Macroeconomics

The world continues to be in the tight grip of the coronavirus. Although the spread is slowing in most regions and several countries are beginning to ease the lockdowns, ‘the new normal’ will be very different to the one we are used to.

It is human nature to hope for a return to the same or even something better. However, this will be difficult to achieve – at least in the short term. There are two main. Firstly, people need safety. When you feel safe that you either will not die from the disease because it can be cured or you are vaccinated against it, you will be able to live without restrictions and fear again. Secondly, one has to assume that the threat from the virus and the way of life during the restrictions will have a longer term influence on people. Consumers will most likely have different priorities. The trick is to develop a feel for how the world is going to look like after covid-19.

Some initial indications suggest “cocooning” is back. Home is the safe place and it is more important than it used to be. Even if the virus subsides people know a second wave could occur, or a new virus could appear. Space and design are becoming more important and socialising online will also be more important. Virtual reality, home schooling and video meetings can never substitute face-to-face interaction, but they will become a far more common, integral part of our lives. Looking at the performance of the main tech companies and their stock market performance recently is offering a taste. 

The sectors that will come off worst are not easy to define. For a while, cheap travel could be one, as could fast fashion. 

As far as the financial markets are concerned, stock markets appear to have decoupled from the reality. Financial markets trade the future and not the present. This would mean that investors have more optimistic information about the future than us. They expect a reasonable future for most companies with a quick recovery. Or there is too much cash around, needing to be invested.

Politics have also been dominated by covid-19. No conflict has been solved, the refugees have not ended their plight, and geo-political issues have not changed. The North Korean leader has “disappeared”, some leaders are denying facts and the others are wondering how long people will be willing to accept government ordered limitations of their lives.

Commodities continue to be depressed or, in the case of oil, roller coasting. Oil rebounded sharply at the end of last week, but physical supply and demand remain well out of balance. As long as driving, transport and air-travel continue to be reduced and manufacturing repressed, serious recovery is unlikely. Gold as the safe haven investment took a break in the price ascent and settled again below the $1.7 mark.

Currencies continued to trade within narrow ranges and seem to be dealing successfully with the virus. The USD lost a bit of its strength and took the USD 1.10 against the EURO back in sight.


Market Intelligence


Let’s start with the raw material situation. After the strong performance of slaughter around the globe well into the pandemic, it changed a few weeks ago. In Europe, the strong decline of beef demand due to the shutdown of restaurants has not been compensated by a barbecue season. Households have also learned that stockpiling foodstuff is not necessary, supermarkets are open and you can get what you need. Consequently, the demand for beef has declined. The biggest problem for the slaughterhouses and farmers is that freezers are full of prime cuts. The demand and prices for processed beef cannot compensate and consequently prices for cattle have dropped significantly.

Slaughterhouses are not making any margin and farmers are not happy with the return for their beasts. There has been a sharp decline in slaughter. All the hopes are now for a quick reopening of restaurants so that some of the better cuts can be sold.

In the US, beef consumption isn’t the biggest problem. Barbecuing at home will not be massively impacted. The more obvious problem there is the vast number of coronavirus cases in meat plants, which has had a knock-on effect on slaughter and processing. Unions and workers are complaining about working conditions. Some of the largest plants in the country have been closed for a while and production is down anywhere between 10% and 20%. The big protein companies were warning that beef supply could be interrupted and supermarkets might not get stock. President Donald Trump signed an executive order to compel meat processing plants to stay open.

Around the globe, there is reduced consumption and demand. Even dairy products have been hit and prices for milk are beginning to fall as well. For the coming four to eight weeks one has to assume that raw material supply is going to be well below normal seasonal average. Only a reopening and ease of the restrictions including more travel, tourism and open restaurants would have the necessary positive influence.

As much as curtailed supply of raw material would be appreciated by the markets to stabilise prices, the question remains whether it will be sufficient to compensate for the collapse of demand for leather and consumer products using leather as a material.

This has made the recent purchasing activity from China even more impressive. Within just a few weeks, Chinese tanners bought well over 2 million cattle hides from the US. At the same time, every tanner is reporting a big loss of orders and not showing much hope that they are going to return soon. How does this match?

This can be interpreted in a number of ways. The simplest one would be to believe that the tanners in China can already see a better future triggered by a positive swing in domestic demand. Well, one can believe this, but there is not much evidence. Vehicle production is running around 60% to 70% of normal levels while shoes and leathergoods seem in the doldrums. The upholstery sector in China is perhaps faring a little better. However, at this time of the year there is a lot of speculation involved, because the high season for upholstery is only going to start after the summer. Tanners with money and courage might be taking the opportunity to grab as many cheap hides as possible. The summer hides from the US are also considered to be the better quality ones and so the Chinese tanners may hope that they are getting good stock in advance.

