The Leather Pipeline - 30.5.17
30/05/2017
Over the past two weeks there has been much more activity with social as well as economic impact on a global scale. Unfortunately, one of the most poignant was another terrorist attack, this time in Manchester, UK, where more than 20 people lost their lives at the hands of a suicide bomber. The ‘free world’ again vowed not to let this minority destroy the values of liberty, tolerance, respect and freedom. It will be interesting to see whether the event has any influence on the UK elections in two weeks’ time.
US President Trump was on his first foreign trip, which took him to the Middle East and Europe, including the G7 summit in Sicily. Observers commented he did not seem interested in uniting with the other leaders and it is difficult for his partners in Europe and Japan to understand what his intentions are. He gave the impression that he doesn’t consider global free trade to be beneficial to the US. Some have said he has shown sympathy to autocrats yet hostility to his Western political partners. At home he is facing rising pressure with regards to his involvement with Russia prior to the presidential elections. This could easily destabilise the political environment in the US. While the West can’t agree on common strategies, China continues to expand its global position.
The European economy saw better results following recent elections, and looks stronger than it has for months. The dollar has fallen almost 7% against the euro over the past two months.
Credit rating agency Moody’s downgraded China in view of the rising credit risk. China’s economic status is unclear. Is there a real estate bubble? A credit risk in state-owned companies? Has the transition from a cheap labour and production society to a consumer and service-based economy been successful? There are many questions that need answers.
Oil prices have been bouncing. They rose in expectation of production cuts by the Organisation of the Petroleum Exporting Countries (OPEC) and fell sharply after the announcement, the market having little faith in OPEC’s ability to control supply. Oil remains about $50 a barrel.
Market Intelligence
The past two weeks were more interesting than preceding weeks. In Brazil, meatpacker and tannery owner JBS was named in a scandal concerning payments and bribes, which has also impacted the country’s president.
The financial markets were rattled and the consequences are unclear. Some investors have said they will stay away from JBS shares until the situation is clarified.
Many of the bigger companies that do business with JBS have codes of conduct preventing them from working with companies that are not complying with the rules. JBS is the world’s largest meatpacker and could face major problems with suppliers and customers. It could mean that companies suspend trading with them while the case remains unsolved.
Some have speculated that if JBS has to pay large fines it is inevitable that assets will need to be sold. The question is now how long the case will be investigated for and how deep investigators will delve.
It would not be a surprise if this affects the leather division of JBS. Its hides, wet blue and leather are sold to some of the biggest brands and retailers in the world. If any suspend relations it could have a big impact on the market. The company will make headlines in the coming weeks and everyone would be advised to follow the story.
In terms of the general leather pipeline, the trends that emerged at the end of March have become more pronounced. The gap between production in China and the rest of the world is widening. The situation in the Chinese market is becoming increasingly difficult and, as the biggest market and producer in the world, this has major consequences for the raw material pipeline.
For some time now we have seen the opposite of the trend in many of the other big tanning centres. Low production costs support leather manufacturing and leather production. This is attracting investors and production capacities are rising faster than finished product demand. In China, this was originally driven by the seemingly endless consumer demand and new tanning drums were installed, creating increased need for raw material, but this was never really compensated by the equivalent demand for leather.
A slowdown of leather demand, coupled with rising production costs and tightening environmental controls, has meant the trend has reversed. The industry is in the process of restructuring and the bigger producers are still doing well, but smaller players, many of whom had only rented premises, continue to close.
This is reflected in the declining demand for raw material from China. For those still in business, margins have become increasingly tight. This means they are trying to solve the problems by trying to buy material as cheaply as possible. This has created the situation in which the prices that Chinese customers are willing to pay are well below the market levels in other parts of the world. Many Chinese customers are surprised that the purchasing power they used to have has diminished. Of course, the Chinese tanning industry is still the biggest in the world and without sales in that market the majority of raw material sellers would not be able to clear production. However, smart sellers reduced their dependency on China a while ago. One has only to study the export numbers from the US and the changes in the volume to various destinations for evidence of this.
Those that have not built an alternative customer base are now struggling, and are becoming victims of the markets.
The US suppliers have been the smart sellers and are gaining market share by adjusting the raw material prices early to attract buyers in need of a regular supply. The American sellers also gained from the exchange rates, as the lower US dollar made American hides and skins more competitive. Alternative markets have been expanded and over the winter the pipeline has become more balanced. The question is who will become the losers in this game.
Wherever European hides have to compete with other origins they are far too expensive. The beef industry in Europe as well as several suppliers have not allowed prices to adjust far and this means the gap is now extremely wide. This might be justified for the high quality automotive hides but it is difficult to explain for dairy cows and heifers, and they are not willing to compensate for the currency changes. It seems one day a sharp correction will take place; this is not usually a good option for market participants.
Those in Europe hoping for a recovery should also be aware that a lot of hides are covered by the big sales of the US suppliers. Some European hides were bought to cover short-term demand. These hides will also build a bit of inventory, in particular in the Italian tanning industry.
In terms of the automotive industry, one has to conclude that car sales have peaked and could enter a slower phase of growth or possibly even a correction. In the US, banks have begun to reduce loans because of higher rates of default and in Europe the discussion about the future of diesel cars is making people wait to buy new vehicles. China is still a strong performer, but even on the mainland, sales don’t match expectations. However, luxury accessories seem to be performing well.
The raw material origins have drifted apart in their prices and valuations. Considering the general position of leather as material, a turnaround cannot be expected in coming months. A real market balance can only be achieved with the Chinese market, which does not seem willing to let the prices of the more attractive sources rise to close the gap. With the summer break looming, it is unlikely that the European, Korean, Thai and Mexican markets can created sufficient demand on their own to hold prices and push some markets higher again.
SPLITS AND SKINS
The split market continues to be the same, with only certain quality splits stable. Even gelatine is hard to sell.
The skin market has been reasonable, with a bit of interest for quality double face. The market is picking up for goat but we are still talking about low levels and prices. Nappa skins remain in the doldrums and with the summer ahead it is unlikely they will see much of an improvement. This is also related to the weak performance of coarse wool in the market.
We wait with great interest to see how the market is going to perform in the weeks to come. The Chinese buyers are getting close to the time when they will have to decide if the raw material will arrive for the start of the new production season. In a perfect world, they might have about three to four weeks left. Letters of credit openings until mid-July would still make the hides arrive in time.
Leather demand for the next season is not expected to be positive in China and raw material suppliers could face another period of underperforming sales, which would make those who kept their positions in balance in the past months look pretty smart. In the meantime, let’s hope the market niches where leather is still an appreciated part of the finished product will continue their strong performance and that this will eventually influence the mass markets once again.