Macroeconomics

Only two issues are having an influence on the general situation. One is political in the broadest sense, the Russian invasion of Ukraine, while the other is economic in the broadest sense, the effect of the covid-19 pandemic in China.

The war in Ukraine is the dominant issue because it is not clear at the moment what the outcome will be and what further developments may result from it. No one can say with certainty today where it may lead. Every option is being discussed. But among the tangible consequences that everyone notices already are sharply rising energy and food prices. The support of Ukraine with weapons and other aid supplies must also be financed at some point, and no one knows at this point for how long this support will be necessary.

It is clear that it will have a negative impact on consumer behaviour and ultimately on people’s disposable income, both in the short term and in the long term. We have already reported on the topic of inflation several times here. The European Central Bank’s decision last week to leave interest rates at 0% and not to fight inflation decisively can only be viewed with incomprehension. One gets more and more the impression that these decisive positions are actually not filled according to professional competence, but according to other criteria. In the end, history will clarify how the current actions will be evaluated and it is to be feared that once again it will not affect those who make the decisions as much as it will ordinary families. One thing is for sure, the mistakes of today will be felt for a long time to come and it will take a long time to correct the consequences.

There is nothing worse than war and its victims, but it must be feared now that the continuing lockdowns in China, the extremely restrictive pandemic policy of the government there, and the consequences for production and logistics, could have serious economic too. The combination of the two events and the possible disruption of global supply chains could, in addition to the direct impact on energy and food prices, trigger significant further difficulties in many sectors and threaten economic stability in many countries. One can only hope that China considers its political preferences less important than its economic interests and its own economic development.

Most commodities have passed their price peaks for the time being and slight corrections have occurred almost everywhere. The price of oil fell to below $100 per barrel before increasing again to $110 at the end of the period, under the influence of the developments in Ukraine. Countries including China and India are taking advantage of the current sanctions policy and supplying themselves with Russian oil at much more favourable conditions. Basically, countries that do not join the sanctions can buy Russian oil at market prices with discounts of $20-$30 per barrel.

The interest rate policy in the US and in Europe has led to a further strengthening of the US dollar, which is now trading at rates of around $1.08 to the euro.

The gold price continues to be trapped in a very narrow trading range and is not managing to sustain levels above $2000. This is remarkable considering the overall situation and global risks.

Leather Pipeline

In the leather pipeline, the influence of the war in Ukraine continues to be felt indirectly, but the situation in China is beginning to unsettle and directly influence the markets more and more every day.

The results of the large luxury goods groups continue to be very impressive. All the big and important names were able to increase their sales revenues in the first quarter of 2022, and in most cases leathergoods played a significant role in this. It remains the case that the wealthy of this world have not changed anything in their consumption, at least not in the first three months of the year, and rising wealth, mostly the result of rising stock prices, rising corporate profits and low interest rates, continues to fuel luxury shopping. While consumption from Russia and other countries in the region may decline significantly in the coming months, the outlook for the other markets remains clearly positive. For the Asia and Americas regions, the war in Ukraine is still very much a distant echo and the potential negative effects will only be felt in consumption in these regions after a long delay, if at all.

Car sales in the first quarter were very disappointing. Owing to a lack of components, vehicle production is significantly reduced. On the one hand, this leads to an improved margin for the vehicles delivered, as hardly any cars can be bought with discounts nowadays, but at the same time it also lengthens delivery times and in many countries the prices for used vehicles have also risen considerably. Contrary to all the assurances of the car manufacturers that they can make up for missing components from their standard suppliers by new and changed procurement, this cannot yet be seen at all in the production figures.

They continue to claim that as soon as the decisions take effect and are implemented, the production backlog can be made up by extra shifts. Looking at the current situation in China, however, this is very difficult to imagine. We are already in the second half of April and it does not look as if, on the one hand, the Chinese government’s restrictions will be reduced in the short term, preventing the Shanghai region in particular from returning to normality. In addition to a return to normal production and a normalisation of local transport systems, more and more backlog is building up at the ports, which, according to the experience of the last two years, will take much longer to return to normal.

If you look back at the past two years, the widely predicted normalisation following the emergence of covid has not really taken place yet, even when there were largely normal conditions in China. At the moment, based on the development of the pandemic and the officially reported infections, one has to assume that hardly anything fundamental can change before May. This would mean that the Shanghai region, and of course others, will be considerably restricted in production and transport for more than four weeks. With the experience we have had in the rest of the world with the Omicron variant of covid-19, it seems unlikely that normal or even increased economic activity can return immediately if the handling of the pandemic is not changed. Since it is completely unclear which sectors and businesses are most affected and to what extent, we can only speculate about the effects. A real normalisation in the automotive sector and, thus, the expected jump in demand for automotive leather, can therefore hardly be expected in the short term in our view.

For furniture leather, the current season is now coming to an end. Without being able to make reliable statements about demand for the next season, it is safe to say that demand for the next six months will decline, purely on a seasonal basis.

How and to what extent the changed economic situation of consumers will affect the demand for furniture and thus also for furniture leather is completely unclear at the moment. However, it is difficult to find many positive factors for another strong season. Consumers will lack the purchasing power to invest in furniture owing to the increased prices for energy and food, and on the other hand, the real estate markets in Asia, the US and Europe continue to weaken. On a positive note, leather as a material in furniture production is definitely not facing the same headwinds as we have seen in other sectors for some time.

For us, the situation with shoe uppers remains completely unclear. On the one hand, shoes remain a basic consumer product, and we have been more positive about leather in footwear for some time because the alternative materials will face large price jumps in the coming seasons; basic materials have become considerably more expensive in the past year. This should put leather back on the agenda of designers and product developers. However, the news we are getting from the big shoe manufacturers does not point in this direction at all. It seems that they continue to rely heavily on automated and machine production and leather is much less suited to this with the technology available today. However, we are not yet ready to completely revise our opinion, we also know that major changes and movements in the use of materials take longer than one might normally expect. Moreover, there is still some time before the final decisions have to be made. It would be good if the big brand manufacturers could put the advantages of leather, sustainability and longevity above all, at the forefront of their thinking. This is a very weighty argument in times of scarce disposable income and rising prices for the consumer.

Experience shows that the second and third quarters tend to be more difficult for business in raw materials. The leather industry becomes cautious, in Europe consumption declines in the build-up to the summer holidays and in many countries there is interrupted production before business picks up again from September.

If we take this situation as a basis for what remains of 2022, then a thoroughly dangerous situation with increased risk is building up, at least in the raw materials markets. The war, inflation, logistics problems and the pandemic situation in China are not a particularly good basis for optimism about the volume of orders that might come from retailers in the second half of the year. As things stand, anything other than caution in ordering behaviour would be a surprise.

If we only look at the supply situation now, we are particularly concerned about the market in the US. One can’t help thinking that the visible price situation is very different from the real situation, and that would be easy to explain. The transport situation from the US has been burdened for months by problems in sea freight. For months, large quantities of material that had been sold was waiting to be loaded could not be shipped. For five weeks now, however, slaughter volumes have been increasing considerably and the freight space that is needed is available. Regardless of sales, many containers are now on their way from the US to China. At least as far as the ports in and around Shanghai are concerned, this is hitting significantly reduced handling capacities and more ships are piling up every day waiting to be unloaded in China. However, the arrival of the large volume of shipments of hides is not expected for a few weeks yet and it does not seem that the problems in the ports can be solved in the short term. Apart from the congestion in the flow of goods, we are actually much more concerned about the fact that large quantities were purchased a long time ago and shipped late, but no one in China has complained in recent months that they lack raw material for production. The logical conclusion is that this should mean that the large quantities that will reach China in the next six-to-eight weeks will arrive at a time when they are not really needed.

Everyone knows the market reaction and therefore the relentless defence of the official prices in the price lists is only too understandable. At the same time, everyone involved in the active daily business knows that the official price lists have very little to do with what can actually be understood as the market price at the moment. This of course leads to a continuous increase in the risk for the outstanding contracts and this increases even more if one assumes that there is not enough demand for cheaper goods at the moment either. The price mark does not really influence the business and may not even stimulate it. Everything depends on how the Chinese leather industry assesses developments for the second half of the year.

Anyone looking at the available statistics will see that the response to these problems is already apparent. Other regions and markets are increasing as destinations and it is clear that flows are reorienting. In the case of US commodities, one can clearly see that Mexico, South East Asia and Italy are the current beneficiaries. It would also not be surprising to find India, Pakistan and Turkey on this list very soon. Nevertheless, the process of restructuring supply chains always takes time and for the next few months China’s importance as the main market will certainly not reduce quickly. This leads to an increase in market risk, at least in the short and medium term.

In Europe, the situation is not yet as strongly felt. Many of the European suppliers have been shifting their focus from sales to China to sales elsewhere in Europe owing to the considerable transport costs and difficulties in handling. Overall a relatively low kill in the first quarter also did not lead to significant sales pressure, so European raw material prices remained more in a local bubble from month to month and did not adjust to international market prices. In a sober analysis, a difference of up to 20% is certainly easy to explain. The current price levels, especially for male products, can only be explained by the very low flexibility of many farms in the use of raw materials and the desire and dependence to process as much fresh, cooled and unsalted raw materials as possible. A look at the purchasing behaviour of Italian tanners in recent times may serve to clarify this. 

There has been a certain calming down on the market for splits in the last two weeks. The bonanza of the weeks before did not continue and this was perhaps understandable if not really explainable. Whereas in China, at the moment, split prices have come under pressure because transport problems have made sales and delivery much more difficult, in Europe prices have simply risen too fast and too far. Since prices here are usually agreed for periods of up to three months, a possible correction is not to be expected until the summer.

For lambskins and sheepskins, the situation looks somewhat friendlier overall. This is no mean feat, as prices for most of the goods are still at historic lows. The focus is on lambs in Europe, where everyone is waiting for new-season production. As there is hardly any supply available at the moment, no reliable prices can be determined for this season. However, we are hearing more and more about increased demand from India and Pakistan for sheepskins, lamb and goat skins for clothing and especially for the glove sector. 

Manufacturers have been over-indulged in the last few years, as they have always been offered raw material from various regions at almost zero cost. That time has certainly passed and with increased transport costs, suppliers demand at least the coverage of the processing and transport costs to justify a sale. There are sometimes quite considerable differences in the ideas about prices and despite all the demand, the volume of business still seems relatively small to us. However, the buyers have little chance of being able to buy in volume at their price expectations, because hardly any supplier is willing to sell goods at cheaper than cost. The times of large stocks that had to be sold somehow are certainly over. All in all, the situation is positive, but it will probably take some time to determine whether the prices can be realised in the end.

Without a renaissance in the use of leather as a material, business will not improve significantly. We also see an increasing risk that leather manufacturers might run into liquidity problems. Lack of sales combined with skyrocketing costs and the need to pre-finance them are a real threat to many small and medium-sized businesses. We have already described the problem with the situation in China and it does not seem to us that the market can return to balance in the next few weeks.

The big buyers will now do everything they can to push prices down further and then, if necessary, replenish their raw material stocks at risk-free prices in midsummer. Suppliers only have the chance to refrain from selling in the near future if they have the space and the financial resources to stay out of the market for a longer period, which they have not been able to do in the past.

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