Macroeconomics

The world continues to drift into further unknown territory. It is a bit like the era of the discoverers; Christopher Columbus was also sailing west with a vision and hope, but with absolutely no knowledge of what to expect and whether he would find the destination he was looking for.

We face a similar situation with the coronavirus around the globe. Scientists are collecting more and more data, but until a vaccination is developed, produced in sufficient volume and applied, it is going to be extremely difficult to contain the epidemic. Until then, it will continue to be a matter of life and death for those suffering from severe infection and intensive care. For the remaining with light or no symptoms, and those already recovered, it is a matter of life and the effects of the collapsing economies around the globe. 

Governments are trying to protect the people with almost unlimited money and support programs, but this can only be a very short-lived cure. Consumption, manufacturing, travel and normal social life are hindered or stopped, and it is not just money that keeps business and people alive.

So far, we are using containment to flatten the curve of infection. Simple mathematics proves already that not only will many medical systems go under but relying solely on containment will not allow a return to normality in any foreseeable future. Immunisation can only be achieved by vaccination; we have to hope scientists are successful in clinical testing and can allow the use of vaccinations as soon as possible.

The global economy faces the consequences. Stock markets tumble, productions suffer or are closed. The consumer focuses on the essentials of life and refrains from the rest. Only China is beginning to return to something that can be called normality. Factory production and manufacturing there is slowly normalising, with numbers of about 60 to 70% reached so far. As isolated data, this may look positive, but the heavy export that depends on Chinese industry suffers from the big decline in global demand. Many orders are cancelled or delayed, so production is either for domestic consumption only or just going into warehouses. 

The present trends of infections and decisions in the main export markets of Europe and the US do not suggest sales and shipment for many products will resume soon. This may not be true for all kinds of products, as people are still alive and purchasing mostly online, but there is massive uncertainty in the supply chain. This restricts purchasing decisions and shipping instructions, with most businesses still in a wait-and-see mode.

In the oil market nothing changed, but prices jumped by 40% from its earlier, lowest point. Forecasts are for single digit prices per barrel due to exhausted storage facilities and massively reduced demand. As the northern hemisphere enters the summer season, manufacturing, air travel, transport and vehicle movement are significantly down. This is taking a lot of energy demand out of the market, while the producing countries are in desperate need to generate returns from the oil production. The idea that a possible price war between Saudi and Russia could be ended by US intervention, thereby allowing prices to be pushed to that extent, shows once again how much markets can lose the connection to real facts.

Gold is a safe haven investment that is able to hold its value, but it’s not gaining sufficient investors' attraction to result in further price advances.

Despite all the problems in the US economy the US dollar was able to maintain its safe haven position and global anchor.

Market Intelligence

There has been very little change in the market fundamentals since two weeks ago. Global beef production remained on very solid levels, because consumers in many countries were filling their stocks and freezers. China, despite all the problems, continues to be a large importer of foodstuff. The African swine fever has disappeared from the headlines, but the country and the population are still looking for animal proteins and importing accordingly.

This has actually disturbed the supply and demand balance for hides even further. Prices for raw materials continue to fall and in some cases the word ‘collapse’ is appropriate. In particular, where stable supply chains have been interrupted, missing alternatives are weighing massively on the situation.

We are presently not dealing with the problem of price, as price is once again not the determining factor. Lower prices are not stimulating demand. We are missing production capacity due to lockdown and we are missing demand for finished products for the same reason. The Chinese New Year holiday coupled with the lockdown in China was followed by the same government decisions in most other countries around the globe, which has paralysed economic activity. China may or may not have stopped COVID-19 infections, but in the rest of the world, developing cases don’t yet allow the easing of restrictions. Logic suggests it will still be awhile before a serious revival of activity can be expected.

For the moment many leather consuming industries are stopped or working at substantially reduced levels. Somebody in the pipeline is either closed or creating a bottleneck of supply. In some cases it is spare parts, in others it is chemicals, sometimes it is labour, sometimes it’s government lockdown — and if those are not the case, then it simply is the lack of sales. One issue in the supply chain is enough for everything to suffer or to stop. 

The big automotive production clusters in Europe and the Americas have almost all closed down. Some had been indicating they might reopen next week, but in most cases this has been cancelled; the shutdown is extended by a few days or until further notice. In the shoe and upholstery industry the lucky ones are still working down their order book while others are either simply closed or producing for stock.

Retailers are trying to promote and reorganise their online sales with mixed results. In particular they are beginning to understand what the internet giants had already noted before: the consumer may order online, but he or she loves to first see, touch and feel before they buy. Standard articles may have an easier time, but when it comes to fashion and apparel — not to mention upholstery — you still need a place to go and to see what you like. 

There might be no obvious connection and shops may complain that people are just gathering information to then order online but, for certain consumer products, one is reliant upon the other. This is especially true of the leather and leather product industry, which depends even more than others on the haptic and natural beauty which cannot be displayed on an Internet photograph. The industry is suffering much more at the moment, because only hardcore leather users are shopping online.

