The Leather Pipeline - 26.06.18
26/06/2018
The past two weeks were busy as far as politics and the financial markets were concerned.
Mr Trump’s decision to separate children from their parents caused intense criticism and had to be revoked. In Germany a serious political crisis about the migrant policy of chancellor Angela Merkel could cause the end of the government coalition. What seems to be a local and national issue could become a serious threat to EU stability considering the strong shift to the right and nationalism in the community, which could have long-term consequences. The deep fissures between the east and south and the north and the west of the EU could become wider.
The trade war, war of tariffs, is having a more intense influence on the economy. Most think-tanks and institutions have revised their forecasts downwards. Plenty of industries are beginning to get a clear picture of what tariffs would mean for them and this is beginning to hit home even for those who supported tariffs to begin with. Most have now had enough time to analyse how tariffs would affect their calculations and business outlook and most have come up with alarming results.
The US dollar became firmer, but was once again not able to break the level of $1.15 against the euro. The markets are once again nervously watching national banks and their decisions on interest rates, but they are struggling to achieve a clear picture of the impact of politics in the long run.
Stock markets are beginning to retreat. Rising interest rates, higher oil prices and the trade wars are beginning to worry investors. The first comments that politics could affect companies’ 2018 results are also appearing and investors are becoming increasingly cautious.
Oil prices came down a little and the recent OPEC meeting has come to an agreement that the production cuts to stabilise oil prices are going to be limited and will allow oil supply to rise by about 700,000 barrels. The effect on prices will be limited because many players are not convinced that all producers will be able to serve the market with extra quantities at the moment.
Market Intelligence
Actually one could come to the conclusion that we should take a break from writing reports or analysis about the leather pipeline at the moment. Little has changed for quite a long time. The leather pipeline used to be very dynamic and always ready to offer a surprise. It was never mainstream and although one could talk about general attitudes one had always to be on high alert and to sniff around for hidden trends or activity that was worth analysing because it had the potential to change the pattern of the pipeline and the markets.
For a long time now this has not been the case. This is difficult for old pundits who find it extremely difficult to accept that no gossip, rumour, fake news or even general changes in politics and financial markets have been able to change the trend we have had in place for something like two years.
The raw material markets had always been reasonably volatile and offered sport and entertainment to suppliers and buyers. Currency markets and short-term trends were able to move markets in either direction in a very short period of time. The same has been tried within the present cycle, but without much success.
Imbalances between the supply of raw material and the production and consumption of finished leather can no longer be hidden or ignored. For many along the pipeline it would be better to take a summer break to review the situation and to prepare and plan for something that we have never seen before in the history of this industry. Hide and skin prices have been cheap before, even very cheap, even cheaper than today, but there was never any question that, at whatever price, the hides and skins would be turned into leather eventually. The lower prices went, the more they were seen as an attraction to the tanning industry to build up inventory and hold stocks of raw material as an investment for the future. Correctly, large and cheap stocks were never considered to be a problem, but rather a good investment.
Many of the last remaining elder statesmen of the trade will remember huge warehouses full of raw and semi-finished hides at factories from Spain to Italy, from Korea to Taiwan, even from Germany to, latterly, China. Cheap stock rarely put any tanner out of business. There was always leather to be made; cheaper hides and cheaper leather stimulated demand from finished product brands and even if that was not enough, tanners proved that they have always been a very creative tribe of people. They suddenly developed new types of leathers that became fashionable and triggered consumption. We saw that in the shoe industry and in particular also in furniture upholstery. The only expanding natural organic growth that was basically a long-term cycle with almost no fashion influence was the automotive industry.
Other industries have not been able to support and sustain their demand for leather as a material, even during what has been one of the strongest-performing consumer demand periods we have ever seen. After the financial crisis global consumer demand recovered and expanded massively due to low interest rates, positive performance in the labour markets and very strong growth in many emerging markets: the best conditions imagineable for leather and the leather industry.
Depressed as the leather pipeline and leather demand may be now, we should not forget that we saw record prices for raw material not too long ago. It is only two or three years since many thought the sky was the limit. Leather demand was strong, raw material prices were climbing to new records and the beef industry was convinced that all projections and studies indicated that leather was entering a new era of prices. Inflation-based analysis was made and the interested parties found more than a hundred reasons why the price of leather and the relative raw material was going to keep climbing into unknown territory.
