Macroeconomics

The last two weeks offered us no relief or even any indications that we might have reached the bottom of the negative cycle. It seems the situation is actually getting worse every day. The vast majority of companies are still reporting declining sales and/or profits. Layoffs, closures, production cuts and government bailout programmes are still making headlines and one has to search long and hard to find any positive news.

Although the banks are still the key problem, the automotive industry is also the subject of much attention at the moment. The ‘big three’ in Detroit are in big trouble at the moment. Their subsidiaries in many other countries are also under threat because of the restructuring programmes and a number of local government leaders have been travelling to the US to fight for their locations. Although everyone knows that production has to be adjusted to market realities, and that this is impossible without reducing capacity, every country and region hopes it will affect the others.

Taking into account the massive influence the car industry still has on the economy—particularly in Germany, France, Japan and the US—any major problem would dramatically affect national economies. Saab is the first arm of the GM group to have declared bankruptcy and things don’t look good for Opel either. This leaves governments to make decisions over whether they should guarantee the survival of these firms and pump more taxpayers’ money into the operations in order to save jobs. This will all depend on whether the necessary capacity adjustments can be made at a realistic cost, and whether individual brands can increase sales enough to justify their existence.

The situation in the financial sector is far more critical for people in general. The fear is back and daily news about banks’ losses is getting worse every day. A growing number of people feel that risks are rising and that the financial system could eventually collapse altogether. Although, logically, it makes sense that (big) nations will not fail, it feels as though the growing burden of national debt will never be repaid as more losses and guarantees are added by the day. It looks as though the only probable outcomes are higher taxes or nationalisation of private property. Not much has changed.

The stock markets have lost almost all their optimism and many markets have closed much lower in the last week, with some reaching record lows. The euro faced some weakness as a result of growing concerns about Eastern European economies. The dollar’s 1.25 level against the euro remained fairly steady. Gold rallied again as a safe haven and broke the $1,000 per ounce barrier on Friday. Oil remains under pressure because of the negative outlook for the global economy.

Market intelligence

The last fortnight has not offered much light at the end of the tunnel for the leather pipeline either. The constant influx of bad news from the global financial markets has swiftly swept any potential optimism away. There was a short spell at the beginning of the last fortnight when at least some European players believed the situation had improved. Numerous reports about a round of interest from China and a good number of letters of credit opened led to a rapid rise in optimism, and this was followed by greater competition for abattoir hides.

While some were warning people not to get overexcited about the situation and saying that it would be better wait to see whether it was a sustained development, others were only too willing to believe a market turnaround was taking place. Many are still living in the past, where market movements were local and price cycles short-lived. The argument that hides have fallen so far that they only can go up is a little too simplistic in the current climate.

At the moment, it is still important to look across the globe and think about situations in areas where hides are produced. Things will look a bit different if people do this. In countries that have large hide productions, such as Brazil, the US, Australia and Argentina, supply is far exceeding demand and better hides are still selling much more easily than the cheaper ones. In many parts of the world, we are still working at theoretical market levels, which will, in general, not be enough to secure and preserve the hides anymore. Many are still doing this because they believe that better times, which have to return eventually, will compensate for their investments. We can only hope that they will be rewarded sooner rather than later.

Supply still outweighs demand

Until then, we have to deal with the fact that valuable raw material may be destroyed. This is even worse when we consider that a hide that is not preserved and made into leather will be lost forever. In countries where abattoirs and processors are still marketing the hides, it is becoming increasingly difficult for processors to find a sufficient margin when slaughterhouses are dumping their hides in an attempt to move production rather than stockpiling hides. This is resulting in the same price competition locally that we have been seeing on a global level for some time.

It seems that no one is really able to estimate the present gap between the regular supply of hides and demand. It appears that around 30-40% of the hides are not covered by demand and production. This is not hitting all hide types and origins to the same extent and lower-quality hides are definitely suffering more than others. Higher-quality hides are setting the price levels and others will have to adjust accordingly, if they still can.

The effect of this can clearly be seen when comparing US and European hides. In the last quarter of 2008, US hides corrected so sharply in price and the dollar depreciated so much that EU hides lost all their competitiveness. The result was a reasonable clearance of US hides, while European hides got stuck. With the appreciation of the dollar and further price corrections in Europe, EU hides became more competitive into 2009, which made US hides less attractive. So, it would not come as a surprise if the next correction for US hides comes when packers have enough hides and see no other option than to introduce further, and sharp, price adjustments in order to move product.

The real question is whether we are now facing a situation of total surrender. Everyone is scratching their heads over whether this could actually happen. There is no need to discuss the situation in the automotive sector and upholstery is not offering any signs of hope either.

