the event into a two-tier show. While some went home disappointed due to the lack of interest and sales, others – mainly the Europeans – were pretty happy. Not just because of the sales, but also by the sudden rise of revenues in local currency.
However, just to focus on the sales of raw material would be again a bit too limited for an analysis at the start of the new leather season. We have passed the summer and raw material suppliers have been able to hold prices pretty firm, in some cases wiping out the corrections that we had following the pollution problems in China. This means that the tanning industry and the rest of the leather pipeline is to begin the next leather season with prices already considered to be too high at the end of last season. Consequently, the industry has to deal with the fact that the new season forces everyone to find solutions if they are not convinced that leather prices can be adjusted on the upside. Without too much new business, this has already been the discussion of the summer: what the solutions are going to be and how leather demand is going to react if leather prices need to go higher.
In the good old days such a situation was handled in a pretty simple way. The old saying ‘what goes up must come down’ was enough to ease people’s minds; it was a question of when rather than if this would happen. Cost averaging of raw material was the masterpiece and the logic of calculation for an experienced tanner. But this system which had been the basis of raw material trade and leather making so long doesn’t work any more, at least not within a timeframe that is workable for a normal leather producer.
The main problem today is that the conditions for various types of tannery have become completely different. From industrial to artisan, from index-based pricing to free purchasing, from long lead times to short, from flexible sourcing to prescribed standards, from fresh only to wet blue, you have today more and more restricting factors for purchasing decisions. As if that weren’t enough, we also see an increasing number of overlapping interests, with packers becoming tanners, leathergoods manufacturers becoming tanners and in between a rising number of wet blue producers who see their business concept as taking over the initial production step only. This has led to more tanning capacity, reduced access to raw hides for traditional full-scale tanners, has developed additional inventory locations for semi-processed materials and become a pricing tool.
We don’t support the story of a generally reduced supply. Bovine slaughter is shifting and we see regional variation, but global slaughter has not dramatically changed.
Standard supply types from the US, for example, but also for certain European types, have become less available to many tanners. There are three main reasons for this: reduced slaughter, more wet blue trading, and the increased dominance of large industrial buyers that are less flexible and need regular and standard supplies. This is topped up by the raw material index-related supply chains, where obvious interests command the public pricing.
The above is reflected in the increasing spreads between the prices of hides that are either the traditional standard materials for large industrial leather products or the reference article for the pricing of leather contracts. The price spreads do not reflect the real value of the materials any more and display the realistic price levels in the present market prices for leather.
The Lineapelle show in Milan serves especially the shoe and leathergoods sectors. The number of visitors was quite promising and if one is not involved in the general dispute about fair locations, it seems indeed that Milan is the better place. Infrastructure and connectivity are simply better and in particular international visitors appreciate the easier travel arrangements. Timing is another issue. The congestion of fairs in September is more and more of a worry for the ones who have to attend all the shows, in particular as exhibitors. Cost and time make it almost impossible to attend all of them and it seems that the fair calendar needs a new organisation or a trend to more specialisation. We see the conflict less between Shanghai and the rest, but more between Paris and Milan.
The fair in Milan itself sent some clear messages. On one side it confirmed that leather as a material is not losing any of its attraction – as long as it is clearly recognised as leather. This means that productions will become increasingly specialised, which is a risk and an opportunity at the same time. It’s a chance to find market niches with better prices, but a risk that articles will not reach critical mass to fill and run production sites. Theoretically it is nice to serve a niche at a good price, but practically you still have to run a factory, which needs to have capacities filled. Often not an easy task.
Tanners reported business to be decent and regular for the very top, classic and natural leather types for leathergoods. The same applied to shoes; the wealthy still want outstanding quality and ‘the real thing’.
Also where leather can compete in price with the artificial articles, business is still good and demand good. The problem is that there is not enough cheap raw material around, at least not in the bovine section. Apart from this problem, the market has not found a solution to the difficulty of all the selections that are not good enough to qualify for the luxury end and are not cheap enough for the commodity sections. No matter what people say, there are huge stocks of this kind of material in semi-processed state in the pipeline. With raw material prices being high and still rising, the story of supply shortage is always repeated; people hold onto stock in the hope that one day they will become the right material for the product and will repay the investment once an outlet has been found for them.
The main reason these inventories have been built up is the specialisation and the marketing of wet blue and crust selections, which has become so popular in recent years. But let us not forget that the popularity of this marketing tool was in particular related to the strong demand for high selections, which could be sold at very profitable levels when raw material prices were significantly lower. The average return was intact and with rising raw material prices many of the companies in this business were not too concerned about increasing stocks. This has become a bit different since spring of this year although even today many players are not very happy to talk about this.
We have dealt with the subject a number of times already and it will remain the subject of speculation until the day leather prices increase by enough to pay for the stocks or people simply have to liquidate them at whatever price. At the moment, pockets may still be deep enough and interest rates low so still the owners think it is a better deal to keep the investment in the hope that the prices and the supply story will remain the market maker. With the strong and big players dictating, it might even be possible up to the point when demand will be negatively affected to an extent that suppliers lose confidence.
Interesting in this respect is that the first rumours are swirling around of larger liquidations of wet blue stocks at serious discounts to the present market levels. This might be an individual case, but it might be worth monitoring the situation.
We remain of the opinion that the correction of the raw material markets that we saw after the closure of tanneries in Hebei, was more than needed. The big industrial supply chains are run according to different rules and these rules are not for the public. Big meets big, et cetera. But this is still only a part of the raw material market and possibly also still the minority of the total leather business. The majority of the industry is struggling, margins are tight, cash-flow a problem and article ranges and calculations not in line with consumer market realities. A number of the commodity markets have been in a similar state and had eventually to adjust.
The start into the new season and the conclusions of the fairs so far make a similar picture; it might be time that the market balances are restored.
The split market has hit bottom and, here and there, has even shown some improvements. In particular in China a number of tanners report some recovery in the prices for their lime splits. However, the levels seen in April are still far away.
Everyone was waiting for signs of interest in China for nappa skins. Many had hoped for some interest during the fair in Shanghai. Very little was seen. Only double-face material and lining skins are still in reasonable demand and prices remain pretty steady. It was interesting that we noticed some speculative interest. Non-members of the trade were said to be sniffing around and talking about the potential interest to buy large quantities at low prices. Well, with the level of prices reached in the meantime it doesn’t require too much investment to buy a significant quantity of raw material with pretty low risk.
The next weeks will have to prove if the record price levels for raw material can be sustained. Geopolitical uncertainties, a slow down of consumer business in several parts in the world, low or negative margins in leather production and rising leather substitution could have an effect. On the other side we are at the start of the high season of leather production and we have to see how much leather demand is going to be converted into raw material prices. For the moment suppliers are still aggressively defending their raw material revenues as owners of wet blue stocks do. So, it seems all will possibly remain unchanged for another fortnight.
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