Macroeconomics

The financial markets have been pretty stagnant in the past two weeks. Stock markets, the currency market and the commodity markets moved sideways and most players are trying to close the first quarter without taking any major new positions.

In the political world, the headlines were dominated by the negotiations between the Western world and Iran, where some agreements have been reached. If the sanctions against Iran are lifted we might see two major influences. The oil price could remain under pressure because Iran would be able to sell its oil, and the country has a great need for imports which would offer many countries potential for new business. However, this requires the final decisions and within the next two weeks we should know more about the consequences. In any case, one can be happy that at least one bit of positive news can be noted.

As far as Europe is concerned it seems Greece is finally running out of money and the government is desperately looking for new allies and potentially preparing for a possible exit from the euro community. There are only two options - China or Russia - and both of them could be very much interested in getting a foothold in Europe. The euro community knows this and they will work hard at preventing it from happening.

Although the Ukraine has been out of daily reports, the situation remains sensitive. There are rumours about new activities of the separatists and NATO remains on high alert. We should not forget that it is a very important that this fundamental problem with Russia has to be resolved in a friendly manner.

China’s economy seems to be slowing further while its stock markets run from record to record. In the first quarter, they were one of the best-performing investment locations in the world. Analysts are convinced that this is just a bull market because of small investors and that there is a serious bubble developing. Big players have been pulling out for some time and this could become a challenge for the Chinese government if the stock market faces a correction, which could wipe out small investors’ and families’ money. The stance against corruption, the bubble in the property market and bad loans with the big banks are a dangerous mix and one can only hope that the government will deal with it successfully. A serious issue in China would be a dangerous scenario for the global economy.

Neither currency markets nor commodities markets showed any major movement and price variations remained in pretty narrow ranges.

Market intelligence

The Hong Kong leather fair (APLF) is over and the majority of visitors and exhibitors are either on their way home or have celebrated their Easter break.

In many cases, people took the chance to travel around Asia to visit customers before the show. A lot of people questioned the value of leather fairs. In the case of the APLF, this has been happening for a number of years and some think it will lose its position. The reason is that it is not really a real leather show, a shoe machinery or a chemicals show, and as a location it is not as close as it used to be to the centre of leather production and manufacturing in the south of China.

This year, the show proved that it does have value, but more as a gathering place than as an exhibition. Those who are exhibiting see the cost and for the leather business there are much better shows to spend money on. Many of the exhibiting tanners in particular complained that they have to spend a lot of money on the exhibition and some feel they are paying for an event that supply chain uses as an opportunity to meet and talk.
Well, it is fair to say that the percentage of suppliers paying for their own stands seems to rise every year and so tanners should recognise this and the event could never take place without many being responsible. Many tanners also admit that it is valuable to meet many people you would never travel to and the number of add-on events, which is constantly increasing, is a bonus to some. Some may go home not having completed the amount of business they were expecting, but even then, obtaining valuable input as to why business is poor helps to inform commercial decisions.

In times of big data, and everything available on the internet it remains impressive to see that the leather pipeline is still following its own rules. When you talk to experienced pundits, the face-to-face information is still far more important in this business than any written report or published statistics. We spoke to many visitors and exhibitors to confirm that the three days of the show had given them much more clarity about their business. An email and a phone call still cannot substitute direct communication.

Coming to the hard facts, we came to the following conclusions:

• The imbalances that have been created due to currency issues have finally to be admitted by a number of players. The suppliers from the US dollar regions which were so stubbornly holding their prices steady had to realise that they have been substituted by more attractive options and quite a bit of business has been lost.

• Leather demand in total has come down globally since last year’s APLF when many thought there was only one limit - the sky.

• China, which has been the dominant player as a market and for production, has been facing changes of many kinds for the past 10 years, which are either a temporary or long-term negative for the leather market. Anticorruption, strict control of pollution, a slowing economy, sharply rising production costs and problems of cashflow have reduced consumption and production capacity significantly. This was also demonstrated by the reduced number of Chinese exhibitors and visitors to the leather show.

• Luxury leathergoods, which had been the success story of the past years, are facing headwinds, because of problems in the main growth markets, China and Russia. Several luxury brands are slashing prices and telling the public in China that this is a policy of fair treatment, so as not to make the Chinese customer pay up to 30% more for the same product. Let’s face it, this is just a reflection that inventory in the shops in China is far too high and it is nothing other than a discount policy to clear inventory and to increase demand for the seasons to come.

• The decline in leather demand has been different and less pronounced in the different sectors, but in total has been significant. This can be seen best by looking at ovine leathers and splits but can also be seen in the normal bovine section. The argument of many raw material producers that raw material production has declined has proved to be wishful thinking to hold revenues up. On a global scale, beef production was pretty stable and only varying in the narrow ranges you always see. This has led to a surplus of raw material in the market which had been absorbed mostly by the producers by producing similar articles from the excess of raw materials deriving from their beef production. At the same time this was limiting raw material supply and supporting the prices. However, the hides are still there and they need now to be marketed from a different production level.

• Consequently, we saw the market of salted hides being reasonably in balance but the price for this is a market of wet blue and crust which is seriously oversupplied and facing pretty sizable stocks along the supply chain. Even in Europe suppliers have become increasingly active, trying to market wet blue hides. So, those selling salted hides might have had the desired opportunities to find customers, but those selling wet blue or crust material were disappointed during the past two weeks. The present conditions in the leather pipeline and the global demand for leather is simply not big enough to absorb the excess amount of processed material. For the suppliers this means they must either decide to keep the material and to wait for better times or to lower prices to meet speculators’ interest. Having said that, we could not see any of the suppliers willing to consider this option at this stage.