Very few people warned that there were strong arguments against the theory of higher prices. The main one was certainly a lack of willingness to respect what happens if you scare your best customers. When hides crossed the magic three-digit limit on price and the beef industry told tanners that they should be aware of scarcity and rising prices and that they should behave well to be sure of future raw material supply, things began to get problematic. This message was passed on to the large consumer product manufacturers, in particular in the shoe industry. When you tell multi-billion-dollar consumer product manufacturers who are planning for growth and expansion that they must expect shortages of material and rising material prices, what do you expect them to do? Well, it was only to be expected that they would begin to do seriously what they had been dabbling in already: check out alternatives and choose them over leather as much as possible. What a nice add-on that manufacturing of alternative materials became so much easier, needed less labour and materials were becoming so cheap with rapidly falling oil prices.
If in addition you don’t respect the leverage of price of material in the finished product you make the second mistake. While leather in many cars generates an extra margin and leather used in luxury handbags and leathergoods creates a distinctive look and feel and raises exclusivity, the shoe and upholstery industries, in their volume businesses, just leather as another material. Plastic was promoted as offering better margins in shoes and sofas, so the consumption of leather reduced and the more shoe production expanded and the acceptance of plastic grew, the more dynamic this process became. What helped were rising profits for most protein companies. The more money they made from beef, the less interest there was in supporting the use and consumption of their main by-product.
Also the leather industry did not do itself any favours. Lacking a common institution to promote the material, and lacking a universal interest in the product or understanding of it, no counter-campaign ever got off the ground. The industry was just looking at prices and believing in the same old rituals, that pushing raw material prices lower would be enough to solve the problem. Even a sharp and relatively sudden decline in tanning capacity never created any shortage of leather in the market.
During the past two weeks, things in the bovine leather pipeline continued to progress in the same way as before. Prices continued to decline although one has to wonder if all the prices that are quoted are really a reflection of the market and can be related to real trades. Today it has become more and more a private decision if any of the bids are accepted or not. Sales to the volume markets outside the regular programmes are rather sporadic. Most suppliers confirm that they don’t feel that any of the bids are really related to leather orders, but are just based on the fact that some buyers want to be active in a falling market.
Slowly, the industry is beginning to look at its options and in several countries producers are refraining from processing low-value hide; they consider it not to be financially viable any more or they simply want to reduce the input of this material. We are beginning to reach a similar situation to that of the sheepskin market.
In the split market the same trend is taking place. Standard wet blue splits have already been in trouble for a while and large producers have decided to change to lime splitting. This has slowly begun to congest the lime split market and prices for gelatine and collagen raw material are beginning to slump as well. Some producers are already beginning to talk about surplus situations building up. Summer is not the best time to make an evaluation, but if the rumours about unsold finished inventories are correct it would be worrying too.
The skins market is presently less exciting because it is further advanced in the cycle. European suppliers learned a lesson about what happens if you think you can challenge the market with the same old tools as before. Attempts to push new-season skins higher failed and asking prices were never achieved. Now levels are in retreat again and it seems they will settle back where they started. The uncertain situation in Turkey and the environmental problems in China are keeping business and demand under tight control so far. Nappa business continues to remain almost inexistent.
We are heading into the holiday season. There will be always some business to fill the last gaps and to have a certain inventory level for the restart after the break. However, it is unlikely that this will rebalance the markets. So, it has to be expected that the trade will soon start to focus on the next show, the All China Leather Exhibition in Shanghai at the end of August, to obtain the necessary information about the market and trends. Until then, there are not many options. It is unlikely that there will be a huge round of interest in clearing existing stocks and sellers might do well to analyse the position of the various raw materials they produce. Quality and functionality are the determining factors. If you can find good reason why your hides perform for one or the other reason, there is little else to consider other than price. If you cannot find arguments for the material or if there are plenty of similar options, it might be time to think about plan B.
Leather demand and production is in decline, but it will not stop. For many, the present market situation is even beneficial. Strong hands that can manage this situation are getting stronger for the next cycle, which will begin for sure eventually. If that requires that the supply of raw material will have to be curtailed by destruction has to be seen. However, one thing is for sure. The market will get back into balance eventually and it is time to plan for the future now, if you are sure that you have one.
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