Another theory is based on speculation. Tanners are aware that the special deals they were able to get from their suppliers might lay the foundations for a successful future. Many may even remember in 2008 when the same strategy offered the Chinese tanning industry a very strong position in the global markets in the years after. 
We tend to follow the idea of the speculation, because we cannot find any proof that leather sales will cover anywhere near the number of hides bought. We don’t have to look back too far to remember that many Chinese tanners were struggling to get sufficient leather orders well before the corona crisis and even more were complaining about cashflow issues. While the cashflow issues could be eased by government credits, the leather orders cannot.

Those who have been in the business for a while are warning the strategy could become difficult, after some had problems with contracts. For instance, tanners could book the hides at cheap prices and then wait. If the leather market does not recover you have a long list of possible excuses about why you are not walking away from the contract but you are not in the position to pay for the material. If the leather market recovers you will be happy to take the hides and be the owner of cheap material which you can either resell or use. Both options are favourable. This scenario could become toxic for the rest of the industry. 

If it happens the beef industry and the sellers will be very happy to see the market rising again. For them it’s time to see what’s going to happen. A rising market would make it difficult for other tanners. In a turnaround prices could jump quickly and could even be exaggerated. Leather prices tend to recover with a time lag and tanners would be squeezed to finance an adequately priced raw material. Sufficient credit and cash to do so is usually difficult in a rising market with negative margins.

No matter the truth, the second option would be a ‘not to lose’ scenario for those who have been buying large quantities in the recent weeks. In all respects, Chinese buyers have always been smart and so we consider that there might be some logic in this. Time will tell and we will have to wait a little longer to understand what the real reason was for this massive anti-cyclical round of purchasing.

From the other origins we hear similar stories. However, the situation is a bit different, because prices in Europe have never been that low and most suppliers have not been willing to take the rock bottom price ideas suggested by China. Some, who needed to liquidate stock and to raise cash, were willing to join the party, but we tend to believe that the volumes have not been big. From Ireland and the UK we understand that some of the larger suppliers were willing to go the same way and so a few are claiming that they have already sold forward well into the summer.

In the meantime, the Italian leather industry, which is by far the largest in the European market, has begun to reopen. Some of the larger automotive tanners have been in the market for small quantities of premium hides, shipping them to contract operators. However, the vast majority have been closed and absent from the raw material business. 

While the just-in-time deliveries from Europe had stopped, there have also been large numbers of containers sitting in the ports waiting for clearance and delivery. This congestion is now going to be sorted out. The Italian tanners were not super active, because like most of their European colleagues their business conditions are different to in China and only a handful might have the financial resources to play a similar game, trying to average raw material cost down. 

We have a pre-corona and post-corona situation. Raw material prices in February are not the same as today and with the pipeline in Europe slowly beginning to start again there’s a question about how the situation will be handled between the tanner and their customer. There are existing contracts and they will most likely be honoured. The next question is how much of the raw material had already been bought and how quickly the contract volumes can be shipped. It is unlikely that in the coming 3 to 6 month the quantities that had been lost will be recovered. It is likely that many of the leather buyers will now ask for new solutions. 
Many will claim that they have to stimulate consumer demand after the crisis by price discounts. Retailers and brands will definitely take this path. For the manufacturer who had to handle the shutdown and is also sitting on stocks and material at pre-crisis prices, it’s going to be very tough to discuss such ideas. These are the times where the quality of the supplier and customer relations will be tested and we hope that all parties involved will be sensitive.

In our next issue we will deal more with the time after the corona crisis. Many countries will reopen in the next fortnight and this will tell us a lot more about how this is going to affect the leather pipeline. Hopefully, it will lift a lot of the paralysis, but we believe that the time after is going to be different to the time before. They might be even pretty good chances for a successful restart of leather. Maybe a complete stop was needed and hopefully some have taken the time not only to manage the problem, but also to think what can be done better in the future.

In the coming weeks we will try to monitor what is happening to all the spring-summer collection material which has basically got stuck. Will the material be dumped into the markets at any discount, will some big retailers and brands even take the loss and just sell what the consumer is willing to take? When will the automotive industry restart properly? How will the buyers react in the times of financial uncertainty? Will discounts, government subsidies and zero finance stimulate vehicle sales quickly? How is the raw material supply going to continue into the summer? How will the players along the supply chain interact with each other? Respectful or ruthless? Will we have any indication of consumer sentiment? Will fast fashion or value for money be the driver? Plenty to watch and to discuss in the weeks to come.

We will leave the skin on split section out this time. With the only exception of collagen and gelatine productions, the parameters are the same.

We have too many questions and too few answers. We are at a junction and now we have to watch and analyse which road the leather business is going to take. Those who are creative, ambitious and optimistic might find even better chances now than for a while. The conditions are difficult, but the best has often emerged after times of stress.

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