The Leather Pipeline - 24.03.15
24/03/2015
Macroeconomics
The financial markets are offering little excitement. Everything seems to be known and acknowledged by the financial markets and investors do not seem to have paid too much attention to what has happened during the past two weeks.
The headlines remain the same. In Europe we are dealing almost every day with the situation in Greece and the poker game between the members of the Eurozone and the government in Athens is still on. There is a lot of sympathy for the people of Greece, but not too much sympathy with for the government, which appears unwilling to accept that quite a lot of action and reform have to be put in place to convince creditors that the country should to continue to have their support.
However the situation is complicated and what is finally decided for Greece is going to spill into the other countries with problems too.
The Ukraine crisis is not making much progress and there, too, money is becoming a serious issue; larger aid programmes and financial support for the country have had to be granted to avoid a collapse.
The problem with the Islamic fundamentalists persists as well and new terrorist attacks such as the one with more than 20 victims in Tunisia, have shocked the majority in this civilised world.
With regard to China, there are a lot of different opinions about the policies of the government. Is it a step back or is it a step forward? This is the key question. However, it seems clear that, for a while, the times of exceptional growth are over and it’s going to be interesting to see what an iron-first policy is going to mean for the country and the economy. The fights against pollution and corruption will be welcomed by the majority, but China is a very large and diverse country and if the central government steps on too many local feet it could risk rising conflicts and trouble. All this leaves open the question of what the status of the economy is and how the government can deal with rising labour costs, a tricky situation in the property market and in state-owned companies. Beyond question, there are still a number of bad loans around, which are a serious headache for the banking system.
In the United States, the times of cheap money might be over reasonably soon. There’s nothing clear, but the markets expect that in the second half of 2015 interest rates in the US are going to rise again. At the same time, the European Central Bank continues with its programme of money injections and has started to pump more than 1 trillion euro into the financial markets of Europe.
This has sent the value of the euro down further and it fell to levels of around $1.05 before recovering, ending the period at around $1.08. A lot will now depend how the problem in Greece is resolved. Whichever way that goes will determine the direction of the European currency.
A recovery in oil prices seems to have been reasonably short-lived; the price fell back significantly and depending on which type of oil you are looking at we are now trading either in the 40s or in the 50s.
Market Intelligence
The leather pipeline remains pretty much in the dark. There are plenty of opinions around and we , too, have expressed our concerns already a number of times in the first quarter of 2015.
Fundamentally, the battle continues between the ideas, interest and intentions of the raw material suppliers and the realities of the leather market.
Lineapelle has already taken place in Milan (at the end of February) and APLF is about to follow (March 3-April1). The leather pipeline and the trade is waiting in the hope that the situation will become clear when people conclude business at this round of fairs. We all know that leather shows can have a psychological effect sometimes, but they can never change the fundamentals. If one takes the market as a whole, there has been a decline in leather demand since the second quarter of 2014. Stable and positive demand from the automotive industry, which many people point to, cannot compensate for the decline in other sectors. It may be that automotive leather is going to dominate the leather business one day, but at the moment we are still far away from this.
Many people along the leather pipeline are trying to figure out if there’s any chance of getting a clear picture of leather demand and if there is any chance of using analytical tools to predict what is going to come. This is what we are all trying to establish and, let’s face it, so far everybody has failed. One can ride a trend, and we have also seen a number of times in this business already that people’s view of the situation can become a self-fulfilling prophecy, but any kind of analysis or prediction will always suffer from the fact that we have too many parameters to consider and, at the moment, time is becoming another important factor on top of supply and demand balance.
This is really nothing new is not related to the leather pipeline only. If there is anything special in the production and manufacture of leather it really starts with the raw material and, as a leather maker, you can only source exactly what you need for your specific product up to a certain point. There is a wide range of raw material and not all of it is suitable for every product range.