Lack of orders continues

However, the situation for shoes and leathergoods is not so depressing. The shows in Paris and some of the big brands’ financial results have offered a much more positive vibe. Uncertainty is still the biggest problem. Information from this part of the industry remains quite good and far more people seem positive than depressed. However, the fact is that tanners (in Europe) are simply not receiving the leather orders to back up the sentiment. This is actually really worrying. People can talk as much as they like, but business is still based on facts and orders and, if these are not placed, then all the optimism and talk means nothing.

It is hard to understand why everything is so complicated and why retail is obviously still holding orders back. The winter in the northern hemisphere was cold and long, and shops reported a good clearance of winter shoes. Some may now argue that this is in the past and that orders are for the future; however, it is also true that shoes are essential items. None of the recent shoe and leathergoods shows delivered any negative feedback. To get a better understanding, we carried out a quick poll with a number of large European shoe manufacturers and this mainly delivered positive feedback. Not a single company complained about business or indicated negative expectations for the coming season or seasons. However, when it came to the question of orders placed, the replies were still reasonably vague.

This could mean that orders are simply delayed, but who really knows? We have very little choice other than to wait and see what the final decisions are. For the tanning industry, it really is a hard time and reports from tanning centres such as Tuscany are so depressing that it is more than worrying.

China offers some hope

The domestic market in China is the bright spot as far as tanning and leather demand is concerned. If any market is performing close to normal it is this one.

As far as export sales and shoe orders are concerned, the situation is quite slow—particularly for the US. However, tanners and manufacturers that have good local set-ups are not complaining. Quite the reverse in fact; they have been confirming that they are enjoying good demand from the domestic market.

This is also reflected in purchasing activity. A number of suppliers are surprised by the consistent demand for European dairy steers and bull hides. Price is not the only factor here; China’s leather trends are also playing a part. The leather bag and shoe fashion is finding in favour of much finer and softer grains than are normally produced from male material in China. Because of the lower kill, less material is available and so this needs to be compensated with imported hides. US steers, except dairy types, do not really fulfil this need and so a lot of interest is being received in Europe, where suppliers are more than happy to find a way of compensating for the declining demand locally. However, nobody knows how significant this will be or how long it will last.

More credit crunch casualties

There are claims that the splits market is receiving a bit more interest. While the demand for lime splits in Europe continues to be steady and the drama from the automotive and upholstery tanning sectors is restricting supply prices, lime splits are still being supported by this situation. Globally, demand for wet blue splits is said to be improving but, with the huge stocks available, there is little effect on the market. With the present prices for hides, there is little chance of improvement for the splits market.

The skins market has also been unable to step back from the general crisis. Areas that were already struggling prior to the downturn—namely the leather garment business—has almost received its final blow. Only skins of the highest quality or those that are suitable for shoes, bags and leathergoods are able to do slightly better. Like every other year, we have noticed a fair amount of leather in the fashion shows and celebrities are also wearing leather to media events. However, no one knows how much of this will finally make it into the shops.

Retail still considers leather to be a very dangerous product. If it doesn’t suit consumers’ (ladies’) tastes, it will end up getting stuck on the shelves and is hard to shift even with a decent discount. So it is better to stick with standard products that everyone else has on their shelves. Previous leather fashion cycles came right out of the blue and sometimes it just needs the right person at the right time to trigger a new trend. The leather garment sector can only wait in hope for the time being.

Time is of the essence

We remain rather skeptical for the next few weeks. There is no question that we still consider the situation for side leathers to be much better than the facts and reports from the various markets are confirming. Despite this, we have to accept the fact that, at least so far, very little has been converted into measurable results. We have already reached mid-February and time is slowly running out if a normal ordering season is to be achieved. There will be a maximum of another six weeks and then the cards will have to be laid out on the table.

Time has already run out for the upholstery season. The further we progress into spring, the more the demand for upholstery leather will dry up. The situation for upholstery production centres is becoming more and more frightening and nobody really knows how the industry will survive the second and third quarter when production and turnover are traditionally reaching their seasonal lows.

We do not need to talk much about the automotive sector. The industry, and particularly the vehicles that consume the most leather, are experiencing the worst crisis in history. With the general downturn in the global economy, there is little hope for any improvement in 2009. The only hope for automotive leather producers is that more leather will be used in cheaper cars, which are still selling significantly better and are even, in some countries, in short supply. Mobility is still essential; the question is simply how much the consumer is willing to pay for it.

So, from the demand side, optimism has to remain limited. There should be a reasonable amount of activity from Asia until the end of March. In the short term, there is very little indication of any fundamental improvements. The supply side is now playing a minor role because of the abundant stocks available to cover the industry’s current requirements. Supply has also been harmed by the general economic situation and, although there will definitely not be any shortage of commodity raw materials in the short term, shrinking supply, particularly for better quality material, will eventually start to impact on the markets.

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