The Leather Pipeline - 17.05.16
17/05/2016
In the past two weeks the global economy hasn’t done any better. The Greek crisis is beginning to make the headlines again and we are starting out from where we finished about a year ago. Greece is not in the position to repay its debts because it has missed growth targets and has consequently seen no improvement in the labour market. Private investment is insufficient and the so-called experts are debating the reasons. Generally it is quite easy as it usually is: investors simply do not feel comfortable about the location for many unresolved reasons. Normally one would expect that with the situation in Turkey, Greece’s location within the EU and relatively cheap and easily accessible labour should make it the place to investment in manufacturing and build factories. Maybe the Greek government should ask itself why the country is still not being considered as an attractive location for investment.
In Europe the general political situation in many countries continues to be called fragile at best. The Austrian Chancellor has resigned, in France the government is not making any progress with desperately needed reforms, in Germany a large part of the population is not longer happy with Mrs Merkel’s policies and the UK is preparing to decide if it wants to stay in the EU or not.
In addition we have only a few months to go before the presidential elections in the United States which generally means that also on the other side of the Atlantic some kind of a political paralysis will continue until the new president is elected.
China has reported a figure of 6.7% growth for the first quarter of 2016 but nobody in the business community really trusts the number; most pundits strongly believe that the real growth figure is well below that number. Many people see a lot of risk in the debt situation in China and are still painting a very cautious picture about the second-largest economy in the world.
Most first-quarter results across global companies are coming in at round expectations. However, the number of companies reducing their forecasts for the full year is growing. Chief executives are becoming increasingly concerned about the general situation in the global economy and are beginning to prepare their investors and the public for annual results that might not meet budgets and expectations.
The oil price continues to move around the $45 mark, which is more than most recent forecasts predicted, but still much less than most producing countries would like. Only precious metals are seeing a good performance so far in the year and investors in gold or gold mines must be very happy with decent gains since beginning of the year.
The US dollar continues to trade in very narrow ranges and one has to be surprised by the stability of the euro, considering the situation in the euro zone.
Market Intelligence
The leather pipeline continues to be a fair reflection of the general global situation and continues to reflect the consequences of the past as we described extensively in the last issue of Market Intelligence (May 3).
We have not been able to trace any major changes in the situation over the past two weeks. Our expectation that the general situation would clear up and activity would rise in the past week was obviously wrong. Hides for the global industrial supply chains remain in decent demand. Large production units have to refill their inventories on a constant basis and with limited stocks held they have to come back to their suppliers on a regular basis. The supply side knows this very well and also knows which type of hides are the ones required for constant and reliable production.
This continues to apply, mostly for automotive and for big brands in shoes and bags. The situation has created the two-tier market we have been seeing for a long time already. This would be far less of an issue if the price spread between the two segments were not so great. A lot of the old school people responsible for sales are just shaking their heads that the technicians are not capable of developing acceptable products from lower-end material. Technical departments claim that changing raw materials means they cannot meet what is expected of them. This is true.
The biggest problem, however, is still the very disappointing performance of the Chinese tanning industry in general. There are plenty of theories around, including our own, over what the real problem is, but a definitive explanation hasn’t been found yet. There must have been serious planning errors in many tanneries and maybe even on finished product manufacturing. Market demand may have been hopelessly overestimated and this may have triggered serious problems in terms of stocks and cash flow. However, this is all speculation. Regular and reliable planning could never lead to the situation we are seeing presently. Something can go wrong at any company, but not with everybody at the same time.
Various regions in China are being blamed by raw material suppliers once again for not honouring their contracts. Of course there are plenty of excuses, but in the end it all comes back to the fact that nobody wants to lose money. This does not apply to everyone and to generalise would not be fair to those who are meeting their obligations. However, the situation could become a bit tricky in the future. After the problems many suppliers experienced in spring and summer 2015, which are building up again now, many suppliers are beginning to discuss protection measures. Last year there were a lot of discussions between associations and even at a political level, but without too much success. A number of suppliers are discussing the possibility of sanctions against those who have been failing to pay or are trying to renegotiate contracts; so far the only way to deal with this is either to run public blacklists or to ask for a significant deposit at the time of agreeing a deal. If a buyer has to pay a significant deposit within seven days of contract agreement things might get a little better in future, but it remains to be seen if the trade is strong enough and has enough discipline to implement a measure like this.
As far as business is considered we have seen another two weeks in which the core players of the industry have continued on the same course as before. One can say that the leather business in Europe is far more stable than in most parts of Asia, in particular in China. Anyone who can is increasing the level of business they are doing with European customers; there are no reported problems in the traditional European supply chains. However, for those type of hides that generally find their home in the Asian tanning industry it is much more difficult. Too much production, in particular of dairy cows, has left Europe and settled over the past 10 years in Asia. This can’t come back for various reasons and consequently the supply chain for these types of raw material is pretty congested at the moment.
For almost three months now the level of business for dairy cows and other standard hides has dropped significantly, probably by well over 50%. Tanneries seemed to be overstocking until Chinese New Year (in February) and are now desperately trying to liquidate leather stocks and to stretch their raw material inventory as much as they can. However, as a number of pundits have said already business never stops and never falls to zero. There might be over-capacity and there might be excessive inventories, but one day you either have to decide to shut your factory down or you have to make sure that your supply chain is not interrupted. This is to say nothing of the fact that several raw material types are 10% to 15% cheaper today than they were four months ago and there might even be a chance of getting them at an additional discount right now. The inventories may be stretched and the tanneries may even be in a position to feed production for another period of time from the stocks of various importers, but the day when decisions have to be taken for the second half of the year is definitely not too far away.
Let us assume that the usual suspects in Hebei province have gone into their May holiday with a two-month supply of raw material stock, plus another month’s on the way. Let us add one more month’s worth from the material in the hands of importers. This would mean that these tanners could stay out of the market for about four months at most, which would take them from the end of January until the end of May.
Of course this is just an assumption and may be totally wrong, but in the end we don’t think that this can be too far away from the truth and that just leaves the question of what plans they have in place to meet their needs when stocks run out and how much finance is available. They are all connected through the social media and activities are coordinated between several groups and import companies, with agents involved too, and most likely it will end up in the usual bonanza with the hope of beating the market, to buy cheaply enough to lay a positive economic basis for the next production season. What they are betting on is that enough material will have accumulated to allow them to replenish at comfortable price levels with a co-ordinated buying strategy and build enough inventory again. Let’s see how this works out. We should know by the end of June or the start of July at the latest if this theory is right.
Splits, with just a few exceptions, are suffering again from a lack of demand and consequently also from difficulties to sell them on at an adequate price. So, we are dealing again with two problems. One is the demand for splits and the second is the issue of tanners’ calculations. However, this applies mostly to lime splits, while it seems that the vast majority of wet blue splits are still selling at prices that are reasonably stable.
The skins market is in the same troublesome state as before. China, for so long the dominant consumer, remains almost absent from the market for nappa leathers. This, added to the almost standstill in Turkey, has not left too much market potential for sheep and lambskins at the moment. More and more skins are either being dumped or are moving straight to rendering. Only raw material of higher quality or for specific use can still be placed at reasonable price levels. With the upcoming summer season not many changes can be expected here.
It is very difficult to make a statement about the near term. For the hides that are the production base of industrial leather production it does not seem that any big changes can be expected. There is very little that seems able to move the market out of the balance that has prevailed for quite some time. This applies to European heavy males and to US premium steers.
For the rest everything or nothing could happen because sellers will not move. They know that raising prices will not scare anyone while reducing might make everybody want to wait even longer. So, it will all depend on the buyers and the timing of their return to the market.
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