The Leather Pipeline - 06.10.15
06/10/2015
In the last issue of Market Intelligence the world was mainly dealing with refugees in Europe but in the past two weeks the world has had a new toy to play with. Volkswagen, Germany’s biggest automotive producer and the second-largest in the world, has had to admit that it was manipulating software to ‘reach’ the emission standards required in many countries around the globe.
Something known already for quite a long time suddenly became a big public issue and wiped away within days a market value of more than €25 billion. The subject of this publication is not to deal with the technical details and legal issues or to make any judgement about the alleged wrongdoing on the part of the company, but it might be worth thinking for a moment how difficult it has become today to deal with global legislation. Something that in the past would have been dealt with between the authorities and the corporations according to the law, ending with court decisions and consequences, is now all about media hype with a crude mix of emotion, facts, legal action and media morals followed by commercial and political interest.
In the general there is really not much happening in financial markets. Stock markets are fundamentally lower although many of them are still trading within accepting trading ranges and are not in free-fall, although commodity- and raw material-related stocks have seen a bloodbath and lost huge proportions of their value.
The situation of the economy in the US remains pretty robust and everyone still wonders why the Federal Reserve is still waiting to raise interest rates. Now everybody is waiting either for October or December.
In Europe most people are still trying to deal with the refugee problem. The debate is not only about who is going to take them, but how they are going to integrate refugees into the labour market and into society. With the numbers coming, one has to assume that this is going to be a serious challenge for the EU and the recently renewed instability and violence in the Middle East and Afghanistan will not reduce the problem. This is of course not even considering the constant flow of people from Africa who are also sitting in shipwrecks trying to cross the Mediterranean to get into the EU.
All this is not just going to be a temporary problem, but will be one for the next decade. With no master-plan and with winter knocking on the door it is going to be a very big challenge to deal with. One should not forget how many people are still waiting in camps in Turkey, Jordan and Lebanon who are also still looking and waiting for a new home.
Another issue of concern must be the situation in Syria and Afghanistan. Russian military action and presence to support the Assad regime has to be a concern for the West and will also not reduce the numbers of refugees from that region. The Taliban is beginning to expand its presence in Afghanistan again after the NATO presence in the country reduced. It seems the government and the army are still not capable of controlling the country.
The currency and commodity markets have generally stabilised and there have been no big moves recently. Oil has found a bottom with the trading range in the $40s for the barrel. This has now been a stable base for almost a month now, despite the fact that experts still consider the market to be seriously over-supplied.
The US dollar is also trading in very narrow ranges after a steep rise in early summer. Against the euro a very stable trading range between $1.10 and $1.15 has been in place for a long time. It might need very clear decisions about interest rates to propel the dollar into different territory.
Market Intelligence
The past two weeks have been mainly dominated by a lot of market confusion, in particular with the questions raised around the automotive business and Volkswagen problems.
To start at the beginning of this story, we have to admit that it is not clear if this particular issue will have any serious influence on the automotive business in general. Without any question, though, the production of Volkswagen be hit. All models in which the engine type E189 can be delivered and continue to be manufactured as planned. The cars using petrol engines and other engine types are not involved at the moment. However, clients might put their purchases and deliveries on hold and some factories have already been told to cut production for the moment. However, it is more than unlikely that the consumer will postpone or cancel his purchasing decision for a car. He might move to other brands or other models, but the general decision will most likely be unchanged.
Far more worrying is the general situation in many global markets. Sales in Brazil have dropped by almost a quarter, Russia is only a fraction of what it used to be and the Chinese government has decided to support car sales (at least the smaller ones) by cutting VAT in half. The US market has had a pretty good year and with a positive labour market sales numbers in this very important sales region have a fair chance of meeting the same levels that we saw for 2015.
However, the general forecasts of a continuous growth in car sales of more than 2% per year might have to be reconsidered. The weakening Chinese economy, financial problems in a number of countries around the globe and the general uncertainty about global growth in the coming year might also have an effect. The sharp decline in prices for commodities in particular for oil and industrial metals and the decline in the values of stock markets has also wiped away some wealth and it remains to be seen if the big spenders from the Middle East for example will continue to purchase vehicles at prices above $200,000.
