Macroeconomics

First of all, we would like to wish all our readers a very happy, healthy, prosperous and, in these times, peaceful New Year!

We will try in 2015 to serve you with insider information, analysis and provocative statements to allow you to think, analyse and to run your businesses successfully in the year ahead.

It seems that this year is going to offer far more challenges for anyone with a business to run and macroeconomic influences might even have greater impacts than they had in previous years.

It might have been a bit bumpy in Europe, but generally the global economy until the last quarter of 2014 was solid and growing, so for many businesses, planning and budgeting was relatively easy. But with the massive changes we have seen politically over the past six months, the conditions for the coming 12 months have now changed by quite a bit.

The holiday season is normally expected to be a quiet and peaceful one and we hope it was for most of our readers. However, despite a reduced flow of news and information the situation has again deteriorated in the past three weeks. Political instability in Greece has made worries return that the country could leave the euro and possibly not be in a position to repay debts. This has led to exit discussions and the phrase ‘Grexit’ has become pretty common.

General concerns about deflation and the performance of the southern European countries have sent the euro into further decline and we have easily broken 1.20 against the US dollar at the start of 2015. Many are trying to play the problems down, but the endless policy of easy money has not created the desired results and there are massive conflicts about what the next steps should be. The head of the European Central Bank, Mario Draghi, favours more money injections in different ways while others feel this tool is not very helpful in the short term and dangerous in the long term.

With the exception of the US (positive news from the labour market), most regions are showing worrying signs about the status of their economies. We don’t need to repeat the problems in Russia and the Ukraine, but the situation in China is also far from positive. As far as one can tell from the statistics, the problems of banks, bad loans and a sluggish real estate market are leaving imprints on the economy. There are numerous reports about provincial banks facing serious problems with bad loans and struggling to finance their regular commercial clients.

The fall in oil prices has been pretty impressive and while it is not in our scope to deal with other commodity markets in this publication, oil is a very powerful tool that has the potential to destroy economies. For the moment, cheaper energy prices are very much welcomed by those countries depending on imports and of course they make production and transportation costs substantially cheaper. On the other side, falling national incomes are resulting in reduced demand for imports and eroding wealth in various regions.

Last but not least, the year has started with a number of terrorist attacks which have cost numerous lives. The cruelty of the IS in the Middle East is not even making the headlines any more, but the attack in Paris and the cruelties of Boko Haram in Nigeria are leaving deep impressions and very bitter tastes. People don’t feel safe and this can easily result in further tensions and confrontations. Everybody is asked to do their utmost to stand for respect and tolerance.

Market Intelligence

For the leather pipeline, the start of 2015 was not as quiet and easy as we thought it would be. The changes on the commodity and currency markets have created different conditions than we had some weeks ago.

Falling prices for oil and the rising value of the US dollar have let raw material values drift apart again. The massive drop in oil prices, which have reached levels around the $50 mark for the barrel, is making alternative substitutes for leather significantly cheaper. Of course, it takes a little while until it really reaches oil-based alternatives, but without a serious rebound of prices (which nobody expects in the near future) many leather substitutes are not just becoming significantly cheaper, but also have a significantly higher supply guarantee and far extended price security – things that leather cannot really offer.

As far as the raw materials themselves are concerned, those countries which are not dollar-based are seeing their raw materials becoming more competitive every day. Any potential pressure on prices is easily compensated by better returns when the hides are skins are exported on a US dollar basis.

So far so good, but in the end, prices always find a balance and the question of the balance between supply and demand is far more critical when we look into the potentials for the price trends in the near future.

We are seeing massively conflicting interests and positions taken about the market trends for the coming weeks or months.

It seems that the large beef producers in the Americas are facing the biggest problems. The beef business as such is not really profitable and so the byproducts are becoming an important focus.

There is no reliable information about inventories, but it is no secret that there are still a good number of wet blue hides sitting in warehouses looking for customers willing to pay a price considered as adequate by the owners. Of course, these prices are directly linked to the general raw material price and normally one has to take a certain discount, which is calculated by adding raw material price to production costs, but in this environment hardly anyone is willing to follow this.

Being linked to the raw material price, and to protect the value of the semi-finished material, most of the beef producers are desperately trying to find a bottom in the market and or, even better, trying to turn it around. They have been trying to convince buyers and the general market that there is a shortage of salted material that will eventually lead to higher raw material prices. They thought this would encourage potential customers to buy quickly.

However, to justify such a position, demand has to exceed supply and that has not been the case for a long time. There might be reductions in kills in certain regions but demand has been falling and we all know that a weak market has been feeding itself for quite some time. There were always more attractive alternatives to buy, rather than to jump on the bandwagon and believe that raw material costs could turn around.

