Macroeconomics

 The misery and suffering of civilian populations continue as hopes of an end to wars in different parts of the world remain frustrated.

In the US, everything is beginning to focus on the duel for the presidency. The election in November will, once again, be between Joe Biden and Donald Trump. Two men of advanced age will run for the leadership of one of the superpowers; they will be the only alternatives for voters. Some Europeans are coming to terms with the idea that another Donald Trump presidency, with all its consequences, is a likely outcome.

The National Congress of the Communist Party took place in China, where the political cadres are traditionally brought into line and the party leadership formulates the goals and measures for the country for the coming months and years. The growth figures were set at 5%. Apart from that, efforts were made to create the conditions for stronger domestic consumption and to suggest to the public that the country’s considerable economic problems can be controlled and solved.

Of course, this includes a solution to the difficulties in the property sector and the debts of state-owned companies.
On the financial markets, artificial intelligence remains the topic of the hour. The question of how long share prices worldwide can continue their record highs is also an important subject for discussion. While there is no doubt that the changes brought about by artificial intelligence and the potential productivity gains will change the world significantly, the question remains as to whether this can really justify the record share prices at present. The arguments in favour and against have been exchanged and at least investors and savers around the world are enjoying the increase in their wealth.

Nevertheless, despite all the positive arguments, the question remains as to whether this is nothing more than another of the recurring bubbles that we have seen so often before. Until the bubbles burst, there is a multitude of arguments as to why that will not happen. When it does happen, there is at least the same number of plausible explanations as to why it had to happen. In any case, there is currently only one major market that is lagging behind the trend, and that is China. Even in Japan, share prices have now returned to the absolute record levels of 30 years ago.

It is not only the stock markets that are booming at the moment, but gold and cryptocurrencies have also jumped from record to record. In the meantime, it must be assumed that it is still an after-effect of the phase of low interest rates and the policy of the national banks, which means that there is simply too much liquidity in the markets looking for investment opportunities and possibly not exercising any caution or expertise. Economic theory offers many solutions and explanations, but every investor should realise that this excessive liquidity must be removed from the market. The easiest and quickest way to do this is a sharp fall in asset values, which is of course not in anyone’s interest.

In terms of statistics, we saw gold at prices rise above $2,100 per ounce, while the oil price stubbornly held at around $80 per barrel, with the dollar weakening slightly and losing some ground against the euro to stabilise at around $1.09.

Leather Pipeline

The situation along the leather pipeline suggests a world divided in two. We have already reported on the problems of the leather industry in Europe and these have been confirmed increasingly in recent weeks. At the same time, the recovery of production in Asia is gathering pace. While a high degree of uncertainty still prevailed in the last quarter of 2023, the positive trend has solidified in the first quarter of this year.

Mass manufacturers and major brands have significantly reduced their problems with excessive inventories and are therefore showing willingness to replenish their supply chains and stocks. Most major manufacturers, particularly of leather for the sports footwear industry, are reporting full order books and a continued positive outlook for production in the second quarter.

We could conclude that the crisis is over and that the current situation is the restart of a new cycle of positive development in global leather production. However, this would probably be a little too simple and would not describe the situation correctly. For us, there are two key parameters that could possibly explain the current development. On the one hand, many production facilities outside Europe are currently favoured because of the cost situation. The costs for energy and chemicals are far below the levels in other parts of the world and at the same time this is combined with historically low raw material prices. The second point could possibly be a result of the first, although it is not entirely clear which came first: the chicken or the egg?

The retro trend in shoes with the use of leather may have been supported by favourable hide and leather prices, but it may well be that the retro trend itself has simply triggered the demand for leather. In the end, it doesn’t really matter what the reason is. The fact remains that the demand for inexpensive leather and for sports  and casual shoes has undoubtedly increased significantly. Those who can produce at a correspondingly low price are benefiting considerably from this.

The same applies to furniture leather. The current low prices for hides and leather are making it attractive again and many furniture brands and manufacturers are trying to use the image of leather for their marketing purposes. Even in the clothing sector, where genuine leather has been in the doldrums for so long, big global brands are increasingly producing leather collections for women again. The optimists see this as the start of a new cycle, while the pessimists point out that this is exclusively price-induced and that a possible increase in raw material prices and thus also leather prices would very quickly lead to the substitution of leather again. We believe that both positions have very good arguments in their favour.

In any case, it should be borne in mind that this significant ray of hope only applies to one sector, namely the low-priced, mass-produced part of the leather industry, and that this alone is certainly not sustainable enough to bring about a fundamental change in the situation.

Without going into more detail about the other sectors of leather production, it must be pointed out once again that we are obviously not confronted with an increase in demand for leather across the board, but rather with a shift owing to the extreme divergence in production costs. Production in Asia, South America and the Indian sub-continent has always been cheaper, but the spread has now widened even further.

