Macroeconomics

The financial markets have been pretty quiet. The public has been much busier considering the FIFA corruption scandal and the possible consequences for the football World Cups in 2018 and 2022.

The slowdown of the Chinese economy has been reflected in the decline of exports and imports. Exports for April fell by around 16% and imports by around 6%. This is quite a number when we consider the size of the economy and reflects a remarkable decline in industrial production and consumption.

On the sidelines, there were worries for car sales in China and some of the international brands are said to be cutting shifts in Chinese factories. We have been talking about significant rebates in the Chinese car dealerships for some time; nobody would be discounting if they didn’t need to. Several pundits are also suggesting the demand for cars in China is shifting from the medium high-end to cheaper or even local brands.

In Europe, the media is dealing with ‘Brexit’ and ‘Grexit’. In the UK the public may vote to leave the EU community and in Greece they might be forced to go. Although such news would have caused chaos in the financial markets and send the euro in freefall two years ago, today it is more a small note in the business sections of newspapers.

In the meantime, the eurozone has grown by 0.4%, which has been called a recovery but is in fact a very small movement considering where it is coming from.

The euro went a little down from the peaks it had seen after the recovery and ended around 1.10 against the USD.

Oil prices eased a bit as did most precious metals. A bit more weakness was seen in industrial metals, but none of the markets delivered anything significant.

Market Intelligence

We are missing anything really new that could push the leather pipeline in a new direction. The new direction in this case means prices stabilising, demand increasing and the general mood improving.

There are still a number of people desperately trying to move the market, painting a rosy picture about the situation. They are using statistics and company results in an attempt to erase concerns relating to manufacturing and sales of leather and leather products.

The past six months have been a good example how cyclical the leather business is. It was not just the decline of leather demand due to the exaggerated material prices, we had a number of other issues and indeed one has to be impressed that the market reaction has been rather limited and the retreat of raw material prices has been quite orderly - more sliding than collapsing. The general volatility of the market as far as short-term periods are concerned has declined.

The market also had to digest changes in China in the production sector, meaning the tight controls on waste and the anticorruption policy of the government, making production significantly more expensive and reducing consumption of luxury goods. In addition, we have the sanctions on Russia which had previously been another market where wealthy people like accessories, fashion and expensive cars. The slow recovery in Europe has not lifted demand and the crisis in Brazil hasn’t done any good either. The recovery in the US and Japan has not been enough to compensate.

The problems in China have been the main reason for the deterioration in the conditions in the leather pipeline and have laid the foundation for the difficult conditions we have to deal with now.

In a world where the governments and national banks are flooding the markets with cheap liquidity to combat inflation the option to pass the cost onto the consumer in the form of higher prices is an almost impossible task, made even worse when we consider that alternatives to leather have become more competitive due to the fall in oil price.

As a consequence, leather production in China is far less profitable at best. This means tanneries are reducing investments and production and only those backed by strong demand from the automotive industry are able to keep going.

We are all aware that the leather industry in China has been financed for a long time by the grey financial market. Businesses and private investors lent money to an industry that saw rising raw material prices, reasonable margins and a global environment where leather products and interiors were considered a never-ending success story.

All this was added to in China by a real-estate boom and many apartments and offices had leather upholstery. The day when these positive conditions began to fade was also the day when finance into the industry became far more complicated and investors were suddenly confronted with losses. This made it far less attractive and those who had already borrowed found it difficult to liquidate their stocks to repay the money. Saying that, there are still a lot of people disposing of great wealth and businesses making decent profits.

Almost all international business media is talking about the stock-market bubble in China. Every taxi driver, housemaid and shopkeeper is reportedly busy checking the stock market on their smart phones.

Some have been comparing the situation with the conditions before the last crisis in south-east Asia. At that time, businesses had been investing into property and the stock market in the expectation of making easy profits. The only difference is that these countries had been pretty weak and were not in the position to stem against the chaos when the bubble burst. It is hard to believe that the Chinese government would allow a collapse of the financial markets. However, the bubble is still a bubble when the prices for assets cannot be justified (and we think this is the case). The bubble will still burst, just causing less damage.