We are not trying to be negative nor trying to write markets down since we don’t have any specific interest. We are – as we always do – just dealing with facts and have no particular commercial interest other than hoping for a healthy and positive condition in the leather pipeline. This leads to a view on the general situation, while most commercial players have to see it through their specific window.

When we look at the situation in general we have to deal with the fact that total leather demand is well down versus a year ago. There are various reasons for this, and consequences. In our opinion the main reason is price. The second is a general slowdown in private consumption, the third is low profitability and financing problems in the industry and, lastly, lower confidence and falling prices which leads to a minimum purchasing policy in the expectation of lower prices.

We are not dealing with the question of whether prices for raw materials are going to be higher or lower next week, but we are trying to figure out what the fair valuation of raw material within the leather pipeline might be in the coming season. In this regard, it is concerning us that we see a lot of raw materials that have drastically fallen in the past six months and are not showing any signs of a recovery.

The only exception, despite the recent declines, are bovine cattle hides, which have seen a correction of anywhere between 10% and 20% and this has also been manipulated by currency issues. So the decline and the valuation depends on the currency you are using for the calculation.

However, we have seen a lot of ovine skins and splits which cannot really recover from their dramatic price correction in spring and summer 2014. Although both items cannot directly be compared with bovine hides, they are a raw material for leather production and have a certain correlation. In particular, splits are reacting with a time lag to price variations for full hides and when you see supply shortages, splits are the ones that are generally seeing their correlated ups and downs with a delay of six to nine months.

All the above is leading to the question: what is the real and fair valuation of raw material? This can never be properly answered because there is never a one-to-one correlation between the raw material options. Technology, production costs, fashion, scale of production… there are a lot of direct influences that can make an alternative product interesting. As well as whether it is attractive price-wise there are other influences such as the effort for procurement and the security of quality and supply. Leather may have lost its shine for the active group of consumers.

This, as usual, does not apply to luxury consumers. Their decisions are far less price-driven than the ones of the medium and low income consumers, who the same desires but have to make concessions related to price. The big retailers know that and so are extremely price conscious too. When it comes to price negotiations and a similar product can be made from cheaper, man-made material, they will buy less or none of the more expensive options. Whether we like this in the leather business or not, it is a fact we have to deal with.

Only if leather can be distinguished as something different so the purchasing decisions are not solely on price will we be able to get back to the discussion of whether leather products will achieve significantly higher retail prices than alternatives.

All this makes us believe that in the coming months the leather pipeline will be confronted with a lot of price-related problems. How much leather demand will suffer remains difficult to gauge. It can’t be repeated frequently enough that in the leather pipeline, input and output are never correlated in a one-to-one ratio.

The split market has been pretty quiet in the recent weeks, aside from news out of China that the reduced output of splits is not finding enough customers to absorb them. Split prices have fallen again and a number of tanneries are reporting that they are considering or being forced to store splits in their own warehouses. We will review the situation after Chinese New Year (February 19) when the output of lime splits in China is going to resume again and maybe the market will improve. However, this is pretty unlikely.

The skin market is showing a bit of stabilisation. Again, it can be divided in two. On one side, prices are pretty close to the historical lows for many of the standard items of nappa leather and in Europe skins are produced that are offering the tanneries in China the best value. In winter, quality problems during shipment and storage are significantly reduced (heat affects the skins in summer). It is very difficult to find anyone confirming that business is better, but considering how little has to be invested, how good the return for wool is and how little risk for a buyer, one is not surprised that interest has become more active in December and January. Suppliers are now hoping that this is the turnaround and there will be follow-up business with better prices after the Chinese New Year break.

As far as double-face is concerned, the political situation in Russia is still weighing heavily on the market but some people are hoping the low temperatures in Russia will lead to a clearance of stocks, which have built since September.

We think that the next four to six weeks will be pretty challenging. Raw material inventories in the tanneries is not brilliant and possibly even low. However, this has been the case for some time and it has not really triggered any significant rebound of activity.

When we consider how many of the already existing contracts are facing significant delays in payment and shipments, it is not really a demonstration that the industry is short of material. The Chinese New Year break, which this year is much longer than usual (many producers have announced three to four weeks closure), does not make us believe there is going to be a big flurry of replenishment ahead of us. A bit here and there, yes, and possibly steady business for the high-end sector, but generally we would be surprised if the tanning industry is ready for a large round of raw material purchasing.

On the other side of the table, there are sellers who think they have made enough price concessions and are not willing to reflect that the raw material price level is still on the high side. They will defend against any further price reduction as long as they can, and this makes us believe that we might see a few weeks where the volume of trade is going to be very limited, and as a consequence, price variations too.

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