As important as the car market is, one must still consider that shoe leather remains the dominant application area for the leather industry. We are entering the low season for shoe leather with the production of the summer models 2016. The substitution of leather in many consumer markets has now been sufficiently discussed and so we do not need to mention this again. Shoe leather in the mass markets will face less consumption for some time and this is also being reflected in the raw materials market. Lower-quality and side-leather-related raw materials are still the biggest losers in the market and there is hardly any argument at the moment that could be used to present a more optimistic position.
We have noticed a bit of a difference in the past two weeks with regard to better-quality dairy cows. In particular the market in China has become significantly more interested in this particular product, which has taken many players by surprise. Most of the interest came out of the north of China and this had been the most problematic spot in the market for quite some time. Apart from the complaints regarding leather demand we have heard a large number of complaints about financial issues and frequent delays in the opening of letters of credit.
All this has become much better in the last fortnight and now the discussion in the trade is whether this improvement is about the need to replenish stocks or if it’s really a turn to the better in terms of demand for upholstery and bag leather. Maybe it’s a bit of both. Traditionally, Chinese buyers are not brilliant when the market comes down and they barely ever buy in a falling market. Realising that the quality dairy cow market had found a bottom after the drop during the summer it seems that at least those tanners with a stable business were too cautious and waited a bit too long to buy, so they had to step into the market prior to their October holidays.
Many suppliers have also reported that letters of credit suddenly came very quickly and buyers were annoyed to learn that shipping space was not available in the following week. Consequently, also related to the ‘slow steaming’ policy of many shipping lines (they argue that having ships travel at lower speeds improves their environmental impact) they will have to wait until the middle or even the end of November for the hides they have ordered recently to arrive. What is putting quite a lot of people under stress is if they will still be able to finish enough leather in time for the Chinese New Year shopping season. With the Chinese players taking a holiday until October 7 one has to wait and see if this was just short-lived replenishment activity or if the leather business has really stabilised and we have seen the bottom of the market at the end of the summer. We have to be realistic: at this stage there’s not much evidence that the leather business is really improving fundamentally on the mainland yet.
Another argument people have been using to explain the improvement in prices for dairy cow hides is that particularly cow splits saw a moment of sharp increase in price. A number of people were quoted as saying that the better returns for splits made certain leather types more profitable again and tanners took the chance to lock this in. The problem in China is however that the splits can only be sold when they are already produced and with the hides arriving only in November or December nobody knows yet what the tanners are going to get for splits when they come out of the splitting machine.
We should not forget that a lot of the high prices for hides in the first quarter were also related to the record revenues people expected from the split credits and when it came to selling them the market was already totally different.
Generally the more active production season has started and one can actually feel that the summer is over. However, this does not mean that all the hides and skins being produced at the moment are really needed to cover existing leather demand. Some segments are in balance but in total there is still more supply than demand for the time being. The recent slaughter levels in the Muslim world for the Eid al-Adha festival have also added to supply.
The cheaper end of the market remains a real nightmare and is seeing very little improvement. We need to stress again, that the entire market situation is different from the one in the individual sectors and so some raw material suppliers – in some regions in particular – might disagree. When they look at their order books and look at their sales over the past weeks they might be satisfied. Of course one cannot substitute a French bullhide with an Iraqi sheepskin and a South African hair-sheep skin cannot be substituted by a wet blue drop-split. Consequently many are of the opinion that the issues in other sectors do not influence their situation and price levels at all. Well, we tend to disagree because in the end everything is connected. It is just a question of the direct or indirect correlation and the time it takes for trends to filter through the system.
To improve conditions for the coming seasons we need leather to return to the catwalks and to come back as a genuinely popular material in the shops. Here, the lower price levels will certainly help. With several raw materials (in particular sheepskin) already being sold below cost price it is rather a question of when and by how much the articles that have not corrected yet (mainly the higher-quality ones) need to be reduced to stimulate the interest of designers and commercial directors to focus on leather again.
