Macroeconomics

It is summer, and this is the time business people sit back and evaluate their companies when they are not caught up in the daily challenges, meetings and budget planning. It is not easy to be optimistic, even though the International Monetary Fund is expecting a positive 2016.

The following represents summer 2015:

Greece
Nothing has been solved, despite the Troika (the European Commission, the European Central Bank and the International Monetary Fund) and the Greek government negotiating the next bail-out program. The problem for the EU persists.

Middle East
Turkey has now been dragged into conflict and, as well as the fight against the Islamic State, the old conflict with the Kurds has been reactivated. However, the nuclear agreement with Iran is good news for businesses, and will allow the country to return to the global markets.

Ukraine/Russia
Ukraine has serious financial problems; more money is having to be injected. There is hardly any indication that the West and Russia are any closer and so it seems the sanctions will remain and rouble will stay weak, and for many exporting countries this means a serious loss in sales. While China could take some advantage, the spending power of the Russian consumer is still falling.

China
The Chinese economy is slowing. Nobody knows by how much, because of the limited confidence in the official statistics, but we would not be surprised if it is less than the official 7%. The sharp correction of the stock market and the reaction of the government has confirmed how sensible the government is. Many state companies are producing a lot of bad debt and the real estate market is in retreat, and this could eventually become a threat to banks and financial stability.

Emerging markets
Many emerging markets are suffering from the steep fall in commodity prices. This is positive for material costs, but negative for the producing countries and, coupled excessive liquidity, increases the risk of deflation.

General market conditions
Consumer spending in the US is stagnant. Stock market and real estate prices look increasingly inflated and many investors are expecting a correction. Rising interest rates in the US could become a problem in the emerging markets which are frequently financed in the dollar and a further strengthening would cause additional problems for repayments. A lot of the global growth was based on quantitative easing, liquidity injections and low interest rates. If that fades any major change could cause serious problems. On the positive side, low energy prices will leave more money in many consumers’ pockets.

This list is not complete, it is merely a guide for general parameters that could influence business in the medium and long term.
 
Market intelligence

We are now in the holiday season and the European industry will be very quiet until the end of August. In Asia, the situation is a little different and one can sense a number of tanners are considering how they will prepare for the upcoming season. With the rapid correction we have seen in the past month, the tanning industry has regained confidence, finding that raw material prices more favourable, meaning there is far less risk involved when it comes to price negotiations with leather buyers for the next season.

The big story of last week was the US Department of Agriculture’s export numbers. The sharp decline in prices and the resulting special deals had led to export sales recovering, but many were suspicious that a great part of these deals were just resales and renegotiations of more expensive sales. However, the impressive sales number of last week has swept away any doubts that the US market has found a bottom and no matter what the real situation is, suppliers will use the figures to justify resistance to lower bids. This will create a firmer undertone for their trips to Asia and the meetings at and around the Shanghai fair [All China Leather Exhibition, August 13 to September 2].

Although the US statistics are widely monitored they should not be taken as a general market indicator. Over recent years the number and interpretation has raised many questions as to whether they reflect the real sales and physical inventory situation. [World Leather readers: We cover this topic in the upcoming issue, published on August 18].

From the US perspective, the suppliers have managed the crisis pretty well. After they realised they had lost the battle by pushing the hide prices so high they were not shy to take the beating and regain control. It must have taken a lot of work to straighten everything out and to invest into the market to regain some of the lost market share.

If the price was right they could rely on their customers that prefer uniform hides that are the least challenging for their technicians. Also, many brands focus their leather specs on US hides. This has brought the US back into the game.

CHINA SUBSTITUTES
As we have mentioned in the past, the leather pipeline is fragmented in terms of its performance. While the big brands, the automotive industry and some parts of the luxury sector are seeing only limited demand fluctuations, leather has suffered in the low-price sector, athletic and casual footwear, upholstery and garments as a consequence of the inflated raw material prices.

