Macroeconomics

The last two weeks have been peppered with some significant developments.

Politically, one has to be concerned about the instabilities in many western countries. The UK the prime minister has had to announce his resignation and, last week, the prime minister of Italy was also forced to resign and dissolve the government. While these may all be democratic rules of the game, one has to lament that political instability is really simply the worst option at times such as these. Unfortunately, many local political forces see the citizens’ insecurity and difficulties as an opportunity to push their own interests.

The handling of the events surrounding the storming of the Capitol in Washington DC in January 2021 must also be of great concern. First of all, we assume that the witnesses in the committee of enquiry are telling the truth. Here, too, it can be seen that individual egos are prepared to go very far to put their own interests and hunger for power before the interests of a nation. The fact that they can also count on a large number of supporters in the process does not make it any better.

At the end of last week, the news that an agreement had been reached on the export of grain from Ukraine appeared as a small ray of hope that the war and the suffering of people there might have a prospect of a short-term solution. At the same time, Russia also resumed gas exports through the Nordstream 1 pipeline at a significantly reduced level, which could also be seen as a small sign of possible negotiation. However, this changed abruptly when news of the bombing of grain storage facilities in the port of Odessa made the rounds. If this continues, the hope for a short-term solution is no longer very high.

Consequently, one must prepare for a longer phase of armed conflict with all its consequences. This also means that the likelihood of a normalisation of food and energy prices for the next few months is ruined for the time being.

The European Central Bank may have been doing what was necessary for a long time now, but the timing of this institution remains extremely frustrating. The 0.5% rate hike may be more than adequate in absolute terms and have exceeded market expectations by a factor of two, but a forward-looking monetary stability policy looks very different.

What must be particularly irritating is the fact that the pride of having an independent central bank in Europe is unfortunately no longer justified when one has to assume that the decisions are much more political in nature.

The euro was able to recover somewhat after a brief visit below parity. The interest rate step certainly helped here, but it could be deceptive in the medium term, because if Europe does not operate convincingly against the current problems and crises, then the euro will again come under pressure. At the moment, the political answer seems to be that the state can solve all problems and has endless money to do so. This situation has never been recorded in the history books. It is a really big experiment to see whether the task of the state can go so far beyond supporting what is really needed.

Especially in fiscal policy, one must expect massive changes in the next few years, as the media call for redistribution will certainly become louder and finance ministers will one day have to ask themselves how they can balance their deficits.

No real clear trend can be discerned on the financial markets. The only exception may be the further decline of the gold price, while all other markets rather continued to show volatile ups and downs. The price of gas remains high owing to the circumstances, while the price of oil is controlled solely by the supply of the OPEC countries. Their interest at the moment seems to be to keep the price at around $100 per barrel as an acceptable line for everyone.

Leather Pipeline

The general market is not moving much. On the one hand, this is because most decision-makers and the most important companies in the consumer goods sector are taking a summer break. This means not only an interruption in production but also a change of models, articles and seasons.

In addition, the changed situation in logistics and attempts by many companies to free themselves from the dependence on production in China are also leaving their mark. It is very difficult to say at this stage whether this is part of the general paralysis or whether it has not yet had its full effect. In the long run, of course, it will not make much difference whether production takes place in China or in another country in south-east Asia. However, the complete restructuring of supply chains must first be implemented and start functioning. Moreover, the scope and destination of the reorientation cannot be fully determined at this stage. It is likely to take at least one or even two more seasons, and that means a period of at least six months and possibly up to 18 months.

The ways in which the major retailers and internet platforms have already re-managed their supply chains to take into account extended delivery times is not yet clear to us. Given that major promotions by large retailers have to be planned at least six or nine months in advance, the next few months will be spent deciding what, how much will be produced and where. The consequences for the supply chain in the leather industry derive from this.

The situation is clearest in the automotive industry. Here it is a question of whether the hope that sufficient components will be available in factories in the coming months will actually materialise. At the moment, car manufacturers worldwide are spreading an extraordinarily optimistic view, going so far in many cases as to forecast that they will still be able to compensate for the declines of the first six months in the second half of this year.

This will mean an extreme increase in production, because if the target figures for the year are to be achieved, it will mean producing up to 20% or even 30% above target figures for the second half. When asked, some major brands assure us that they have used the last few months to build up component inventories accordingly. At some production sites this may even be true; in the case of China, for example, the decline in production was not only due to a lack of components, but also to the government’s covid policy. It can therefore be assumed that a large number of components are already in stock, at least for the missing production volume. The sales situation will not be a problem either. In most sales markets, the manufacturers’ order books are more than satisfactorily filled and will certainly ensure production until the end of the year, even with large increases.

The only question that remains is to what extent leather volumes will benefit from this and whether leather manufacturers have already stocked up a considerable part of the raw material they will need. There are many indications that this is the case; the exception may be China, since here too the leather industry was affected by covid-driven closures. In conclusion, this would mean for the automotive sector that in China there could still be a greater need for raw materials, whereas in Europe the impression is that the leather industry has already stocked up on sufficient raw materials and will not develop any great additional demand beyond normal production.

Let us stay in China for a moment. The latest figures show a substantial increase in sales of electronically powered vehicles. All the major manufacturers expect this trend to continue in the second half of the year, and thus significant growth in production and sales. In China, the share of leather-equipped electronic vehicles, especially among domestic brands, is significantly higher than in Europe, for example. So, if the expectations of the Chinese automotive industry actually come true in the coming months, we can expect a noticeable increase in automotive leather production in China. However, this will not necessarily be the case in all other markets and production locations.