The period of the great fashion shows is over and one has good reason to be more optimistic again for later in 2016. The normal cycle is governed by price. Metallised leathers, foils and prints, lamb suede and nappa, retros from the 1970s and 1950s and patent leathers were all shown in many collections at the major fashion week events and this encourages the use of leather that can be procured presently at bargain prices. Although the fashion shows don’t actually tell us what is going to be seen in the big stores later, trends are set and while we are sceptical about a number of trends (in particular in shoes) there any many others that seem to us saleable to the general public. In particular a comeback for the looks of the 1950s and 1970s offer a lot of opportunities for leather, since it was a material of fashion and prestige in those eras.
We hear about large volumes of low-grade calf and kips presently being sold in China, which would suggest that metallised and printed styles will be reaching the mass market and that volume producers are covering their needs for the coming season to make sure they have the raw material secured. It is a bit early yet, but we will continue to watch the trends. Usually a new cycle begins at the bottom end of the price and quality range. Time and conditions could not be better right now with prices for many raw materials unable to go any lower now. Nobody should expect the changes to come overnight, but the base is laid.
The split market must still deal with the present and this continues to be pretty difficult. With the exception of high-quality suede splits, the situation remains exceptionally difficult. With the total congestion of wet blue splits for leather production, many tanners who can technically do it (outside China) decided some time ago to shift to lime splitting and make use of the gelatin and collagen, sure that the splits would keep moving out of their factories. This has created what might be expected, that in several parts of the world now the non-leather consumers of splits are overloaded with material. Prices are dropping sharply, production capacity is at its limit and congestion is beginning in this market segment too. One can only hope for a recovery in split leather demand to secure the flow of splits also in the coming months.
The ovine sector remains as of today in a difficult situation. The Eid al-Adha slaughter has brought a lot of additional skins to market in volumes that cannot be absorbed. Several of our contacts report that they are receiving numerous emails from suppliers from the Indian subcontinent, the Middle East and Africa every day asking for help in placing raw skins that are piling up. The better-quality material for the luxury and high-end market is not caught up in this.
The Asian industry is still in a semi-holiday mode. Leather production is now on the seasonal rise. The cattle kill in the US is higher and the numbers in Europe are rising too. We have always been of the opinion that the market is going to be at the next junction in the second half of October. For the moment the rise in production and demand is in balance and so the market has come to a period of tranquility. This is good, but will not endure. In our opinion we are presently seeing a 50-50 chance of things moving in either direction. Were it not for the great political instabilities of these times we would even tend to be 51% positive.
But the economy and financial situation in China still has a big question mark over it, the situation in Syria and the region around could quickly turn into something serious and also the Ukraine conflict is far from being resolved. All this can change the situation overnight. Oil prices can explode, or collapse. Military conflicts are never any good for the mood of consumers.
Emerging markets with the exception of India are struggling too and the low commodity prices are hitting the income of countries, corporations and individuals as well and with a time lag this will be recognised and felt. The Volkswagen affair could maybe have a great influence on car sales – or maybe not. Maybe it will only hit the group itself and keep their clients away from Volkswagen showrooms but seeing them move next door to buy a car. Maybe buyers are just putting their decisions for a new car on hold because they want to know if their preferred brand may have a similar problem to Volkswagen’s (or because they hope that car prices in general will drop with discounts offered). If Volkswagen decides to offer large discounts to hold their customers it will not leave the others untouched. Maybe car shopping will continue just as it was and only the market shares will shift. It is difficult to predict and consumers in different regions react in a different way to such issues. Whatever happens, it could be a hard time for Volkswagen suppliers anyway. The normal reaction in this field is that the giant will ask their suppliers politely, but decisively to help and share (by lowering component prices) their problem. This is not good news for auto leather prices in general.
All the above strongly points to deflationary conditions, which would keep pressure on consumer prices and so on the price of materials, including leather. This problem has been tackled for years with low interest rates and more liquidity pumped into the markets, without too much fundamental success so far.
It might be wise to manage the market and business presently as much by sight than by anything else, watching tightly the daily changes until a real and clear new trend emerges, supported by the facts. We expect that more clarity is going to be offered in the next four to six weeks.
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