The Leather Pipeline - 19.05.15
19/05/2015
The past two weeks have been a good example of the financial markets just picking what suits them rather than following rational facts and figures. In a different market environment the unresolved situation with Greece in combination with the general election win of the Euro-critical Conservatives in the UK, would have sent the value of the euro significantly downwards. However, nobody is really concerned about these issues or they are not paying attention to them. This is always explained by the idea that the markets had ‘already priced this in’ and investors and speculators are turning their interest to other topics.
In real terms it seems that the big players in the currency markets are now in ‘take-profit’ mode and so the number of euro buyers is presently larger than the number of speculators willing to bet on another serious decline below parity of the European currency.
There is a similar situation in the oil markets where not much has changed in the fundamentals. This means a decent surplus of oil production and supply, but for investors who have to a large extent taken physical stock positions, the rebound of prices is what they need to cash their positions in. For oil-producing countries, present prices might be a fair compromise.
The global economy remains in a pretty stable condition but the outlook is, in our opinion, not as good as some organisations are painting it. Considering that we have Russia, the Ukraine and Brazil as some big economies with serious problems at the moment one has to be surprised by moderate growth in the world economy.
However, it seems we have to deal still with some big unknowns. This is presently China. Growth in China is slowing down, the government has found it necessary to stimulate the economy by another rate-cut last week. Everybody involved in real business and those who have good information from the streets in China are reporting that the Chinese boom is seriously cooling down in all different sectors. This may exclude the government sector and infrastructure investments, but industry production and private consumption seem to be far lower than the public statistics appear to demonstrate.
In particular exports from China of consumer products must be significantly down. If you talk to shipping lines and look at the number of empty containers sitting around China looking for product to be exported (mainly to Europe) one has to question how well the Chinese production sector is really doing. Some production is moving to other locations as a result of sharply rising costs in the Chinese mainland, but if this is not compensated by high enough domestic demand it could have a serious impact. With the great importance the Chinese economy has today, this is definitely something that should be watched with great care in the months to come.
From the US an unexpected drop in consumer confidence was reported last Friday. The index fell by more than seven points to its lowest level in the past two years. US employees are again fearful of losing their jobs again. This doesn’t fit too well into the picture of an economy in a mode of growth and further recovery.
Market Intelligence
Reading through the last issue of Market Intelligence, published two weeks ago, we had the feeling that we could have written the same this week. As far as the leather pipeline is concerned, there is not very much new. The parameters have remained pretty much the same and the leather pipeline is now in spring, trying to figure out what the conditions are going to be after the summer break when everything will be set for the next seasons. This may sound far away, but many will know that, in between, speculation or issues of general economic importance could really change things.
Production along the supply chain, beginning with raw material, is set for the period between June and September. It is the season when in some places like Europe beef consumption declined and the kill with it. At the same time you have other places where beef consumption is at the annual high point and the kill is going up. Consequently, supply is not such a big issue. However, leather demand and leather manufacturing tend to slow down at this time of the year because we are entering the period of seasonal changes and the summer in the northern hemisphere usually means a slow-down in retail business for leather-related products and production also slows down because of the summer holidays. None of this has ever been very positive for the raw material market and leather demand in particular until the end of July when the Asians need to step in (earlier, because of their a longer lead times).
If one looks at the leather pipeline from a distance we have to realise that quite a few of our concerns have materialised in the past six weeks. We were worried about leather demand in the general material mix of consumer products that can consume leather as a material. This concern was based on the prices that raw material and leather reached in 2014, which generally only unfolds in the following seasons, a timeframe of six-to-nine months.
We have an exception still in high-end of automotive leather production. In today’s world, the wealthy are willing and in the position to spend, and that is what they do. There is enough demand and production of vehicles in the price range of six figures, and to justify their price and exclusivity you have to offer a superior interior. In this market, leather is still an essential material. The number of cars built and sold determines the amount of leather produced. However, this is just a very small percentage of the total and many make the big mistake that they see the growth in automotive production and make a direct connection to the growth of automotive leather demand.
Material changes in automotive may take a bit more time but automotive manufacturers are as price sensitive as all others. If the majority of the growth in the coming five years is related to cheaper brands and cars, one would not be surprised if leather demand had a lower growth rate than many people assume today.
Automotive represents about 20% of global leather production. This is the section that is the most attractive for an industrial manufacturer today. This is definitely also the reason why more and more leather producers are trying to get into this business and shifting from other sectors to automotive. Predominantly of course from upholstery, because the production know-how and machinery are more easy to adapt than from side leathers. As more players are getting into this field, more price competition will take place, limiting some of the price hype people expect in this field.
