Confirmed: the structure of the global leather market has changed
02/10/2007
MARKET INTELLIGENCE — 02.10.07
Macroeconomics
The last two weeks were pretty exciting and a lot of expected events happened. The US Federal Reserve cut interest rates by 0.5 %, which was more than most pundits expected and was seen as a proof that the US economy is in serious trouble; the central bank seems to consider the problems in the housing market as a much more serious issue for the economy than just the potential risk of inflation.
There is a variety of opinion on this, and only time will tell if the policy of easy money is going to solve the problem or make it worse.
With the US dollar falling, the price of many commodities has gone up, including oil—oil is now trading steadily above $80 per barrel.
The housing market tension also reached Europe, specifically the UK, Ireland and Spain. All reported falling house prices, and insecurity among savers was easily seen from the queues in front of the tellers of Northern Rock, the UK’s fifth largest lender, where people acted quickly to remove the money from their savings accounts. Government guarantees were given to prevent more severe damage to the financial system, but the situation added to the present uncertainties.
More bad news came in the form of sinking consumer confidence in the US and slowing growth and business outlook in Europe. In Japan a new prime minister needed to be elected to end a political crisis, and the dollar ran from record low to record low, not only against the euro, but also against a range of other currencies.
While the weakness of the US currency had been expected by many, and common understanding was that devaluation was necessary and would not cause too much trouble to the global economy, it might be better now to watch things carefully. The global anchor currency cannot go into freefall without hurting not only the US’s trading partners in Europe and Japan, but also the US itself through higher import costs and further economical instability.
China and Russia seem to remain untouched from the turmoil, and stock markets around the globe are still showing surprising stability. Investors still trust in corporate earnings, and, with falling interest rates, believe that the private sector is not going to suffer.
Nevertheless, the idea that higher food and energy prices, as well as problems in the housing markets of a number of countries, are not going to influence the consumer and corporate sector might be rather wishful thinking.
Market intelligence
Over the past two weeks, very little changed in the mood of the market. Business activity is dragging itself from day to day, but we cannot sense any of the enthusiasm expected after summer period.
It always takes quite a bit of time for the market to sort itself out after the summer break. In addition, the global community is facing a great deal of uncertainty because of the developments in the financial markets.
And so we are entering more and more into the world of conflicts. While on one side economies like those of China, Russia and other parts of Asia, the Middle East and South America are still enjoying growth and positive economical fundamentals, the rest of the world is struggling and not showing any clear direction as to where economies and, in particular, private consumption are heading.
Uncertainties about the housing markets and the future trend of food and energy prices are making forecasts about consumer spending extremely difficult. All this uncertainty is also reflected in the leather pipeline, and the mood and opinions could not drift further apart than they are today.
If we were to use one statement to describe the present situation it would be this: raw materials are still in great demand. This is reflected in the positive growth in leather product consumption. At the same time, though, market prices, the prices people expect to pay, are making life hard for providers of medium- and high-priced raw materials.
As a consequence, the leather price-trend in the last fortnight has been uneven. While lower-priced raw materials are still in high demand, and prices are steady, hides from the US and Europe are finding significant resistance in the markets and have continued their moderate slide in the last two weeks.
European hides are obviously suffering even more because the rapid decline of the value of the US dollar is hurting European exporters more every day. One must not forget that the US dollar has lost almost seven cents against the euro since mid-August, which translates as almost two euros per piece.
The balance shifts
There is very little sign that the demand for the products in the global market as a whole is declining, and we feel confirmed in our general positive sentiment for the market that we have expressed over the past month. However, we have to admit that we fully under-estimated the shifting balance between the dull consumer markets in the western world and the relatively strong performance of the so-called emerging markets. It’s not that we didn’t see it, but we were not right about the extent and the influence of the trends.
In this, too, the falling value of the US dollar has had an effect. Another factor influencing the present market situation is government policy in China, which is focusing much more on pollution controls, causing a lot of tanners (justified) problems in keeping their tanneries running. Then there is the tax policy, which was already decided and implemented a year ago, but the effects only developed in full after the first quarter of 2007. The result is that domestic raw material has gone up, which is why so many buyers are trying to escape by finding cheaper imported materials.
No justification for the negatives
A number of people with whom we have discussed the market have pointed out that all obtainable statistics show that sales to China in 2007 have not declined. They also suggest that global sales of raw material have substantially increased.
