Macroeconomics

The winds have felt like they have been changing for several weeks, but there had been no official statements. People were uncertain about the rebound of the euro, oil prices and whether interest rates in Europe could rise earlier than expected.

However, over the 10 days, there have been several positive comments about the eurozone in the media. There were reports that Greece’s exit, which had been thought to be the biggest threat, might not be a problem for the euro, growth was forecast and the risk of deflation was said to be fading.

There were also reports the US economy is cooling down; data was published showing the recovery is slower than was previously thought and consequently the rise in interest rates might come later than June, when many pundits believed they could see the first hike.
 
The interpretation of the facts seem to have shifted. Currency rates and commodity prices are driven more by investors and speculators than the status of the economy. The steep fall of the euro and the drop in oil prices helped the eurozone but hurt several other important regions. The market makers in the central banks and the international institutions might have deemed it to have gone too far and are now trying to create a better balance. Sometimes you just need to make investors believe something different and predictions become a self-fulfilling prophecy.

In general it was an example of how little one should follow the predictions, considering it is only a few weeks ago that experts were predicting an oil price of $40 a barrel and parity between the euro and US dollar. In the meantime the euro has recovered to levels around 1.12 which is 7% up from the lows and the oil price is $60.

Stock markets are showing a strange reflection of the situation. While the economy in China is sluggish, stocks markets are setting records. In Europe, experts are positive and the stock markets are in correction mode while in the US, the economy is not meeting positive expectations but the market holding steady. It will be different again in a few weeks if Greece struggles to repay debts, and the UK elections could result in its inclusion in the EU being in question.

Market intelligence

In the past two weeks, a lot of the ‘market pollution’ was cleaned up. We have been discussing for a long time reports about the excessive spreads and imbalances of prices between origins and quality levels. In particular, prices in the US and Brazil never really adjusted according to the market levels in other markets, which have also been impacted by the currency movements in the past six months.

The US dollar lost some of its shine and adjusted against various currencies by between 5% and 7% and the US hide market came down by similar levels. This added up to a total price adjustment of between 10% and 20% between the competing origins, and means US and Brazilian hides have regained their competitive position and others - predominantly the European and Australian hides - have lost the advantage that has been making them so attractive to global buyers in the past six months or so.

Aside from the currency situation, we are seeing a similar situation as in spring 2014. Driven by speculation, general pricing and strategies of the beef industry, “cheap” money and the confidence in the global economy, prices for raw materials were pushed too high last spring and the market got a shot in the arm by the pollution controls in China in April/May [when the government closed tanneries it deemed too polluting]. Prices began to slide, but the markets reacted differently due to the producers and suppliers having conflicting opinions.

Although we had seen a remarkable correction until the end of the first quarter this year, some players had to deal with spreads that were mainly currency related.

We have been warning for a long time that the price level for raw material and leather will eventually reduce demand. The problem is that barely anyone can quantify the reduction, although it has been significant.

Global leather demand is significantly down and wherever leather as a material can easily be replaced the manufacturers and retailers have chosen that option. We are right in the middle of seasons, and tanneries are reporting that customers have either reduced their orders or pulled out completely. This of course hit the low end to start with, but now it is apparent across the board, with the only exception being automotive leather.

A few other negative influences have been apparent. Ongoing government action in China against polluting factories, rising labour costs, its anticorruption policy and the moderate slowdown in the global economy have added to the problem. The supply chain has to deal with the side effects. High inventories are leading to serious losses and this is creating financial problems in those companies that are not sufficiently financed. Some can’t or maybe do not want to honour their payment commitments or to honour outstanding contracts. As prices and markets decline, the problems increase.

This time last year, the market needed a trigger, and it was the pollution controls in China that made the difference. The fundamentals had been in play for a long time but the real changes began when rumours spread that tanneries were being closed because of intensified pollution controls.

Within the past two weeks the price slide accelerated. The problem is that nobody really knows where the real prices are at the moment. Business has not halted completely, but buyers in Asia in particular are selecting their suppliers carefully. The reliable ones can therefore defend much better against the trend than others. If we look at the prices we can confirm we can see differences between 5% and 7% for the same origin and description.

What has happened is not as interesting as what is going to happen next. Quite some time ago we were of the opinion that a price correction of between 10% and 15% would be adequate. This has now taken place and the real question is now whether that was enough or if we are set for further declines over the summer.
We are now entering now the low season of leather production and a good proportion of tanners are busy trying to sort out their problems rather than having the confidence to push for something better. It is very difficult to catch a falling knife. Despite the fact that many would like to see the market settle there is very little, as far as facts are concerned, that makes us believe the price correction is over.

We are still at pretty high average levels. Markets and price trends tend to exaggerate before they balance. We may all recall what happened on the upside in the past two years. It seems that there are still too many hides stuck in the supply chain and the problems in the split market are not making us believe the trend can be turned around.

Having said that, we have to mention that of course no market trend goes in a straight line and this one might also have temporary rebounds. However, we remain of the opinion that over the summer further corrections will be necessary, although one has to watch the trends in the origins, because currencies will continue to play a major role.

Spilt market

The split market continues to be in a difficult state. Demand isn’t good enough in either the leather market or in collagen and gelatine to stem against the negative fundamentals. Only a reduced supply, which would obviously be no good for the hide market or leather production, could ease the problem, because we would need a new season when splits return into the material mix of the shoe producers. With a sharp reduction and the present levels there is a chance, but we are sceptical.

A similar situation is seen in the skin market, where there is only enough demand for isolated fine wool skins to absorb the supply. The new season of spring lambs in Europe will give us a better view of the situation for double-face production. Although the situation in Turkey is said to be poor, tanners will have to decide if they are going to replenish their raw material stocks. The recovery of the Russian currency and the fact that the demand for jackets has not stopped completely makes us believe that prices and demand could stabilise and the situation for skins even improve.

For Nappa, the only positive aspect is the pretty good conditions in the wool market, which is making returns for wool good enough to justify raw material prices. However, with almost non-existent demand for leather the problem remains what to do with the pelts and the skins.

For the coming two weeks we believe that the focus of interest regarding price and market movements will shift back to Europe. The stronger euro and the price adjustments in the Americas have made European hides, for the first time in six months, pretty expensive. It is difficult to forecast how buyers are going to react. There are still a number of reports saying that various European suppliers have already surrendered and lowered by significant figures to move product in the early summer. It is likely that the European beef industry will need a bit of time to understand the market. As we have learned, nobody can escape.

It would be better if the decline would settle for a period. This would give everyone the chance to sort their positions out and would get buyers who need raw material to market sooner rather than later.

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