The Leather Pipeline - 16.06.15
16/06/2015
Grexit, Grexit, Grexit!
There are different positions on the debate about Greece and the Euro Zone, but something that should also be considered is how much time European leaders are spending on this subject. Everybody is discussing the potential cost of whatever decision is taken but nobody seems to realise how much it is costing already to hold all the meetings and spend so much time on a situation that has not become any better since the problems began to make the headlines. Everybody involved, including the public, is becoming increasingly fed up mainly because nothing is becoming better and there is no sign of an acceptable solution.
The financial markets continue to react in a pretty relaxed way. The players seem to think that whatever happens it is already priced into the markets anyway.
This leaves the focus on other issues, and in particular in Europe people are not really taking too much notice of what is happening in other parts of the world. Most international organisations are shaving their expectations about global growth significantly down, reflecting what people in business have known already for some time. Secondly, everybody is waiting for the monetary policy decision of the United States: if interest rates rise this autumn or if it will be postponed until 2016. As a market reaction, interest rates have begun gradually to rise.
Most important might be the situation in Asia, where various nations have begun a war of currencies in reaction to the serious devaluation of the Japanese yen. The Malayan, Thai and Indonesian currencies have substantially lost value against the US dollar and a number of people are beginning to draw parallels to the last South East Asian crisis of 1997. Nations and currency reserves might be better today, but a rise in interest rates and United States could create another serious money flow out of the countries and cause similar turmoil to what we saw about 18 years ago. This could even be transferred to China where the stock-market bubble is also developing serious worries in the financial markets and in the country itself. The Chinese government has certainly more tools and reserves to handle such issues, but a bursting of the bubble would definitely have negative impacts on the global economy.
This is certainly a worst case scenario, but it is not so unlikely that it can be totally ignored.
So far the financial markets are reasonably unmoved. Most major stock markets are moderately down, gold and metal prices have dropped too and the US dollar has lost some value against the euro in reaction to rising interest rates in Europe and uncertainty about the monetary policy in the US. Oil prices are also trading in a narrow range within the 60s and have been for some time.
Market Intelligence
Although this Market Intelligence report does not deal just with material issues the main focus of interest along the pipeline remains the situation of the raw materials market. This is not really a surprise considering the high percentage of the total cost of finished leather that raw hides and skins represent.
Slowly but surely, everyone is realising that what had to happen has happened. Everything started about a year ago and our regular readers will remember our concerns about the long-term effects of the exaggerated price levels in the first half of 2014. It would be far too easy just to blame sellers for what has happened and for the situation today. It was just a mixture of the understandable interest of the beef industry in obtaining maximum revenues for their byproduct and the usual experts predicting a fantastic future for leather and an expansion in consumption, no matter what. There was excessive production capacity and liquidity, in particular in China, and this led to buyers pouring more money into the bubble simply for the sake of making speculative profits on the back of the producers.
The main mistake was in the analysis of leather demand and total ignorance of price. The lessons students learn in the first hours of their economics studies have been totally ignored. There is a tight correlation between price and demand. Sellers put prices at high levels and those on the buyers’ side supported the trend beyond any realistic levels, driven not by long-term consequences but by short-term hopes of profits.
Maybe the party would have continued but for the environmental controls the Chinese government imposed in 2014, triggering a contraction in available tanning capacity. This continued and, with a decline in demand for price reasons, purchasing and production capacities suddenly began to shrink too. Very quickly, this put quite a bit of speculators’ money in trouble and some had to liquidate stocks while others went missing altogether because they were no longer willing to invest money with little chance of making a profit. In the end, the trend is your friend.
Today we can possibly discuss if it was better that the bubble didn’t burst in the end and was only deflated. What can be said for sure is that the sellers’ timing was pretty poor and it would have been much more advisable to begin a correction of prices sooner.
Anyway, the leather pipeline has to live with the facts as they are today. The never-ending stories of shrinking supplies in some regions becoming the market-determining factor have caused some misdirection. For the reasons stated above, demand has been shrinking far more quickly than supply, which has left us with a situation of surplus production in the market and it is very difficult to predict when demand is going to increase by enough to absorb the excess raw material supply presently circulating in the markets.
Nobody is pleased by news of this kind and we are fully aware that we still will have a large group of market players that are not willing to listen or accept the facts. This has been the case for a long time: you can postpone market problems but you can never escape from them in the end.
So far, so bad. We are now at the beginning of the summer season and because of the seasonality of our business this means very little can be expected from the demand side for leather in the weeks to come. Only speculators buying can offer any support in the short term.