The other factor is time. When we talk about the market, we are mostly talking about the past. As a reference we are looking at the consumer markets that are just selling now what was produced a few months ago. The main problem remains that of finding a way of looking into the future. When we take leather production for consumer goods like shoes and leathergoods we are generally dealing with budgets and programmes that try to predict the future on the basis of the past. Retailers and manufacturers are, in almost all cases, basing their projections and order budgets on the sales and the successes of the previous season. Success and good sales clean the pipeline up while subdued business creates stocks and actually has a double negative effect on orders for the coming season. They can be greatly reduced and the orders that do come can come with a substantial delay because retailers want to collect as much information as possible before deciding what orders to place.
‘The market’ just reflects the present, which is not what people are interested in because it’s what we know already. What we all want to know is the future and here the problem starts with many forecasts being strongly influenced by hopes, targets, budgets, investors’ expectations and so on. A serious anticipation on the basis of the hard facts might not really match the hopes and budgets mentioned above. This means not only that the forecasts can be wrong, but also that many players are trying to influence the parameters as much as they can in the hope of shifting them to their advantage. It is our belief that you can actually buy time, but you can never change the fundamental realities.
We think that we are in a period right now in which the fundamentals and people’s expectations are drifting further and further apart, and by expectations we mean mostly the ones of the raw material suppliers. It is the never-ending story when you look at the balance of supply and demand. From our perspective, the leather market is not a uniform one but is separated into many different segments that are far less connected today than they were before. This means that, for the time being, in the commodity section (mass production) price is the determining factor and leather competes ever more on price and not as a natural material with a special beauty and benefits. Certainly finishing technology has improved tremendously and you can turn defective raw material into very good-looking leather, but this increases cost significantly. If it no longer matters whether or not the material used to make shoes is leather, it makes very little sense to spend more money avoiding defects when you can buy something ‘off the roll’ that is cheaper and accepted just as well by consumers. We might not be producing fewer shoes around the globe and we may consume just as many as before, but we have to live with the fact that less leather is being used to make them.
We begin to see a similar situation in upholstery and, even if people don’t want to hear it, the beginning is on the horizon in automotive too. In particular in automotive a lot is still played around with the description of leather.
It is not a protected name and you can create tremendous amount of combinations and material deviations to make buyers still believe they are getting a vehicle fully upholstered in leather when in reality they are getting nothing like it. This applies in the very price-sensitive sections that are still creating the volume of sales. There would not be enough high-quality raw material available to satisfy the demand for superior quality interiors, no matter what the price is.
In the luxury leathergoods sector we still see a stable requirement for high-quality leather as far as volume is concerned, but we have also learned that High Street brands are extremely sensitive when it comes to price. We have seen the most expensive calfskins falling quite significantly in price because the real luxury brands have made it very clear that they are not just going to meet whatever price they are asked for. Since the less price-sensitive markets for luxury goods, which are mainly China and Russia, are showing declining demand for different reasons, the big party in the luxury sector is over. This does not mean there are not enough wealthy people around the globe to maintain the success of products that offer the highest levels of fashion, quality and image, but the growth potential that many people have anticipated cannot, at least for the moment, be justified. Just opening new stores and furnishing them with product does not necessarily say there is enough demand out there to buy them.
It is not the superior quality market that concerns us, however. These products will be manufactured and they will be sold and it doesn’t really matter very much if the material prices are 20% higher or lower for seasonal reasons. Material is scarce; producers who can really make outstanding quality leathers are limited and it will remain a market on its own with a limited fluctuation, as soon as the normal balance has been found again and it will be back to be the normal exclusive club of manufacturers, brands, retailers and customers. The main matter of concern must be the balance of the medium-to-low end, where there are commodity products that are made from leather but do not have to be made of leather. In volume they would definitely account for the vast majority of raw material supply and leather production. We think the balance has gone here, and it is high time that we got it back to protect the industry from major damage.
When we look at the situation at the end of March, while waiting for APLF in Hong Kong, we can understand how important it has become to make the right decisions. It is hard to believe there will be positive news regarding leather demand in the second and third quarters of this year. It is not the high season for production, but it is a time when retailers and brands discuss their collections, orders and budgets for the next seasons. If leather is not an attractive material, there are alternatives.