In summary, barring unforeseeable events, a very stable and normal capacity utilisation can be assumed in automotive leather production in the coming months. However, as already noted before, this does not necessarily mean that there will be an overall increase in demand, because it is possible that sufficient intermediate storage facilities have already been set up or created in some markets and thus only the output of finished leather would increase.

At this point, however, we should also discuss the influence of the pandemic. While China continues to adhere to its zero-covid strategy, which means that every new flare-up of infections leads to a reduction in production, the situation is somewhat different in the other regions of the world. Lockdowns are now being ruled out by almost all governments in the major production regions. If you look at the infection situation worldwide at the moment, it is by no means low and a year ago governments and politicians would probably have reacted to these figures with great haste. By now, people have come to terms with the virus, and since current variants cause milder symptoms, it has come to be considered a normal disease.

There are many companies that are unable to achieve normal production solely because of a significant increase in sick leave. This is somewhat less noticeable now in the summer, because on the one hand people have become accustomed to delivery delays and a lack of availability, but on the other hand the reduced production and the interruption due to the holidays are clearly glossing over the effects at the moment. The situation will change in autumn, however, when the number of infections could increase significantly again and thus people even with milder symptoms will be absent from work for at least a week or so.

Since infections usually occur in waves, they could affect whole groups in the workplace, and the bottleneck for production could shift from the availability of components to the availability of labour. All planning will immediately become obsolete if supply chains and production are affected exclusively by sick leave this time. This is all unpredictable, because no one knows how the virus will behave in the coming months. Predictions that the number of infections in the northern hemisphere would drop significantly in the summer have not come true. So there is a legitimate prospect that the virus might spread more rapidly again as life moves back indoors, but no one can predict today whether there will actually be an increase in the number of outbreaks because of the disease. Critics will now object that we want to play down the risk of infection, but far from it. The only thing we have learned is that the virus has not necessarily behaved as most expected in the past two-and-a-half years. The other thing we can draw conclusions from is that although planning should and must be done, the certainty of that planning is much less than it used to be.

However, all this also means that flexibility and adaptability will probably be much more important for business success in the coming years than size and ‘management by budget and forecast’. This is probably a very exciting development, because it would call into question everything that has been the standard of corporate management for the last 25 years.

With regard to the other sectors, especially the large volumes in the shoe and furniture sectors, we have already explained our expectations in previous issues. We expect declines and at the same time hope that the positive forecasts published by manufacturers of leathergoods, especially handbags, could actually lead to a partial compensation for the declines. We saw something similar in the first years of the new millennium, when the car industry with its growth in leather consumption would be able to compensate for considerable declines in the shoe sector.

The bottom line, however, is that the trend in the use of leather as a material remains negative. The tipping point may have been some time around 2016, and since then we have seen a rather increasing supply of raw material on the one hand, but a moderately declining demand trend on the other. If we then assume that inflation will siphon off part of the purchasing power of global consumers, then one may continue to give positive developments for leather on a sector-by-sector basis, but in its totality one must assume a decline in global production. Unfortunately, of course, this also means that processing capacities will have to go down with some producers going out of business. 

As far as cattle hides are concerned, there are other possible uses, so that the often voiced conclusion that they will all be destroyed will not come true in our view. The only thing that is unclear at the moment is what added value can be generated from the raw material and where.

As everyone knows, many regions of the world are struggling with droughts this summer. The availability of water is clearly limited and this also affects the leather industry. We only hear about real restrictions for the industry from China, but even if the leather industry does not consume water but only ‘borrows’ it, we have to assume that without a quick and significant change, the decision will be taken at some point that the use of water must be restricted in the industry. In the case of Southern Europe, Italy in particular, this means that the summer holidays have come at exactly the right time.

However, if the situation does not change in the long term by the end of the holidays (not really to be expected), it would not be surprising if the production stoppage had to be extended by another week or two.

In the end, everyone has to make their decisions for the next months from all the different information and opinions available. There are definitely still very extensive stocks of raw materials and semi-finished products. If these stocks really do exist in many regions of the world, the first question that arises is what types of goods are involved. Then there is the question of when these goods will come onto the market. Until that time, it is completely ineffective for the supply and demand situation. There are certainly many interesting questions for the second half of the year, and this is certainly one of them. It will probably take until the Lineapelle at the end of September for a real statement and answer to be found on this.

The split market remains dominated by demand for collagen products and the share of raw material processed for this sector is continuously increasing. For the leather industry it is certainly a helpful support for companies’ calculations at the moment and compensates a little for the increased costs. How sustainable these levels are will become apparent in the second half of the year. The share of the product that compensates for the decline in the output of lime split from the leather industry is steadily increasing and the raw material is available in more-than-sufficient volumes.

In the case of lambskins and sheepskins, one notices the fact that Russia has had to seek new procurement channels for some products. The countries that have not joined the Western sanctions and continue to trade with Russia are benefiting from this and are already noticeable on the markets today. To procure the right raw materials for production with available stocks and, mostly, still very low prices is not particularly difficult. Once again, leather apparel was seen at the fashion shows. Considering the massive campaigns against the material, one can only welcome and support the courage of some fashion designers. Whether this time the leap into high-street fashion will take place must, once again, be in doubt. In haute couture, however, leather is still popular and extremely successful.

We are refraining from making a market forecast. We have a clear opinion, but the markets and the market participants are not behaving rationally. There are also a large number of very regional influences that play a dominant role. This means that a generalised statement would not really be justifiable at the moment. It cannot be ruled out that we could see opposing trends in various sectors in the coming months without this changing anything about the general and long-term challenges. That is why it is more important than ever for everyone to analyse their own situation and supply chain carefully and not allow themselves to be guided by general opinions and wishes. In addition, the behaviour of individual market participants, emotion and speculation can always play an important role in the short term.

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