Well, we are not going to argue with that; we have always claimed that leather demand and the levels of consumer business offered no justification for the negative positions many adopted before the summer.
At the same time, neither we nor anybody else, can ignore the fact that the structure of the market has changed (as explained above).
In addition, questions have arisen over some of the statistics available. The biggest concern in this respect are the statistics from the US.
Since the start of the second half of 2007, the numbers from there have not seemed to match the real market situation or the information available from buyers or sellers. There is an odd feeling that the numbers of cancelled or renegotiated contracts during the sharp price correction of the second quarter have not been taken into account in the statistics.
Lack of confidence
The next question raised by many is over why the strong performance of leather retail sales and the good and positive outlook for the next season are not resulting in higher raw material demand and prices.
To put it another way, people want to know why business has become so much more difficult for many, and why many prices have been corrected since spring without showing any sign so far of reversing.
Well, one explanation has already been given by the change of the pattern in demand and prices, but this might not be enough to fully justify what has happened and is happening at the moment.
Most likely the main reason for this particular development is the low level of confidence within the industry. The leather pipeline, in particular at the raw material and manufacturing level, is traditionally pretty sensitive to changes and usually reacts quickly to variations. Quite a few influences in recent months might have changed the mood. Looking back to the beginning of 2006, the leather pipeline was full of confidence and has acted accordingly, with steady and consistent replenishment of inventories and faith in further growth of sales.
Costs were much lower at that point, of course, and profitability on manufacturing levels was certainly much better than today. Since then, and in particular during 2007, the situation has become much more worrying for many. Rising costs, rising interest rates, and growing uncertainty about the economic future in the US consumer market have made players along the leather pipeline much more cautious, despite the general positive order books that many are still carrying.
This is one reason why people have used continuously cheaper raw materials. Another reason for this—and this would add to the general price trend we have seen recently—might be a general reduction of inventory and manufacturing levels. Higher interest rates and the uncertain outlook for the future is frequently the reason why manufacturers start keeping low stocks.
Low inventories
This conclusion is reasonably in keeping with the observations many have made after visiting tanning centres around the globe. Everybody has their own explanation of why tanners have problems, even though business is good.
On one subject almost everybody agrees: there is no heavy material inventory anywhere along the manufacturing pipeline. Consequently, most of the stock has been pushed back to the processor or packer level, the very people who, today, have the biggest concerns about the market and the future.
And so history seems to repeat itself with a positive mood sucking the pipeline empty at one end, and a negative mood squeezing the material back to source at the other.
Demand for split still low
What hasn’t been mentioned so far, but plays quite an important role, is the situation on the split market. The insufficient demand for splits and, even more so, the insufficient shipments of splits, have clogged up the bovine sector.
Even if some people have begun to sort this problem out, it is still weighing on the general mood of the business. More and more people have lost faith that the split market is going to turn around in the near future.
The split market has certainly produced no positive news in the past two weeks. While heavier splits still seem to move at a certain price and in a certain volume, there seems to be no activity in lighter-weight splits. Price is less of a factor in this than ever before. It is simply that there is not enough demand out there to absorb the material produced.
Skin games
On the skins side, there is definitely an improvement in the nappa business, and with the relatively high prices for domestic material in China, more and more of the cheaper sources around the globe are finding success in mainland China. So, the business for this material is still quite good and prices are rising moderately.
Double-face skins are still a difficult item. Due to Foot and Mouth Disease in the UK, skins from there cannot enter China and many containers carrying this material are on their way back to Europe.
Turkish tanners are benefiting from the situation because, surprisingly, the authorities there are allowing UK material into Turkey (which is good). Buyers there with money and courage are finding a lot of bargains. It seems that this situation is going to persist for a while.
The next two weeks will, in our opinion, still not prove decisive. Holidays in Asia and the general wait-and-see attitude before the autumn edition of Lineapelle in Bologna (October 16–18) will pretty much slow activity down.
Towards the end of October we might have a better grip on the general outlook for the winter production season.
We may be going out on a limb, but we think that the markets for US and European hides haven’t hit bottom yet. European suppliers have certainly still to consider the influence of the currency markets and to take important decisions on how to handle the situation.
However, for the medium term we are still not pessimistic and there is a good chance, that we see the market develop in a similar way to previous years, with further declines until the end of October or beginning of November, before the market stabilises and returns to a moderately firm tone in the first quarter of next year.
We think that this scenario can only be prevented by further unrest in the financial markets, which can certainly not be ruled out at the present stage.
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