It is possible to see just how difficult the situation has become by looking at the split market. Leather is not just a beautiful full grain, natural product. It is also splits and corrected grains, and these products certainly account for the vast majority of total leather production. Split prices continue to come under pressure and in particular the Chinese tanners are complaining loudly about falling prices and rising stocks.
Another price determining factor in many parts of the world is the rising US dollar. Most transactions in the leather pipeline, as with other commodities, are based on the US dollar and this means that for many countries in the world consumer products manufactured in Asia are becoming significantly more expensive. The US consumer will not feel this much, but many other countries are presently seeing their domestic currencies devaluating sharply against the dollar. When price is already an issue, any additional disadvantage will count even more.
In the Middle East where many tanners and manufacturers are selling into the Eurozone on the basis of the European currency, the situation is even worse for manufacturers. They buy raw material on a US dollar basis and sell leather, shoe uppers or even finished shoes in euros. If raw materials and chemicals have not been hedged, many of these manufacturers are facing serious currency losses at the moment and this can already be seen by a number of people claiming ‘force majeur’.
All this and more is causing concern at the moment and it is hard to be positive for the coming seasons as far as total leather consumption is concerned. Things could turn more positive if the sanctions against Russia are lifted and the problems in the Eurozone are resolved, for example. Nobody would be surprised under those circumstances to see fireworks in the financial markets and celebrations in the leather pipeline too. However, at the moment there is no indication that this is going to happen soon. Consequently the US consumer market remains the only one that is not facing major problems.
As already mentioned, we are hearing pretty negative news from the split market. We have been less negative about splits because they have already seen serious price correction and the non-leather demand for splits had been not too bad. However, every day we are hearing bad news from China and other markets are beginning to feel the pain too. In Europe a lot is absorbed by the firm US dollar and a generally solid situation in the collagen business, but in the leather sector splits have become far less popular, even though general soaking levels are not at the levels of a year ago. We stress that leather is competing with cheaper substitutes and this is hitting the lower, more economic end of the product range in particular. APLF in Hong Kong will give us some direction for this market; perhaps cheaper prices will stimulate interest in cheaper leather.
The skins market has not seen too many changes. The excitement and heat that aggressive purchasing by one of the largest global players in the skin business brought to Europe has faded now and some of the price gains have begun to erode. The business for cheaper nappa leather is still pretty poor as the market in Russia is desperately missed by many of the tanners producing leather from sheepskins. We are leaving winter now and this means temperatures are going up and the kill for the Easter season is going to supply more skins, at least in Europe. In normal market conditions we should see another flurry of interest from China because tanners like the late-season winter skins, which are the biggest and carry the largest amount of wool. However at this stage we are not hearing from any of the main suppliers about serious interest so far. Selected high-quality double face materials are still doing somewhat better and in Europe natural coloured skins for decoration are still finding very good interest. However the size of this market is far too small to have any influence on the general situation.
For the coming two weeks everything looks like it’s going to be a stalemate until the trade meets in Hong Kong. One has the impression that the tanning industry is holding enough raw material inventory to cover its needs for some time. We know this is in direct conflict with the news many are spreading, that tanners must return to the market very soon to replenish. It may be true or it may not, but when we look at the slow payments and slow opening of letters of credit, one cannot consider this to be a sign of desperate need for raw material. This applies to Europe, although the supply chain from the United States is still suffering the effects of the strikes at ports on the West Coast. No matter what people say the number of hides that can be shipped and moved is far lower than the number of hides that were intended to be on the vessels in February and March. This should normally lead to emergency cries to get shipments from other parts of the world on their way to Asia. However, we haven’t spoken to anyone would could confirm this is happening.
We still cannot develop a serious and positive feeling about the leather business in the coming months. We are ready for positive surprises, which can happen, but with what we know today we can only hope that the market will continue to see a moderate, controlled decline to lead us back to levels that will make leather really attractive and to lay the base for a rebound. The currency markets, because of dollar-related supply origins, is where the main need for correction is at the moment.
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