The Leather Pipeline - 21.04.15
21/04/2015
Macroeconomics
Politics and the general economy generated no important headlines again. None of the general conflicts has been resolved but the financial markets appear unwilling to surprise the public with any major moves.
In Europe the situation around Greece remains the major topic and the Greek government has now developed new targets to bail them out. China and Russia should become the new partners for short-term financial injections to prevent bankruptcy. This means that the political pressures in the Eurozone are rising and we will have to see how the European Commission handles this. In Asia, China is trying to expend its domination by approaching neighbours with the offer of additional financial and political ties.
International financial markets went mostly sideways although towards the end of the period stock markets in Europe and the US turned a bit sour after massive gains in the first quarter of 2015.
Oil prices continue to recover slowly, which seems to be mainly the result of speculation, the expectation that oil prices in the long term are going to rise rather than fall. Oil supply is still more than abundant and the simple supply-and-demand ratio does nothing to justify any upside price movements. Consequently the present price trend is possibly also a bit politically driven.
In the currency markets has the euro stabilised and for the time being all the predictions of parity with the US dollar seem too optimistic (or pessimistic, depending on the perspective one wants to view it from).
China’s GNP rose by about 7%, which is still a pretty high figure but far from what the general public expected. The main concern is if these figures do not really reflect the truth; they could be just a political number prescribed by the government rather than a reflection of the reality. Imports and exports from and to China fell considerably in March and are not pointing in a positive direction. Possibly the cleaning up of the Chinese government is for the good in the long run, but for the short term it could become a threat to the economic stability of the country.
Market Intelligence
Generally there’s not much to add to our issue of two weeks ago. The end of March and the meeting of the trade in Hong Kong for the APLF exhibition was once again a breaking point for the market. As it happens, in most years directly after the event or sometimes after some weeks, trading activity slows down and prices begin to slide. In this regard 2015 was no exception. While many travellers left their homes with a good deal of optimism, the vast majority had to travel home with reasonably negative impressions and results. We believe that enough has been said and analysed about the situation along the leather pipeline and we feel that there is very little to add.
During the past two weeks the markets have confirmed what had happened a couple of weeks ago. Price corrections in particular from the United States and Brazil, which are said to be happening now, had already been taken by the sellers a couple of weeks ago, but the delay is possibly helping to keep the slide of prices orderly, which has to be welcomed.
What has really happened in the past two weeks? We reported in our last issue about the spread between various articles and origins, which offered some pretty good shelter and opportunities to keep business moving for some, while others were trying to figure out by how much they would need to correct their price levels to become players in the market again. Travelling to Hong Kong, talking to the customers and understanding the situations from face-to-face discussions it seemed, at least to us, that quite a few made some shocking discoveries.
We mentioned an exaggerated price spread (up to 15%), but it has closed over the last two weeks. In particular US prices have had to be shaved down and while prices officially have been adjusted by between 5% and 8%, it is fair to say that at least for a number of grades double-digit numbers have been noticed. There was little option really, and the only remaining question is how many hides have been sold at these prices and how much of the stock has been cleared and if it is enough to stabilise the market for the time being.
We have still some doubts. No matter what is reported, the information from the markets does not give the impression that enough material has been pushed down the pipeline already to offer any serious relief to every seller. Quite frankly, it’s hard to see how this could happen when at the same time there is no trace of any increase in leather demand; nobody could find hide prices so attractive that they would be willing to take positions and to buy inflated quantities just because of price.
Our main worry remains the financial situation in the leather business. This applies in particular to China, which is still the world’s biggest market and production place for leather. We have spent some time in the past two weeks speaking to people close to government institutions there, as well to bankers. The results offer a sobering insight into how the leather industry is rated in China at the moment. It’s at the very bottom. Industries that are polluting, energy-intensive, water-consuming and offering limited added value are coming in for scrutiny at the banks and from the government. This does not apply to leather alone, but also to other industries that are welcomed at the beginning of the development cycle in developing and emerging markets.
Of course, in China you have many very well managed leather producers that comply totally with international regulations and environmental standards. In addition, the domestic market in China is big enough to keep a large percentage of the big industries running. We are certainly not in a period in which the whole or the majority of the leather industry in China is going to be erased. However, even if you cut production in China by 20% or 30%, which is realistic, it would have quite an impact in terms of global leather production and raw material demand. We are already in the middle of this process, not at the beginning, and this is something that people should take into account. There might be some who will close voluntarily. The vast majority of producers will try to adapt and carry on, but not all of them will make it. We must also understand that this is not just about leather production but also leathergoods manufacturing, which is more labour-intensive and is leaving or has already left the country.
The consequence of the above is that credit lines for many industries in China are tightening and credit approvals are no longer just given by local bank directors; approval now has to go up to the hierarchy before new loans are granted and businesses can continue with sufficient working capital. The problem of course, like many of us have learned, has been even more pronounced because the revenues of splits have been dropping so fast that a lot of the cash budgets cannot be met and finance is becoming increasingly short for those who do not have deep enough pockets.
People are just talking about the slide in split prices; it’s not just the slide. It is that many tanneries at the moment can barely get rid of the splits and be paid anything for them. The option for many is to preserve the splits on their own in the hope that one day a customer will pay a reasonable amount of money for them. Whatever the decision, splits are not generating any immediate cash to help pay the bills.
With China in serious trouble, it is difficult for the global leather business to be okay. The relocation of production and the setting up of new supply chains takes time. Most of all, demand for leather products has not been restored yet. It does not matter what people are saying about the short-term outlook of the raw material markets, any serious recovery and stimulation can only come from better leather orders, or a level of certainty that these improved orders are on the way. We have to be realistic: there’s not much of it in sight.
