Macroeconomics

It is time to welcome our readers back and to wish them a very happy, healthy and prosperous New Year with favourable and successful handling of the challenges the leather pipeline brings.

In terms of politics, the reported nuclear weapon test in North Korea and the execution of Shia cleric Sheikh Nimr al-Nimr in Saudi Arabia have increased the underlying tensions across the Gulf.

The oil price has now reached around $30 per barrel. The tensions in Syria, Isis and the increasing instability in Afghanistan have done little to stabilise the oil price – an indication of how big the surplus must be.

For the rest of the world, the low energy prices have been more of an economic stimulus than the zero-interest policy. It is creating a lot of disposable income and this is having far more influence on consumer spending than low interest rates.

The stock market collapse in China in the first week of the year has not generated positive expectations for the Chinese economy. All indices have been negative and people are questioning the official growth statistics.

Chinese manufacturers have become less competitive on many products and not even the moderate decline of the yuan could stimulate export demand. The situation in China dragged other stock markets and commodity prices further down.

The only positive news came from the US, which published promising data on its labour market. Income is rising and unemployment is low.

Europe is a mixed bag and headlines are still dominated by the unity of the European Community, which has been shook by disagreements over refugee policies, elections in Poland, the position of Hungary and the growing risk that England might leave the EU. The EU is reporting the worst performance and stability in its history.


Market Intelligence

It is surprising how many Asians took a break over the Christmas period. There was very little activity during the holidays, which is not strange, but in years when leather demand is strong Asian tanners use the period to see if they can find raw material bargains.

A good number of the players returned last Monday and sellers were trying to shift a bit of the positive mode into the first week of the year. This worked until Tuesday when the Chinese stock market began to make the headlines and people began to consider how it would affect their business.

With most of the European tanneries being well covered for raw material for January, there was not much activity.

It might be prudent to assess whether anything has changed from our last issue before Christmas. Over the past 10 days a lot has happened which is not positive for leather demand. Most people we speak with are not very supportive of business or keen to take decisions. With the general fundamentals not having changed this means rapidly declining demand for leather in shoe and bag manufacturing, with a steady outlook from the car industry and there has just been the seasonal uptick in tanning for the upholstery sector, mainly in the North of China. There is little evidence of an increase in demand for leather and related raw materials in the near future.

There are two main reasons why we believe it is not advisable to be positive about the leather market. Number one is the rapidly sliding demand for leather as a material in the shoe industry. The main players in the south of China are reporting small order books and no indication that their customers are going to increase their leather orders any time soon. The big players closed for more than the usual two weeks during the Chinese holidays for their new year festival. Even high-end trainers are not made from leather anymore and people are still willing to pay hundreds of dollars for them.

Although not directly related, we find strong parallels garment leather. Skin prices have been low for a long time, and although leather as a material in the garment industry has a totally different position one would expect the prices to have stimulated demand. The problems between Turkey and Russia can only be considered as a limited excuse. There is plenty of leather-look clothing in women’s fashion, however they are rarely made from genuine leather. The shoe industry is in the same situation – the consumers do not seem to care if it’s real or artificial.

The falling oil price allows leather substitutes to be offered at very competitive prices. We all know the big brands and retailers will not miss the opportunity of an expanded margin and as long as the consumer does not reject the product there is no reason to shift back to leather. This means that independent of the number of shoes sold, the consumption of leather will probably continue to decline.

It would be naive to believe that after the record years of car production the growth can be sustained. We have to expect that car manufacturers will play the price card soon. A number of well-informed pundits are pointing out that car manufacturers will put a lot of price pressure on suppliers. Under the assumption that a number of tanneries will try to shift from shoe leather into automotive leather we would not be surprised if competition for business becomes much more intense in the years to come.

The sharply rising production cost for leather in China due to rising wages and the increasing control from the government about environmental issues is also taking away from what is left to be spend on raw material.

Consequently we believe that with the exception of the usual niches, prices will fundamentally remain under pressure. Inflation does not seem to be a factor in the next six months or so.

We are now at the beginning of January and heading for the break in Asia when most of the factories close for February. The only exception is the automotive sector as new car models will keep demand steady.

We hope that the positive labour market in the US will keep Americans shopping. Whether they are going to spend on leather products is the only question we need to consider.

We continue to be worried about the financial stability of many operators. Many businesses lost a lot of money over the past year may not be able to finance their business this year. Many quietly closed their facilities last year because they could not make a positive return.

The clampdown on pollution by the Chinese government has had a serious effect. Although tanneries are not responsible for the smog in Northern China they are a popular target. They don’t have a big lobby either. It would not be the first time that the leather industry was moved for production cost issues and environmental restrictions. What worries us in this case is that we fail to see where the producers plan to go. In the past it was obvious when one region became too expensive, they relocated to another. This time, most of them are closing but not reopening elsewhere. One would have expected other regions to grow at the same speed, but there is so far no real rising production in other countries such as India and Pakistan.

Saying this, leather will continue to be produced and used, we just have to find a balance again.

On the raw material side we are always dealing with short term fluctuations. Speculation, quick changes in supply, currency influences and financial issues are making the markets volatile. This means long term trends never move in just one direction. Bounces and declines are just part of this business, but as our regular readers know this is not what we focus on. We try to collect as many facts as we can to draw our conclusions for the longer trend.

We would have preferred to begin 2016 with different fundamentals to a year ago. The only factor that is different is that prices are a good 20% to 40% lower than a year ago and this has taken some of the risk away.

SPILTS AND SKINS

There is no improvement in the split market. There has been a bit of activity and some people are even reporting a few more orders for finished split leather, however, production is low and there is still a large amount of material waiting for buyers. Since the split credits play an important role in tanners’ calculations we would also like to see more demand to allow tanneries to improve their cash flow.

The skin market is as bad as it has been for a long time. The high-quality end and shoe lining business is faring somewhat better but it looks like tensions between Russia and Turkey have become the final shot in the arm. Those of us hoping that China would grab the business opportunities as a consequence have been disappointed.

A number of Chinese tanners had been travelling in Europe before Christmas and they like the winter skins which carry more wool, but so far no bulk orders have come in. It is becoming too late, because February will be a no-go when the weather gets warmer, making shipments more risky.

We are aware that we are starting 2016 on a depressing note. ‘Think positive’ might be a good strategy sometimes, but in the leather pipeline it has always been better to be prepared for the problems. If you are not prepared, this business has little mercy. We hope that the leather pipeline finds the technologies and can change public perception so the beauty, sustainability and comfort of leather is back the focus. The consumer is always ready for a good story and if leather has one it will be find strong demand. Celebrities can be paid to promote leather sneakers the same way they promote non-leather versions – if only someone would take that chance.

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