Macroeconomics

As with the rest of the world, the financial markets were in ‘holiday spirits’ during the period under review (July 13-27).

Mr. Greenspan appeared to take heed of our previous MI as he stopped the USD descending again. His indication was that the interest rates in relation to the dollar would be raised incrementally. In his opinion, the US economy was still on a path of robust growth, and in response to this, sellers of the Greenback decided it was again a good investment opportunity. So, we are back where we were a month ago and it seems the exchange rate – for the moment – has returned to the ranges seen in the spring of this year.

In Europe, and in particular Germany, reform continues. More and more changes are being made and the fact that an increasing number of companies are returning to the 40 hour week is supporting the hope that finally the biggest European economy will become more competitive again, and that the erosion of jobs will come to an end.

The news that Germany’s savings have reached record highs with almost 4,000 Billion € makes it clear that the weak consumer market has not been for the want of money, but a lack of confidence regarding the future. This is good news for the potential of this market when things eventually take a turn for the better.

In the rest of the world nothing immensely important has happened. So far in the summer, China has been struggling with a shortage of energy that is hindering an industry that was already finding it difficult to keep abreast of its production plans. So, how will the Shanghai Leather Fair be affected? Will there be air-conditioning in the halls?

Market Intelligence

The leather pipeline did not deliver too much news. The hide market provided a firm tone, as most sellers had looked into their warehouses and reviewed their production plans for the forthcoming weeks and concluded that they were not overstocked. As a result, they were not impressed by the attempts made by some buyers to talk up the negative effects the holiday season was going to have on demand levels.

Those tanners who had not yet covered their requirements were basically in a very uncomfortable position. The orders for finished leather are booked and the prices are fixed, so they had no chance of protecting themselves against the rising raw material market.  As we expected, most buyers tried to fill their production gaps with bargains.  As always, however, when calculations don't work out, it is more the price of the raw material than the quality that becomes the main determinant in the buying decision. Whether this was the right approach or not will become obvious once the goods have arrived, been turned into leather and been inspected by the customer.

Buyers staying with their preferred raw materials had to pay the suppliers asking price, but they were quick to remind them that the tables can easily turn, and when they do they will underpin the seller’s business.

Opportunity

Market situations like this are always extremely difficult to manage effectively.  Sellers might appreciate the opportunity it gives them to reclaim some of the ground they have lost to buyers, but it is not a real reflection of the supply and demand situation.  And, since the new leather prices have yet to be fixed, tanners are simply buying against existing contracts. In other words, they are just buying what they need in order to satisfy their raw material positions.

Not that this is really changes anything. Had they bought in advance, the situation we are now seeing would only have been anticipated, not avoided.  The real situation between supply and demand can never really be altered - it can only be accelerated or delayed.  However, it would have been good if the steady market trend was maintained until September, which is when the leather contracts for the next season are renegotiated.  However, it’s been a long time since we had such a long period of stability, so in general the leather pipeline can be quite happy about the last season.

In the last edition of MI, we devised a negative scenario for the coming months and this was done to provide a projection other than the one that everyone follows. The key question now is: “Will leather buyers accept the changing fundamentals in the calculation, and consequently allow leather prices to go up?”

To obtain an answer, we took the opportunity to call around some of the leather buyers in the furniture and shoe industry.  What we found was that nobody was really expecting higher purchasing levels.  Unsurprisingly, they were also very much opposed to the idea - even if it was hypothetical! The general reply was that they simply could not afford higher leather prices because the retailers and consumers would not accept them.

We believe that at least in the short term - and this means in the next six to eight weeks - raw material prices will stay high and some sellers will even try to push them up further. The basis of the calculation for tanners - including higher energy and raw materials cost - is going to be at least 10 if not 20% higher than the previous year.  Part of the increase will be absorbed by advances in productivity, better technology and the shift to cheaper raw materials. According to our rough calculations, however, there is an increase of a minimum 5% that cannot be passed on.

Integrated

Accordingly, a less than 5% increase seen in the price of finished leather will either further erode tanners’ margins, or see some of their number even being forced into loss-making situations. Those operations using integrated manufacturing, where they are also cutting, sewing or even manufacturing finished products, will have things a little bit easier.

It can be assumed that buyers will continue to resist price increases, if only because they know overcapacity is so prevalent in the industry, especially in China.

Then again, overcapacity in the leather industry is nothing new and tanners can be expected to either cut soaks or go bankrupt. Alternatively, demand for leather might decline because buyers switch to other materials in a bid to keep their prices down. While we believe the least painful scenario for the industry would be one where raw material prices fall in line with the present market environment, we don’t consider this likely in the short term because of the disturbance that has been caused to the balance of supply and demand over the last few months.  The market will need a reasonable period of time to return to the stability seen this time last year.

Classically, increased leather demand and price pressure has always been countered by reduced inventories along the leather pipeline. But, in the last 10 to 12 weeks we have seen this wisdom overthrown as the output of cattle hides has been reduced, general commodity prices have risen and appropriately-priced raw materials have fallen into short supply. 

If we cannot assume that raw material prices will adjust to the levels the leather pipeline is looking for, we have to consider the other options stated above.  The main hope we have for getting things back into proper order is that we experience a higher kill in September and October.  Looking at the forecasts in the main producing countries, we are optimistic that increased supplies will ease some of the pressure over the coming months.  Those who are not covered for September/October production will have a difficult time, and those only needing more hides in or after November can be expected to wait for more attractive raw material prices in October. However, our advice would be to check your order book carefully.  It will take some time until the pipeline is sufficiently replenished.

We must also be aware that price levels as such are now again on the high side and that when this occurs, it becomes difficult to maintain those levels.

Interest

The other markets showed some different movements.  The split market was pretty steady and didn’t create much interest. Any splits that were purchased were done so at reduced price levels, but only a small amount of trading was done and sellers were unresponsive to the lower bids. Since more production is moving to China, less split production and offers are being seen from the traditional production areas, with only South America generating significant volumes.  Europe and the USA are today offering much less than in the past.

The lamb and sheep skin market presented more of a mixed picture. While cheaper and bigger skins experienced high demand levels, some market standards - such as lambs required for Turkey - came under pressure, something which is usual for this time of year. Buyers pushed the market for double face in May/June in order to cover against expected orders from Russia, but the rush never materialised. As a result, booked orders were not honoured and attempts made to renegotiate contracts. This is why the Turkish market does not make more friends and only serves to push sellers further into the arms of buyers from the Middle East and China. Prices were steady for sheep and lower end nappas, while average quality double face skins were softer. We see this situation continuing through to September/October when skin tanners will have more of an idea of levels of demand for the rest of the year.

In the next weeks, the market will be in the hands of the Asians as the rest of the world relaxes on holiday. There might still be a bit of interest to cover production holes in the next weeks, but in general we expect interest to dry up in the face of current price levels. If the dollar can hold or even gain ground, we could see some firmness emerging in the European market. However, the risks are growing and sellers will be well advised to get the money for their sales and have them shipped. Tanners do not have much of a profit margin left and are unlikely to be happy about the lower market levels and the high price contracts on their books. The present market level is dangerous until higher leather prices are achieved. So, to avoid unpleasant surprises.

Share this story: