Macroeconomics

There has been nothing more important than the terrorist attacks in Paris last Friday. Anyone who needed more proof for the disgusting and cynical positions of the IS fanatics got it. Let’s stand together.

The global financial markets have not digested the situation. A lot depends on the decisions about interest rates.
In the US, everyone is expecting tightening policies and rising interest rates, possibly as soon as December, but the Europeans are expecting the opposite: more easing and injections of further liquidity. In US, the labour market is showing strength and the economy seems to be on a relatively stable growth path.

China remains the wild card and the future remains unclear. Looking at the stock and commodity markets one has to assume that there are more concerns than hopes, with several of the core commodities such as copper and oil falling. This is not a particularly good sign considering that China is one of the biggest consumers of industrial raw materials.

Almost every day the so-called experts and analysts are beating each other with pros and cons. The retail sales for [Chinese online shopping event] ‘Singles Day’ are reported to have reached a record – $14 billion with Alibaba alone – and some consider this to be proof of a recovery while others do not believe the published figures.

In Europe, the refugee problem is ongoing. They are still arriving in big numbers and countries have begun to install border controls. Since many are not registered is it is difficult to judge the impact on the economy, as well as the social tensions, that might threaten stability in some EU member states.
In Portugal, a new government has been installed and many are worried the economy might suffer. Greece is now paralysed by strikes and the government is sitting on the other side of the table trying to handle the situation. Financial aid from the European Union has been frozen because the country has not fulfilled a number of the reform requests.

Commodities are falling again with oil looking at the $40 mark and gold not being far away from $1,000. The US dollar got stronger or the euro weaker, depending on your perspective. Expectations of the widening spread between interest rates has sent the euro down a few cents, trading now in the range around $1.07 versus the euro.

Market intelligence

With only four weeks before the Christmas break, business in most parts of the world will slow. This means many players along the leather pipeline are beginning to plan for their year end.

Looking over 2015, it is obvious we are not going to have an employee-friendly holiday season and many tanneries will have the option to work four days, taking two long weekends, and will begin 2016 without having had the much-appreciated break.
Some many tanneries will close for the full two weeks, with others saying they are closing for one week and several just taking the long weekends. It is a difficult decision because shutting a business for two weeks is expensive. The work force have to take a number of their legal holidays in winter because they can’t use them at any other time of the year, so there have been internal discussions between employers and employees on how to deal with the situation.

After the landslide of most raw material prices since spring, the downward dynamic has been fading and with the start of the winter production season, activity has increased and the market conditions continue to normalise. However, this not the case in every sector.
The balance between supply and demand has become better and some materials - in particular the medium and better-quality range – have seen a shift as producers have been able to move more raw material into the hands of tanners.

The strong suppliers have taken a much firmer position and the some are trying to call the market firm. Expressions such as ‘firmer’ or ‘weaker’ mean nothing; it is a description of how somebody feels and what he intends to do next. It does not mean a market turnaround is under way. When we stick to the fundamentals, little has changed and replenishment over the past two to three weeks should be seen as part of the cycle.

There is no question that the production of leather has dropped, but it has not collapsed. Tanneries that stopping being profitable, particularly servicing the lower end and in China, are closing.

For the rest of the market, leather demand may have contracted from 105% of normal demand to 95%, but it has not declined to 80%. 100% is considered the perfect balance between supply and demand. The price adjustments that had to be made to raw materials were only necessary because the split credit dropped sharply and prices needed to be adjusted return tanners to profitability. For most of the high quality products, this seems to have been achieved. The balance between supply and demand seems to be intact, or not far away.

But as usual this is only one part of the story, and it does not tell us anything about the future. Leather buyers are concerned about by the volatility of leather demand and the unclear position of brands and retailers in regard to the coming season.

Leather buyers are asking for substantial discounts on finished leather prices, which they relate to the drop in the raw material markets they have been seeing for a while. This is not a fair position, because there is no reason for a parallel reduction of leather prices in relation to raw material prices when tanneries have been producing with negative margins for some time. We are still seeing a massive surplus of medium and low grade raw materials and more than abundant supply. Warehouses are full and this means not only sellers and producers but also many tanneries, in particular in Asia, continue to report large stocks and no demand in sight. In our opinion, this surplus will keep leather prices under control and it would not be very wise to try to widen the spreads between the different quality levels.

This is the strategy that sometimes dominates the market. The seller, happy that he has been able to sell successfully, tests the market with higher prices. The buyer who has been buying at reasonably attractive prices and disposing of a decent amount also finds it attractive when raw material prices rise because this makes his negotiations with his leather buyer easier. Different reasons but similar intentions. The problem is that it is very difficult to keep such movements under control: the seller wants to move prices constantly higher but the buyer only wants a temporary support.

Considering that we are now in mid-November when production is normally in full swing, we still find the situation in the shoe and bag sectors, as well as upholstery, not fully convincing.

Demand for automotive leather and the production of cars remains high. However, a lot of the growth and stability in automotive leather will not move the industry away from asking for price reductions for the leather for new models. They are aware of the raw material prices and no matter if the prices are fixed on indexes or by free negotiations the material cost of alternatives and the purchasing power of the industry will leave also deep tracks in the volume leather prices.

Prices will always fluctuate and it would be unrealistic to believe that the markets are a one-way road. There are very good arguments not to get overly optimistic about the potential for raw material and leather prices for the near future or possibly for the whole of 2016. The demand for leather and the material valuation is not justifying any short term improvement at this stage.

The split market remains in bad shape. We are hearing about some isolated trades but some prices are a third of a year ago and even at that price, demand is not getting any better. We believe there are far more splits leaving the splitting machine than are sold. It is difficult to say how far this congestion can go and the prices should now be so attractive that splits should become an option for a number of leather products again. The beginning of the next winter season production, sometime in January/February 2016, will tell us if large shoe manufacturers have realised the situation and are willing to use split leather again. Price can definitely not be the prohibitive factor any more. We think the future of split prices and their use in leather production will be an important factor for the entire market environment.

There is a similar situation with ovine skins. High-end products such as top-class double face, nappa and lining skins are doing pretty well, but the majority of skins can be bought so cheaply that it is a miracle apparel and shoe manufacturers have not made more use of such a quality raw material. There has been a bit of activity in China, which is not really a surprise. Many tanners in China like to take skins in winter in particular from Europe, because they are bigger and carry a bit more wool. However, a real trigger hasn’t been seen yet and the next three months will be very important in terms of whether the big brands and retailers around the globe have the courage to promote lamb, sheep and goat leather again. The risk would be pretty limited.

The coming weeks could become a bit of a wrestling match. There might be some buyers who are afraid they have missed the boat and could pay bit more money for the materials. However, the question is always not how much you get but for how many. We have come to the conclusion that the tanners who have confidence in orders have covered most of their needs for the foreseeable future.
In Europe the situation might be a bit different, because tanners have generally been buying hand to mouth. The production cuts this year due to the holiday season might not be as intense as they have been in the years before, but the level of production is already remarkably lower than in the past.

The holiday break will be felt from beginning of December and in the US and Australia it might be a little later if we look at the shipping schedules. Tanners will go into their holidays with a reasonable inventory, but nothing extraordinary. If the tanners are performing according to what they usually do, one should not be surprised to see them out of the market until the week before Christmas, when they might try to take advantage of the Christmas break in Europe and in the States to test if they can buy at attractive levels for their productions in March and April.

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