The main problem, at least from our perspective, is that attempts to figure out what will happen because leather demand could turnaround for the better again. Seasonally we will definitely see a rise in production from September onwards. The leather business hasn’t come to a standstill. It is just shrinking and for those tanneries who are still in possession of a reasonable order book and a stable customer base, there are definitely better times ahead. Their margins, which shrank so much in the period of high raw material prices, have now got a fair chance of widening again. However, the most important influence on pricing and the situation for the coming seasons is the question of price corrections, which we have seen so far have not been extended enough to influence leather demand for the seasons ahead.
We should take into consideration that most of the reduced demand for finished leather has not been reflected in a reduction in production of finished consumer goods consuming leather. The volume of pairs of shoes, bags, furniture and even cars has not declined, despite generally flat conditions in the global economy. Production and output have been stable, if not moderately growing, just using less leather. Our main concern at this stage is that many manufacturers have shifted to materials in substitution of leather and they might have had a better experience than we might have liked. As long as consumers find no serious disadvantage in products not made from leather, neither they nor the manufacturer have a serious reason to return to leather.
From the standpoint of manufacturing, the use of leather as a material must generate a significantly higher contribution to margins than the savings a manufacturer can make in production costs by using cheaper alternative materials. A change in materials can and will always be reversed if the margins and the advantages are high enough. We think, that the simple idea that leather demand will just return naturally and because it’s cyclical might be too short-sighted this time.
We still haven’t given up hope that we have just been going through a period of correction and adjustment and that leather consumption will see some recovery in the season beginning after the summer break. We continue to monitor the situation and actually we would love to see some life in the market sections that can literally be considered to be ‘dead’ such as splits and parts of the skins market. Cheap though these raw materials have become, very little, if any, change can be seen.
As far as the market activities and price trends in the past two weeks are concerned we possibly had a stronger adjustment downward than we really expected a fortnight ago. The problem remains the same: because the available price reports are still not really reflecting real price levels, it’s hard to call the market today. We agree that there are wide price spreads between different suppliers and that there are good intentions to keep the market decline under control by using a piece-by-piece policy, but this does not change the reality.
It looks a little bit like we are now in a spiral of pricing and the massive correction of prices in the Americas, in combination with a moderate decline in the value of the US dollar, is beginning to put increasing pressure on suppliers from other parts of the globe (Europe) and they will have to consider adjusting their prices again if they don’t want to miss the boat and the market share they gained in the first five months of the current year. In general it means the majority of sellers must now have the courage to hold onto raw material they cannot sell and hope that enough buyers will find their stocks empty by the end of August when the trade gathers again for the All China Leather Exhibition in Shanghai.
We have to admit that our information from the tanning industry around the globe and in particular from China is not pointing in the direction of tanners missing raw material for their production. Quite the reverse. And putting financial problems aside we understand from many producers that they are entering the summer season with far larger stocks than they thought they would have. That still means that tanners will have to buy hides, but possibly later and less than many sellers would like.
No news from the split market. The situation in China is still a drama: there are no prices for a great part of the lime split production in the country. Tanners have the option of letting splits go in the hope that one day their buyer is going to reward them with a fair price. Either that or they have to make the necessary arrangements to store the splits and keep them until the market turns for the better. Neither option can be considered very inviting. Wet blue splits and specialties might be doing a bit better but cannot change the fundamentals in this sector.
For the skins sector we could actually stop bothering. For quite a long time nothing has changed and we cannot see any changes on the horizon. The biggest problems here are low demand for standard nappa leather and a lower fellmongering capacity in China. There is a fundamental question to be asked about where all the skins are going to be processed when demand for sheep and lamb nappa returns. After the Chinese absorbed most of the global commodity skin tanning capacity, the shutdowns today are causing a serious reduction in potential tanning capacity in the future.
We are still in the middle of June and this means we still have about eight or 10 weeks of summer break ahead of us. The lead times for supply to Asia are far longer than for Europe so Chinese and Asian tanners may return to the market a bit earlier than their European colleagues. This means that the total absence of buyers will not continue for ever and leather production will continue. We are in a period in which the congestion in the pipeline and the classic ‘fear’ in a bear market need to be cleaned up before normality can be reached again. Market trends tend to exaggerate and as it took longer to end the bull market cycle it might also take longer to end the present trend.
Everything points to a bumpy road ahead and we would require a recovery in leather orders to re-establish more market confidence. As soon as this happens buyers will quickly return to the market so as not to miss the boat. With the present uncertainties in many economies and currency markets we think that it is still too early to believe in any improvement. Looking at the present price levels we are getting closer to the long-term averages, which is good for the calculations of tanners and the leather business in the long term. However, the market is still in search of ‘the right’ price level to establish a plateau on which leather demand is strong enough to absorb all raw material.
Share this story:
