The Leather Pipeline - 28.07.15
28/07/2015
Macroeconomics
There has been a lot of news on political and financial fronts in the last two weeks.
The most important was possibly the last-minute agreement between Greece and the EU. The Greek government finally accepted the terms and conditions that are linked to further financial aid. In the end everybody got what they wanted to be able to save face. The Greek government, in the eyes of most of its people, fought a brave battle against the ruthless EU under the leadership of Germany while the EU leaders and proponents of ‘Grexit’ secured the terms and conditions they wanted and saved the European idea, which was so important for the European Commission. However, it would be naïve to believe that this was a lasting solution and the end of the story. We are quite convinced that the situation in Greece will be mentioned again in this section.
China has seen some stock market turmoil, but the published growth rate for the Chinese economy in the second quarter was 7%, exactly at the level the government considered its target and pretty much the same as in the first quarter. The coincidence of the numbers raised doubts about their validity.
The purchasing manager index in China fell to levels around 48 points, with levels below 50 generally indicating a contraction of the economy. This confirms that this large and important economy is still failing to show any clear indication of where it is heading for the rest of the year. Worries are growing that despite the efforts of the government to stimulate the economy, the outlook could be negative, which would be bad news for the global economy too.
The labour market in the US delivered further positive news; the number of unemployed people fell and there are still jobs on offer. This, and new remarks from Federal Reserve chairwoman, Janet Yellen, made international investors believe a rate-hike in the US will come sooner rather than later. Very weak data from the property market were published, with new home sales falling in June by more than 6%, reversing the trend again.
Gold and oil prices continued their decline. Commodities in general were weaker because of the worries about the Chinese economy (China is the biggest user of industrial raw materials), while gold is presently not attractive to investors as a safe haven.
All in all, it is fair to say that at the beginning of the summer break the global economy is facing an increasing number of concerns for the second half of the year.
Market Intelligence
With the start of the summer break in Europe and America, this issue of Market Intelligence will also be a bit shorter. So many members of the pipeline are leaving their desks that general activity, from raw material to finished products, is fading to pretty low levels. School holidays and holiday trips are also keeping consumers away from the stores, so not much is happening.
In better times, a lot of decisions are already taken by now, plans made, budgets discussed sometimes even orders placed for the manufacturers in Asia; there is clarity around production and people can plan accordingly. Far less this year. Many producers are still sorting out problems related to the high material costs of 2014 and the first half of 2015. Stocks have to be reduced, cash generated, losses calculated and a clear picture for the second half of the year prepared. This sounds easier than it is.
A lot is in disorder at the moment. The main problem for the leather industry is that demand this year is very difficult to predict. Brands and retailers are not delivering a clear picture about their expectations for business, which is related to the fact that the global economy is uncertain. It is still unclear how much leather, as a material, has suffered in consumer product demand. Although mentioned frequently in this section we have to be prepared to face up to leather, at least in the commodity sector, needing some time (seasons) to recover, if at all. Non-leather alternatives have had much success in the market and proved to be easy to handle in production.
The uncertainty of the general outlook for the global economy, the consumption of leather in consumer products, the problems in some larger consumer markets such as Russia or Brazil and the question marks about the situation in China are creating a difficult cocktail for plans. We are less concerned about strong brands, but the no-name and price-sensitive articles, which consume a large volume of leather too, look pretty vulnerable.
In short: we are not too worried about the medium and higher end of the quality and image range where leather is often part of the DNA of the article or brand, but much more about the standard bread-and-butter articles. These account still for a great proportion of leather consumption around the globe and play a bigger role in the market than many believe.
For the moment at least, there are very strong indications that the spread between the better quality articles and the commodity material will continue to widen. This is a cycle that we have seen many times before, but in the past it normally meant that more corrected fashionable leather items became attractive again and stimulated the demand for cheaper, more defective raw materials. With the new market pattern there is a decent risk that such a correction phase will either not take place again or, if it does, possibly suffer a much bigger delay than usual. It is very advisable to watch fashion shows and designer trends in the coming months to see if leather, in whatever form, makes a return to fashion and larger-volume consumer products.
In the meantime the leather pipeline is dealing with the question of the fall of raw material prices: has it stopped or are in a downward trend that is going to continue for some time? Fact is that the free-fall of prices has at least slowed down, if not come to a stop at the moment. Sales activity has definitely increased although the optimists have to be aware that a lot of the sales are not new ones, but resales of hides and skins that had already been marketed before. However, quite a bit of the immediate pressure to move inventories has been lifted for the medium and higher raw material origins and for the time being it is just the economic hides that are still looking for something like a base.
The price correction of the last quarter has been between 10% to 40%, depending on quality and origin. The top grades in Europe have come down by between 5% and 10%, and in some cases have not moved at all. Commodity products are on their way to being half the price they were in the first quarter of this year. Despite sharp corrections many sellers are still nervous and will do almost anything to convince customers to take hides. A big influence and challenge is of course that many buyers are still suffering from the prices they had to pay between 2014 and the recent correction; they are now asking suppliers why they (the suppliers) were not willing to listen to their complaints at the time. Consequently, the biggest argument today is about compensation for all the money paid during the period when sellers where squeezing the last cent out of their customers without really looking at the true situation of leather prices in the market.
It is very difficult to find an adequate price level when market prices move so far away from the fair value of the material. It is true that nobody can expect sellers to take less money than the levels the market gossip is talking about. On the other hand it is also fair to say that many of the beef producers around the globe are not willing to listen and continue to pour more oil on the fire instead of using their power to bring a bit more control to price developments. In a partnership situation, which is mentioned so frequently between the beef industry and the large industrial leather producers, both sides are better advised not to pursue short-term greed, but rather to sit down and to find reasonable compromises that are in keeping with market realities. We have been addressing this problem since last year and many may remember that the price development and the bubble were not created by the real industrial manufacturers, but by speculators and trading activities. A number of the big suppliers are today also involved in the production of finished leather and so they have enough information about the market realities in consumer markets.
Considering the losses that have occurred due to the recent market developments we are quite sure that a more tempered pricing strategy might have offered a better and higher average return in combination with far less stress. Raw material markets tend to overreact and if one looks at the price trends of many other commodities we see similar price developments. The main difference between raw materials for leather production and many other commodities is, however, that for the vast majority neither a seller nor a buyer can really take any protection measures other than trying to manage inventories, which has tight limitations for various reasons.
The split market remains in almost total agony. If prices are not already at the bottom and sales impossible, they are continuing to slide and the use of gelatine and collagen continues to fade too. During the summer fewer splits are produced and the real future of this part of the leather production will possibly only be clear at the end of September.
There is nothing new from the skin market either. Only the top-quality end is doing quite well and where origin can produce semi-finished materials, life is at least somewhat easier. Raw skins in particular for fell-mongering are still suffering from the production limitations in China and the weak demand. In Turkey many people are saying only a very small handful of tanners at the high-end of double-face production are in operation, while most others continue to be idle. Pessimistic estimates are talking about only 10% to 20% of the full tanning capacity for skins being in operation. With very low prices for skins, we were expecting that tanning centres such as Pakistan and India would become more interested in raw material. However, we can still not find much activity even in those markets but we are still hoping that with the end the Ramadan activity should pick up in that region.
For the next four weeks most of the market activity will be limited to action in Asia. With the longer lead-times producers have to think about their supply chain management and what kind of decisions they want to take for the restart of the higher production cycle in September. A lot will depend on the real inventory situation in the factories today. The overflow seen after all the expensive arrivals from the US, caused by the west coast labour dispute at the start of this year, should have been either re-negotiated or delivered and absorbed by now and the raw material situation in China should be better balanced. A lot depends on the new order situation for leather for the next season, because hardly any tanner will today take any more product than needed after the experiences of recent months.
Due to the low kill in the northern hemisphere until September, supply will not be too much of a burden at this stage and for the better kinds of material the outlook has become more stable now. This depends of course on the price levels. Many of the published levels do not reflect real prices, which are often much lower than those quoted in the official reports and offer lists. We see not much downward potential in the time remaining before the All China Leather Exhibition in Shanghai (August 31-September 2).
No matter what happens, it has never been wrong to buy moderately in a falling market until a clear picture has been achieved and a lot of false valuations have been taken out of the prices. Nobody can say prices are ‘cheap’ looking at historical price trends, but we have reached long-time average range for many products, which is the good news. This has removed a lot of commercial risk for those who have regular business and a safe position in the supply chain.
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