The Leather Pipeline - 11.11.14
11/11/2014
The financial markets remain in roller-coaster mode, with a steep decline followed by a sharp rebound. In Tokyo new records, at least for the last several years, have even been set.
Gold, oil and several other commodities continue their decline. Low-interest policies and stimulation programmes are attempting to boost economies in many parts of the world. This is the scenario we are presently seeing around the globe. Is this new? Actually not. Has it helped? Well, it has helped those who are investing in stocks. For others nobody knows what the other options would have led to.
In Europe in several banks are discussing charging negative interest for some saving accounts. With the low-interest rate policy and excessive liquidity in the market, banks just cannot find enough demand for money they want to lend. Central banks who claim that it is essential to hold interest rates low to stimulate investment and demand still mean more that government budgets need to be subsidised. At least in the case of the European Central Bank members of the board are beginning to question the strategy of the president, Mario Draghi. However, for the moment the EU economy is possibly heading towards deflation, which will mean asking for further stimulus and more liquidity. Will it help?
Looking at private consumption, the low interest rates may have caused something of a nine-day wonder in recent times, but presently it seems that private consumption is not seeing the stimulus and performance one would expect. An increasing number of brands and retailers are cutting forecasts or reporting flat sales already.
The House of Representatives elections in the US on November 4 saw a victory of the Republicans, which leaves president Obama as a lame duck for his remaining term. This situation might become a problem for the economy depending on how Democrats and Republicans deal with this in the coming years.
The Russian ruble continues to fall, inflation rises and low oil and raw material prices are beginning to become a problem. Many exporters in the countries where sanctions have been imposed are beginning to feel the pain with declining sales and exports to Russia and consumers in Russia seeing higher prices and fewer products on offer. At least a gas deal with the Ukraine has been settled, so a warm winter with gas supply to the West is guaranteed.
The Chinese economy is delivery pretty flat figures and air pollution is becoming a problem again. For the Asia-Pacific Economic Cooperation (APEC) meeting in Beijing on November 10 and 11, the government has again imposed production and traffic restrictions.
The euro continued its rapid slide of almost 10% against the US dollar and the dollar is now taking $1.20 as the next target. This is pleasing for European exporters and with the US economy showing a better performance the weak euro might become a trigger for more export growth and could offer a chance of recovery in particular in southern Europe next year. The mixture of low energy prices and a weak euro could be the cocktail the European economy might need at the moment.
Market Intelligence
The leather pipeline has been in a bit of a peculiar situation in the autumn of 2014. Usually this time of the year is the beginning of the strong, active production season and generally sees high activity with a lot of movement. This year it’s pretty much the opposite. Activity is pretty slow, leather production is just about regular, tanners are purchasing and planning very cautiously and one has the impression that leather demand is down, as was expected after the hype and the high prices of the first quarter.
However, having said this you still find a lot of people reporting that business might not be buoyant, but is still pretty regular and within the ranges one has always to expect in this trade. Taking a little bit of a closer look it becomes obvious that this might be true, and the situation is not nearly as bad as many people believed it might be. Demand for raw material is quite a bit lower than a year ago and several types of raw material have already corrected in price. However, the key question still centres on the extent to which demand for leather and, as a consequence, for raw material has really declined versus a year ago.
Studying and analysing a bit who is reporting what, we are coming to the conclusion that the standard quality producers are still running production at levels a little lower, but nothing significant compared to a year ago. Even producers in China are reporting that their retail business for quality products continues to be reasonably steady and normal. The sharpest decline can be seen in the price-sensitive sections, mass products for which it’s easy to shift from material to material. However even the decline in this section seems to be within reasonable ranges and does not explain why market activity has become relatively quiet.
We have talked before about the market being inflated because of strong interest and investment from traders and speculators in the raw material market. This applies in particular to China because this kind of business is not so widespread any more in other regions of the world. Many of these import traders and wet-blue wholesalers were caught out pretty badly in the spring because of the high stocks they were running. They tried to liquidate their inventory instead of replenishing it.
This has created more offer for semi-finished product and at the same time less demand for raw material. These people have not really returned to the market yet and what we see now seems to be a market reality of physical supply and physical demand. Since this is not touching the regular business of the full-scale tanneries it would explain why they are reporting regular conditions.
However, it seems that we are still facing the seasonal surplus of raw material supply, created by the high seasonal kill in Europe, a pretty high kill for quite some time already in Australia and inventory in wet blue that has been accumulating in the US. Raw material supply on a global scale is pretty much unchanged and the only ones who are suffering from supply shortages are those tied up to certain suppliers and origins for volume and production.
Looking at leather production, it’s a fair number who say that side leather production might be 5% to 10% down compared to the same time a year ago. Automotive has so far been the bright spot of the market and has compensated for a lot, but we are realising that in the past weeks quite a few large producers of automotive leather are reporting a sudden decline in leather orders. This has come as a bit of a surprise because car sales remain pretty steady; it could only mean that either the supply chain up to the car manufacturer is trying desperately to keep inventories low for the end of the year or that car brands have had to revise their sales forecasts for the coming months. It might still be a few weeks before we get a clear picture of what the real reason is. At least in Europe a number of the big players in automotive leather production have already advised their suppliers that they are going to take not only a full two weeks holiday over Christmas, but that they plan to reduce soakings at least a week before. This is interrupting the supply chain, although slaughter is going to be pretty low over Christmas and the year’s end too.
As we have discussed in many previous reports, where leather as a material can be easily substituted, because there is no recompense in price for the beauty and performance of the material, the high prices in the first half of 2014 have caused a lot of substitution. At the medium and higher end where the material price is much less leveraged and leather as a material can be used as a selling argument, the decline is significantly less.
The consequence of the above can also be seen in the price spreads between the various articles, and the spread between high-quality material and cheap raw material is wider than ever before. This applies for all kind of raw materials and so it can be seen cattle hides as well for sheep and goat or any other specific raw material source.
It is fair to say that the established supply chains of quality products remain pretty much intact. Those in the second row find it significantly more difficult and are possibly viewing the situation in a more negative way. For the market it means that there is plenty of raw material around which is either of medium or lower quality or has been held in stock on the basis of speculation. From what we can see in the market any non-regular supplier will have a pretty difficult time attracting any buyer at the moment.
This could become tricky. With the leather business not being that bad but supply chains remaining well protected and rigid, the spreads we are seeing at the moment could widen further. Without a substantial increase in demand or a serious round of speculators buying this will certainly drag the upper end of the market down too. As long as this happens in an orderly way we would say it is to be welcomed. Leather production needs to catch its breath, to improve cash flow and to restore better margins. This can only be achieved in a global market environment that does not face any inflation caused by lower raw material prices. Production costs cannot be the solution because they are going up rather than down, mostly because of the tough action of the Chinese government against pollution. This will close a lot of low-cost production units down.
There is no real news from the split market. In fact, there might be a bit more market balance here despite the fact that many Chinese producers are still heavily complaining about their lime split returns. This may also be more related to pollution and to a number of scandals that have been related to gelatine production. There has been no significant change in the quality of standard and regular qualities of drop splits over the past two weeks.
There has been some better news from the skin market. In Europe a lot of stock had been piling up and many suppliers have had a tough time moving production since the closure of tanneries in Hebei in April or May. Many skin types that had become dependent on this region have fallen pretty close to record low levels. However, since the beginning of October week by week, more sales have been generated, including from Chinese players returning to the market. So far nobody can really say if this is a recovery of leather demand due to the very competitive prices or if it is just speculators buying because people don’t want to miss the boat on raw material prices where you can hardly make any mistake in the long run. We have been able to speak to a large number of European skins suppliers who have confirmed that they may have lost quite a bit of money during the falling skin prices, but at least they have been able to ship significant volumes and their position is now much more relaxed.
For the coming weeks we think that the hide market is still to be sorted out. The spreads are too wide, present demand cannot absorb stocks and high production and, so far, prices have not fallen far enough to attract enough buyers to clean up the excessive quantities. Christmas and Chinese New Year make it less likely the situation can be sorted out soon. This makes us believe that we still have a bit to go, with prices continuing to fall, but this will have to be studied and analysed at a regional level because currency factors are becoming pretty severe. We hope for a continuation of the orderly retreat from high prices because this would create the best base for a better future for the tanning industry.
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