It might be wise to look at the situation in more detail. The big industrial players in the beef industry and in leather production that need the standard and easy-to-manage product have reached their price compromises and this has enabled their suppliers to secure sales and shipments after the congestion in the first six months of the year. We cannot trace any serious recovery in demand for split leather or low-grade grain materials while lamb and sheep nappa have also not seen any significant rebound in demand. It might be a bit early to make a judgement, but it is only a few weeks until the decisions about material demands have to be made.

Many standard-production tanneries in China are still struggling. The tanneries in the north are still facing substantial problems in terms of effluent standards as well as financial issues.

A lot of leather buyers have relegated some of their leather orders to other countries, because production in China is not cheap anymore. However, we have been much more optimistic about the strong increase of leather production in Pakistan, India and possibly Bangladesh, but the reports we are getting from these destinations are not really indicating any rise in orders. Most of the production might be heading to more traditional alternatives to China, such as Vietnam and even South Korea and some other South East Asian countries. A clear picture of how the leather production is going to be spread in the coming years might be available in the next few months.

There is no indication leather consumption will recover to the levels we had seen a few years ago.

Tanners with regular order books couldn't wait for ever to replenish their raw material pipeline. Some time ago we said raw materials had been overvalued by between 20% and 30% and this is the correction we have seen so far – at least in the official price quotations.

ALL SIDES HAPPY
For standard articles, the industry is quite happy with the price levels and hardly anyone with regular business is interested in further corrections - the beef industry and raw materials sellers for obvious reasons, but even tanneries see more risk for the long term with cheaper raw material.

For some time, we had seen a 'supply-driven market' and we learnt that there is no supply-driven market for a raw material that can be widely substituted. It was an explosive mixture of supply management, speculation and corporate forecasts that did not take any risk into consideration (for instance, production and financial issues in China and the consequences of the sanctions against Russia).
 
We have always backed the idea of a fair valuation of material and leather and see this as the main driver behind demand. You have leather products that could allow high raw material prices, because of the high leverage in the finished product prices, but this is the minority of leather production. For the rest, the normal rules apply and the idea of the beef industry that hides and skins are basically a bottleneck product and their valuation can be influenced by supply makes no sense for most when alternative raw materials are cheaper to manufacture, easy to acquire and, in some cases, perform the same.

This means we should not get overly excited about the rebound. We will always have a certain temporary market movement, but it is important that the supply, demand and valuation of all items are getting in balance. Our main concern now is that demand for the very cheap items should come back. Prices for split, lamb and sheepskins can no longer be the problem: their valuation is so low that the price is not the obstacle and it will be interesting to see whether there can be a return in this range.

We still see adjustment potential in the bovine markets. In particular, in Europe, several raw materials have not yet adjusted in line with the international markets. The heavy automotive hides and high-quality end has held the prices of lighter and lower-quality materials too high and one would not be surprised if more reductions are needed by the end of the summer. The optimists are hoping for price support from the US for the fair in Shanghai, while the pessimists are trying to adjust abattoir prices as a precaution, so as not to be stressed after the fairs in China and Italy and with the higher kill expected in the last four months of the year.

In the meantime, the most important thing is to get a clear picture of leather demand for the coming season and whether the pipeline is filled. The situation in northern China will also be very important for the lower-priced items and cows.

SPLITS AND SKINS
The split market remains quiet. We cannot trace any change in the depressed market and we are curious as to what we will learn during the Asia trip. If there is any good news, it is that some players report enquiries from the Middle East, but as cheap as the prices are, some buyers are still bidding lower.

We face a similar situation in the skin market, where there are only bargain hunters. Prices are sometimes not even covering the transportation and processing charges. For those with confidence about the future of ovine leather, now is the time to get a lot of skins for little money, which, in the long run, has never been a bad investment.

The next two weeks will be about preparations for trips to Asia and the next production season. It will be interesting to see if the wave of interest will have a follow up. The Chinese are sometimes not smart buyers in the falling market and are hectic when the market rises, so let’s see if there are some who feel that they should catch up. For the sellers this might be an opportunity to fill order books and hope that contracts are fulfilled. Those origins and grades that might miss some adjustment would be better getting in line rather speculating about better times in the short term.

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