• The split and the ovine leather market have not seen any significant boost in demand despite the attractive price levels they had reached in the past nine months. The split market is still facing serious issues and in particular in China the demand for lime splits has almost come down to zero. All tanners producing lime splits are reportedly facing significant problems marketing the material. One way or another this is weighing on calculations and margins in leather production and usually has a negative effect on average price levels for raw material. As far as split leather is concerned we believe this is a direct effect of the cheaper alternatives from artificial products that have kicked out a decent amount of cheap leathers from mass production. Some say the low price of splits means manufacturers are beginning to reconsider using cheaper leather in the next seasons.

• The port strikes on the West Coast of the US had held shipments up for a long time. Independent of the question of whether customers were still willing to take the product or at the same price that had been agreed, a wall of material is on its way to Asia when it had not been really missing. Most tanners had not been short of inventories and this means that all the containers which are now going to come in will extend the raw material inventory position by a number of weeks, right to the low season of production. This will not only have a negative effect on demand in the near future but will also have a negative effect on the financial situation of many of the buyers. Since cashflow has been difficult for some time, one has to believe it’s not going to get any better in the months to come.

• Despite all the negatives, there remain a few bright spots. Automotive leather demand and production is not facing any slowdown. Demand for high quality special leathers remains stable too, and tanneries operating in this sector will take benefit from sliding raw material prices. However, the total percentage of global leather production is too small to use this as a positive indicator for the leather business in general.

Summarising the above, price and demand are the problems of the consumer markets while there is more demand in the medium and high-end and specialty leathers.

The big problem is how to handle the situation. There is a big price spread between various origins which is mostly related to currency movements in the past six months. On top of this we are facing less demand than supply and unsold inventory along the supply chain.

Consequently there is a desperate need to close the price gap and to get the adjustment so that the product flow returns to normal levels. What a difficult task! Nobody wants to see prices sharply correcting because everybody is aware of the consequences this usually has. There is an understanding the prices should not rapidly fall. So far so good, but this has been the issue for some time.

This leaves the problem to those who are disposing of the inventories and the question is for how long they can and will protect prices by managing the material they have. So far, the big players have been pretty patient, but the situation is getting increasingly difficult in particular considering that some are taking full benefit and the others all the punishment. What we mean is that suppliers from those regions that get the currency support are enjoying the demand they are receiving, while the others can do nothing other than wait for the better or falling prices until they become attractive too. With current price gap for hides and leather this could mean 10% to 15% price corrections and nobody knows what the consequences would be and it will all depend on individual decisions. The good news, if there is any, is that so far the big units have been able to play it cool, but they have achieved very little by this.

What else did we take home from Hong Kong? Certainly, the discussions about the value of the market reports and price quotations. We have dealt with this issue a number of times since last summer. With all good intentions, the fact of the matter is that the price gap between the prices which are published and the market has become too wide. It was all for the sake of holding the market steady and protecting the leather and price pipeline from high volatility.

The gap has to be closed, because too many trade relations are based on price indexes reflected by public price quotations. Nobody will ever admit that prices are incorrect, because they are not. You will always find or create the trade which is justifying what is published. However, what is a fair market price? Is it the deal of the day for an artificially limited product or is it the price the market would allow for all material to be placed to keep the market constantly in balance? In the ‘good old days’ stock markets handled this by publishing a bid/ask price quote which demonstrated if there were more people who wanted to buy at a price or more people who wanted to sell at a price. It also demonstrated how far apart the ideas of buyers and sellers were. Whether this would be possible for the leather pipeline or not, it might have protected us against the big task of bringing the daily business reality back to the public. A solution would be very desirable because fundamentally the system has been working very well for a very long time, but the gap can’t be too wide for too long for either of the parties.

Prices in the spilt market are under serious pressure, while good quality wet blue splits are still doing much better than lime splits. This might not apply in Europe because there the collagen and gelatine market are more supportive to lime split prices. In China the situation for lime splits is getting pretty serious and we are interested in how this is going to be resolved in the weeks to come. The situation is becoming serious for many tanneries and the market should also be supported eventually by the business from the non-leather sector.

The ovine market has come down by quite a bit. The short term straw fire which had been set in the first quarter by some purchases of large tanning operations in China is fading and the increased supply of the traditional Easter season is going to have a negative impact on the market conditions. The spreads between the few skins the market still needs, namely the top end of light material and high quality nappas, is widening, which is also never a good sign.

Generally is the time after Hong Kong pretty quiet. People are trying to figure out their order positions for the second quarter and leather production begins to slow into the low season until August/September. In the majority of the cases prices slide into the second quarter rather than rise.

As we tried to explain above, the situation in 2015 is even more complicated. We are not facing a balanced and equally valued market and this means we have to handle obstacles. One is the general price trend and the other is how to close the wide gap between the various origins and types. This means that the tensions are growing. Europeans -  in particular, slaughterhouses - may think that due to the decent demand there’s room for them to squeeze more money out of the leather pipeline while the others have to deal with how they can bring their prices back into line without adding collateral damage to their business. The situation is pretty complicated and the uncomfortable. Consequently, we see the problems but never give up the hope.

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