This brings us back to the difficulties we are facing here in Europe. The bad news continues and the order situation in many leather factories is extremely poor ahead of the traditionally weaker production phase in the second and third quarters. The likelihood is that nothing fundamental will change in the coming months. Here, too, the optimists point out that the complaints have been there for months and, in the end, leather manufacturers are all still active and will just have to wait for the usual cyclical improvements.

It is of course a position and attitude that can be defended, but let’s be honest, what realistic prospects do we have that leather orders in Europe could rise sharply again in the short term? There really is not much that could point to this. However, this also means that the question arises as to how long and how many companies can keep this up? To be honest, the situation is not new and the framework conditions have deteriorated rather than improved. The financial situation of the companies is not getting any better, although reduced production and falling commodity prices are providing some cover.

Sooner or later the low capacity utilisation rates will have their consequences; rising interest rates will put a strain on companies from the moment the financial resources freed up by lower capacity utilisation and lower commodity prices are used up. To make matters worse, banks and credit insurers now have a much more negative view of the sector than they did a few years ago and are much more restrictive when it comes to lending.

As bitter as it sounds, we have to accept the economic reality. If capacities in Europe cannot be quickly occupied by increasing orders, they will have to be reduced. The question that remains is whether this adjustment can take place in an orderly and voluntary manner, as has happened so far, or whether it may be accompanied by involuntary plant closures.

There is much to suggest that high-quality niches in Europe will continue to be able to support production, while industrial producers will have to think very carefully about how they can retain their customers and persuade them to pay cost-covering prices.

Here, delivery reliability, creativity, transport costs, carbon footprint, smaller batch sizes and, above all, flexibility are definitely at the forefront. However, the paradox is that politics and the self-imposed certification and regulation mania in Europe, which is hindering the entire supply chain, may make it impossible to continue. In any case, we are already very close to the decisive turning points for the European leather industry for the coming years. Leather as a product material will remain, but changes across the world will obviously lead to a significant structural alteration in the production of leather.

In our view, the further development between politics and the leather industry is extremely important. The new EUDR deforestation regulations that the European Commission is seeking to impose before the end of this year are particularly important here. If they come into force as planned at the moment, it will be another nail in the coffin of many European supply chains. As is so often the case, this is further evidence of European policy repeatedly getting caught up in the problem of being well intentioned but badly executed.

The current situation in Europe is also having an impact in parts of the split market. In particular, the raw material for collagen and gelatine production is beginning to become scarcer. Significantly lower production in the leather industry and the correspondingly lower output of lime splits is beginning to pose a problem for supply security in the coming months.

On the one hand, low-priced finished products are entering the European market, but on the other hand, production capacities are still there and need to be filled in some way. In a way, the situation sounds very similar to the situation in leather production. Apart from that, there is currently a relatively good demand for splits for leather production, as it is one of the cheapest raw materials and is currently enjoying some demand in the consumer goods markets for finished products.

We are seeing an interesting trend in sheepskin raw materials. Many of our sources are reporting a significant increase in demand. However, the problem is that there is no longer sufficient supply at the prices that are envisaged and possibly already calculated. The warnings that there would be no supply in the long term at prices below the production costs of the raw material suppliers were ignored for a long time.

We have already reported that we are seeing more and more leather clothing collections on the market. In addition, this type of leather also plays a certain role in the glove sector and to some extent in the shoe sector. Here too, demand is certainly price-induced, but this is of relatively little use if there is no longer a sufficient quantity of raw material available. Of course, increased transport costs also play an important role here.

It doesn’t actually take much to revitalise the supply of raw materials. It’s not that complicated, and there are always special situations in individual cases. In principle, however, a stable basis and collection of the raw material for the leather industry can hardly be guaranteed in the long term below a price of $5 per piece, no matter what. If such a price level is calculated as an average and applied to the material costs to be calculated in the finished product, this is by no means an unrealistic order of magnitude. The next six months will show whether this is a realistic assumption and whether consumer demand and interest in leather as a material is sustainable, or if plastic will quickly gain the upper hand again.

In the next two weeks, most interest will initially be focused on the situation in Asia, followed by the APLF exhibition in Hong Kong (March 19-21). Many raw material suppliers are already starting their trips to China and other parts of Asia and will have a clear idea of the expected developments over the next six months when everyone gathers at APLF.

In seasonal terms, we are now entering the quieter phase, but the long supply chains mean that decisions for the period after September are already necessary. We are sticking to our assessment that demand for low-priced leather and its products has bottomed out. The impact this will have on the raw material markets and the calculations of the leather factories will be shown by the behaviour and pricing of the coming months. Equally, and as we have already outlined, we are more concerned about the situation and prospects for the leather industry in Europe. We will probably have more to report in a fortnight’s time.

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