In the sectors of shoe leather and upholstery the summer is never really a period of great production and excitement. So, it’s pretty hard to believe that any kind of positive trends could be triggered from these sectors until the summer is over. All this has very little to do with being positive or negative on business for the leather pipeline; we just try to look at the situation without intentions and emotions.
The market conditions in the past four or five weeks have changed by quite a bit. If we look at the raw material side of the game the rebound of the euro and the decline and adjustment in prices, mainly from the Americas, have changed the market balance by quite a bit. The past six months may have shown how much the currency market is really influencing commodity prices. What is known to many traders in other commodities already has been a serious lesson for some in the beef and the hide industry. We have been talking to people from the US who actually said in response to the currency issue: “We sell our raw materials in dollars to Asia and we get our finished products back from there in US dollars too, so who cares where the dollar stands?” Well, this may be an opinion and position, but it is definitely not the right one.
Also in Europe many people have underestimated how much influence there is, in particular when the US dollar rates went in their favour for over four months and absorbed any kind of pricing problems for their material. It was all so comfortable and easy that, in combination with predictions about currency trends, many had not taken a change into consideration.
The situation however in the meantime has changed very much. The euro has gained around 8% in value and suppliers from the Americas have finally had to accept that global leather demand is down and if they want to move their raw material they have to adjust their prices accordingly to regain market share. So they have lowered their prices and at the same time the US dollar has lost value. This means that over the past three or four weeks they have become very competitive again and a number of suppliers were so desperate to win some of their customers back that they were willing to cut prices by more than necessary to make sure that a regular movement of material for the coming months is achieved again. Just look at the big blocks of sales that have been done in recent weeks; these are sales that are going to cover a certain period of time ahead.
This is now having an effect on the European market. Not on those hides that are still consumed by the higher-class premium manufacturers in Europe, but for the bread-and-butter material that is mostly exported to Asia now. These hides reflect the majority of raw material production in Europe.
If our assumption is correct, that demand in the next 10 or 12 weeks is not going to increase substantially, then European suppliers will have to take a decision on how they are going to deal with it. The logic of the market is always that you have to make your product attractive to interest the potential customer. Few things are more attractive than price and if the Americans have filled the demand of the tanning industry in Asia for a certain period of time, Europeans could face far more resistance just when the temperatures are rising no one wants too many hides in the warehouse.
From our perspective only a round of speculation from the big players in Asia could really turn the market around and we fail to see any serious argument for such an attitude at the moment. We still understand from our sources that many tanners and importers are still handling a decent amount of expensive contracts and inventories and the financial resources remain pretty stressed. This is normally not the time when people are willing or in the position to rebuild stocks and to take a bet on the coming season.
The split market has not really delivered any positive news over the past two weeks. The same story of a dreadful situation in the lime split market in China and also in other parts of the world slowly but surely means split prices are beginning to erode in the face of more market pressure. In China split tanners are considered some of the highest polluting leather producers. In some regions they are facing the highest level of control and problems from the authorities. Some of them are said to be fed up and instead of investing are just closing their factories. Only some high-quality splits for leather production and several core requirements from the collagen and gelatine factories are keeping business going. If the situation were not already difficult enough, some quality and safety issues in the pet food section have arisen, creating new problems. Splits remain an important raw material too, but also this market requires desperately a new evaluation of product prices before confidence and faith can be regained.
The skin market has nothing new to offer. Pollution-related closures in China are still the biggest factor. Production is hindered, if not closed, and we must also understand that after almost one year now lamb nappa is losing a lot of market too. It is not produced, it is not offered, it is not part of the planning of designers and manufacturers and the main reason is that the production capacity is not there any more. It is not a price question, because the revenue from wool and the related price for a square-foot of leather is not causing any problem in the calculations. It is simply that neither India nor Pakistan or any other place in the world has so far tried to compensate for the shutdown in China and the missing production capacities. The double-face and decoration sector is suffering from the situation in Russia, but in general demand and interest for this kind of material is still way better, as is also the case for quality and luxury productions of skins that have never moved to China. Top-quality manufacturers in Europe are still quite busy, but as in the bovine section, the size of this market is very small.
For the near future, with better sales and a gain in market share, the Americans will now defend their positions as much as Europeans did before. The question is now how the European suppliers are going to deal with the situation. In addition, we are still seeing quite a lot of inventory of medium- and low-quality material, in particular in wet blue. This is sitting in many places around the world and needs clearing quite desperately. All of this is creating a not very positive undertone to the general market. We might not see big corrections immediately, but we would not be surprised if suppliers around the globe were to take strategic decisions for the coming three months on how to deal with the market conditions.
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