In summary, production and consumption are way down with retail figures showing numbers of 30% or more; there are similar results in vehicle sales outside China. The Chinese slump, which reached 70% or more, is starting to deliver better figures, but loss in production and sales is significant too. At the same time, we are experiencing a stable supply of raw material and the result is easy to figure out for everyone.

The response in the various markets is different. In some places hides and skins are stored, in others destruction has returned. For the collagen and gelatine industries, the declining lime split production is also curtailing the supply of raw material. In several markets the lack of salting facilities and available tanning drums has led to a peculiar situation. Hides of any kind and quality have just gone into soaking and lining productions to be produced for the food chain just to get rid of them. This is something that can be expected and understood when it comes to lower grade articles, but several suppliers and slaughterhouses had been so desperate to clear their byproduct that also high quality hides are also moving in this direction.
 
Many people predict this to become the new market standard, but we disagree. At the moment we have lack of infrastructure to secure better-quality hides for the leather industry and this leads to any kind of short-term emergency decisions.

This will not last. No matter how much leather production and leather demand may shrink, it will never be so much that there isn’t a market for top-quality hides. The simple logic is that raw material has to achieve at least collection and processing costs. In Europe at least, rendering plants cannot absorb the hides as they come from the slaughterhouses, so this is not an option as long as beef producers continue to slaughter to feed the people.

After a while the commercial logic will return. Hides with the lowest value will be destroyed as quickly and as efficiently as possible. The more you climb the quality ladder, the more the hides will be saved. The cost structure of collection and preservation will be different and, as bad as the demand may be, the minimum price for better quality hides will be substantially higher than the values swirling around the news and markets today.

European tanners may also keep in mind that the world is bigger than their local universe. The cheaper the better-quality hides get, the more attractive they are for buyers overseas. We saw that in the last crisis in 2008 and 2009, and the same logic will apply once again. Maybe price will not matter, but quality does; the correlation between raw material and production cost will dictate a certain minimum level for raw material eventually. It may still be awhile until we reach this point, but we are more than convinced that history will repeat itself. 

Assuming there might be no temporary use in the leather industry for a reasonable number of hides, the question has to be asked what is going to happen to them. In the case of Europe, a good number of these hides will go into the food chain. One day the Italian tanning industry is going to reopen, but whether they will be in a position to produce enough raw hides for leather remains a big question mark. What happens to the supply of lime split and to the European tanning industry is going to determine the value and the destination of many hides.

Right now, many are trying to determine how to handle all the hides arriving in Italian ports from overseas. 

For the moment we have to believe that most factories remain closed until after Easter and the congestion in the pipeline is going to last and get worse.

In the United States, official reports are trying to impress the market with large export sales over the past weeks. Most of the pundits are pretty sceptical. Knowing what is happening in China and in the global market, they believe the numbers are originating in resales of older, more expensive contracts. This is something we have seen in the past: new sales are reported but old ones are not cancelled in the statistics for obvious reasons.

A number of big players may have been able to generate special deals with their main clients on the other side of the Pacific, but only the future will tell us if all the containers are really going to be shipped. Storage and processing facilities are not unlimited in the US, and if the COVID-19 situation deteriorates it could force suppliers into alternative solutions to get rid of their byproduct.

The situation may be bad and even getting worse. There will be a lot of economic damage, because raw material suppliers as well as tanneries will have to make substantial write-downs on inventory. Some will survive and others will disappear. At the end of all, markets will get back into balance. The worst-case scenario would be that millions of hides are destroyed, because they can’t wait until the time when the leather demand is recovered and restored. The best-case scenario would be that global manufacturing and consumer activity normalises with easing lockdown decisions after Easter. It is simple speculation today what is going to happen, and we might know already much more when the next issue of the publication is due. If we want to be rational and realistic, we should expect that things can only fundamentally improve earliest after some.

We can once again skip the sheepskin section, because all that is valid for hides applies also to skins. The market had been improving in January, because of strong demand and the attraction of leather in the fashion industry. Unfortunately, the present situation has stopped this positive trend. However, it is likely that when things normalise the fashion trends will still be in place. Although we might need some patience, we remain positive for garment leather. Raw materials for this segment might expect a brighter future than hides, because congestion in the pipeline had already been cleared before and global producers have experience in what can happen in the hide market in times like these.

The split market is in a very peculiar situation. We understand that, despite the bad situation, wetblue splits continue to clear relatively better than hides. However, the determining factor for splits is going to be the supply and production of lime splits. The gelatine and collagen industry require constant and steady supply, which is not secured and covered by the byproduct split production from tanning. Deviation and production decisions have only just started and are not yet fully implemented. We will also hear more about the influence in a couple of weeks’ time.

It is pretty useless to make any kind of predictions for the coming weeks. We are living in the period of market chaos and this means it will take a while to get back to some kind of normality. The surplus of hide supply will persist and the leather pipeline has to discuss and decide how to deal with the situation. If there is not sufficient money, courage and warehouse facility, destruction will be the only short-term solution. For those who believe in the recovery of the situation within a workable and feasible timeline, the doors may be wide open for good investments. We will monitor the trends as always.

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