Restructuring

The leather pipeline is feeling the pain. There might be some bright spots in those countries that are picking up some of the production losses from China - Pakistan and some other Asian countries - but they are not compensating for what has been lost. In India, environmental issues are also causing troubles for the leather industry, however this is for the good of the environment. We are going through a period of serious restructuring triggered by economic and environmental reasons and if one looks at the history of the leather industry it is something that happens in cycles in time frames of 10 to 15 years.

For the market, this means that the conflict between those who want the maximum revenue for their byproduct and those who have to find a margin between the raw material and finished value continues. The situation in the new millennium is a bit different, because beef producers have become leather manufacturers.

In the last two weeks the raw material price trend has been caught in a stalemate. Currency movements and policies prevented the prices going much lower. Sellers are cleverly playing the supply card and so far no supplier had been willing or in a desperate need to liquidate stocks just by the price. It is also questionable if this would help at this time of year and if much lower prices would solve the fundamental problem. It is pretty likely that a quicker and less orderly retreat of prices would simply increase the issues.

This only applies to the dominating raw material origins. The less known raw material sources are showing a different picture. Many traders and tanners around the globe are reporting that they are getting unsolicited offers from origins and suppliers they have never dealt with. Looking at these offer lists, one has to be impressed by the large volumes and in many cases extremely low price levels. What is actually behind the curtain one can possibly only figure out by travelling to where the goods are. In any case, such offers leave a certain footprint in the market.

There is a large inventory of wet-blue in the hands of traders and producers. These inventories need protection in their values and since we are talking about quite important names in the industry they are keen to avoid any major reactions.

Split market

The split market remains in a difficult position. Again, China plays an important role in lime split prices, which continue to drop week by week. The biggest problem however is not the prices but the fact that many tanners are calling the prices quoted in the market artificial. Many tanneries in China are mentioning that they only have the option of selling the splits with or without the price, but not getting paid until their buyer has been able to sell. As a consequence, many tanneries say that if they cannot raise cash immediately they would rather hold on to the product, and a good number are either renting warehouses or building them to store the lime splits they are producing.

In other parts of the world split inventories are rising too and prices have come down by quite a bit, but the situation does not seem to be as serious as in China. As splits have become cheaper, the price cannot be the prohibiting factor. Manufacturing issues and sluggish demand have kept splits pretty much out of the manufacturing chain in the last season. It is going to be interesting to see if for the coming season manufacturers and retailers are going to reconsider split leather products. If they cannot see any major benefit of returning to cheaper leather it could become an ugly time until a new outlet for the splits can be found.

Skin market

In the skin market the situation is not much different. The good news is that the premium skins for certain specialty productions such as high-end nappa leather, high-quality shoe linings, high-end double face garments and, to a certain extent, decoration are still selling in reasonable volume and at quite impressive price levels. For the rest, the situation is different and unsold inventories are piling up all over the world. Goats, medium and low and lamb and sheep are hardly finding buyers at any price. Like in the split market, many suppliers are thinking about the summer and wondering how they are going to store all the product. The usual spring lamb production in Europe is said to be very. This might be a bit supportive to the market although the demand traditionally coming out of Turkey has been pretty low as well.

Looking ahead

We do not think there is any upside potential for prices for the coming weeks because we are failing to find any indication for an uptick in demand, neither from manufacturers needing to replenish inventories nor from speculators considering prices attractive enough to invest.

However, everything points to the direction that sellers will continue to have a tight grip on the market and they do not need to dump material just to raise cash. The only thing that could trigger movements would be the ageing of some stocks. In Europe many suppliers are still living from the good times when the dollar was rising and competing markets were more expensive. This has prevented suppliers entering the summer season with any exaggerated stocks that could scare them when temperatures rise. This should protect the market on this side of the Atlantic from any serious movement until the summer break. However, from August there is potential for another round of corrections which might be appreciated, because then tanners would start the new leather production season from much more competitive and far less risky levels than they did a year ago.

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