Traditionally leather production runs in low gear in the second and third quarters of the year. Last winter was reasonably warm in the northern hemisphere and the sanctions against Russia, while they may be losing their effect a bit, are still reducing demand for leather products. The optimists still believe that the few bright spots around the globe as far as consumption are concerned (namely the US and to a small extent some countries in continental Europe and the automotive industry, where we believe hopes are running higher than the reality) will generate enough demand for leather to create the necessary demand to stabilise prices.
Many pundits are pointing at reduced supply. No question, it is a factor. The kill in Europe is now going to be pretty low at least until the late summer and the seasonal increases that normally compensate for this, for example from the US, seem to be far less pronounced. These variations are not really big enough to have any serious influence on the global supply of raw material.
There are still quite large stocks of available material around the globe, in particular in wet blue, where excess production so far has been absorbed. You find them in producers’ hands, you find them in traders’ hands, you find them in contract factories and you find them also in tanneries. These stocks may not be what the market wants at the moment, but that does not make the problem any easier.
We have certain market sectors that are in balance or possibly even undersupplied, but we have far bigger quantities in sectors that cannot find a home, at least not at current prices. To be able to see the glass as half full, we would like to see far more dynamic demand for the selections that could pull the others out of the ground. We fail to see that.
Take the calfskin market as an example. This was until recently the driving force for luxury accessories. Just a year ago, hardly anyone could believe that a raw material that is used in the luxury sector could ever become cheaper again. Have a look at where prices are today. This is not because the luxury market has seen a serious slump in demand, it is mainly that the producers of luxury products running their own factories have figured out that the high prices can only be justified for a certain percentage of material and should never have been obtainable for medium or low-end grades. People have had to realise that they were creating a raw material demand but using only part of the material, with no master plan about what to do with the rest. You never know for how long such issues can continue, but they always come to an end in time. It will take quite a while for the real balance of inventories to be achieved again. This example is representative of the entire leather business, although the top-quality end and calfskins have a very limited supply, in quantity and geographically, so it’s easy to monitor. If you take leather on a global scale it is far more complicated, but the same logic applies.
For quite a long time the leather pipeline focused too much on supply, which was of course driven by the beef industry in the attempt to achieve higher returns for their by-product. However, supply and demand are always a market synthesis. On the demand side very little can actually be directly influenced while on the supply side the strong trend of consolidation in the beef industry in many countries has created the belief that steering supply can generate constantly higher returns. We do not support this point of view and believe that you might be able to buy time but you can never create the price conditions without considering substitutes and the demand side. In our opinion the leather pipeline would be well advised to analyse rationally how the present situation can be turned into a new beginning. This would require cooperative communication along the supply chain and an objective market analysis, not influenced or determined by individual interests on either side. The whole supply chain in the leather pipeline wins or loses together.
The split market has not had much positive news to report in the past two weeks. As in the hide sector there are still some isolated areas where splits are doing quite well and where the price reductions have created better business. However, it is still too little and in particular the split market in China is creating headaches. Lime splits there are falling in price and we would go as far as to say that presently all split production cannot be sold and many producers are choosing between preserving the material or letting it go for pricing and payment at a later stage.
There was also a rumour that one of the biggest global producers intended to dump all its split stocks onto the market. We are not too close to the players concerned, but we find it hard to believe the story. In a market like this the best you could get would be somebody purchasing big volumes of the material for investment reasons. This would require some knowledge of the business, plus warehousing and financial resources of quite a significant size. For the split market one cannot see any light at the end of the tunnel. This might be seasonal because the price of splits is definitely no longer prohibitive. A big number of splits can be bought today so cheaply that finished consumer products could become fully competitive again. However, it seems the time has not yet come.
The small skins market is a reflection of the split market. Yes, you are definitely still able to find some niches that have been able to escape the general problems, but all over the situation is pretty miserable and prices for many articles and origins can barely fall any further. You can buy skins in big volume today in a price range between $1.50 and $3 per piece and this kind of price level allows valuable consumer products to come to market at a price that can be a threat to artificial materials again. However, we are paying for the inflexibility of the mass producers and some technical complications.
The good news is that sheep and goat skins are slowly becoming attractive again as linings and, possibly, for some women’s shoe producers for coming seasons. It will still take a little while to move sufficient quantities of product again. The spring lamb season in Europe is just about to begin, but so far buyers are not too optimistic about their order situation in the coming months. However, also here we are no longer totally negative. Everyone was talking about the collapse of the Russian currency, but it has seen a decent recovery. There is still a while to go until next winter’s double-face season and we have to admit that we are no longer as depressed and negative as some months ago. There might still be a backlog of payments and overhanging stocks from previous seasons but it is definitely not the drama the trade was facing last autumn.
For the coming two weeks we have to remain cautious. No market trend has ever been a one-way street, nor can anyone expect major downward corrections every week. In our private analysis of prices we are still seeing certain price gaps that need to be closed between various origins. We do not expect significant change in the outlook for leather demand in the second half of 2015. Bovine raw materials are looking for a new base and the level needs to be discussed openly between the different players in the supply chain. Bovine leather is looking for a new start and this has to come from price levels that can be agreed by the key players to allow a smooth movement of production and sales.
This will not happen in a public discussion, but it would be good if individual interests could be moved into the background and a serious discussion about the imbalances in the market could be initiated. Fully integrated operators that are manufacturing from raw to finished should be first to the table. Until then we believe that the pressure on prices in the bovine sector is going to persist while other sectors that have already undergone a major price correction need to wait until orders improve; price can’t be offered as a reason not to increase the amount of leather in next season’s consumer products.
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