The Leather Pipeline - 06.08.19
06/08/2019
Although we are at the beginning of the summer holiday season in the northern hemisphere of the globe, which is normally the time for the financial markets and politics to take a rest too, there was once again quite a bit of activity, which is touching the leather pipeline too.
The UK got a new prime minister and nobody really knows at this stage what this is going to mean with regard to the Brexit negotiations. The talk remains tough, but what is actually going to happen between now and the end of October, when the UK is set to leave the European Union, nobody really knows. The only thing that is clear is that the uncertainty is definitely no good for the European economy, particularly for the UK economy.
In Hong Kong the public protests continue and one will have to watch carefully how the government in Beijing handles the situation and how long its patience is going to last. There have also been public protests in Russia, where the government seems intent on handling the situation with an iron fist, arresting hundreds of mostly peaceful protesters.
Despite discussions at diplomatic levels, the tensions in the Persian Gulf are not easing. The oil price remains largely unchanged and is reacting far more to news about the economy, but at this stage it seems a day could be coming when the transport of oil could be seriously affected.
The global economy saw the opening of another round of interest rates cuts. The US Federal Reserve lowered interest rates and the European Central Bank published a clear intention to react to any kind of slowdown in the economy with another flood of liquidity.
The US economy slowed down to a growth of 2.1% in the second quarter of 2019, which is what triggered the Federal Reserve decision. There is a similar pattern in Europe, where the economy only grew by 0.8%. After the decline in China, one can definitely see that the global economy is going into a much slower gear. Whether or not more money is the solution is up for discussion.
Most likely the biggest slap in the face for the economy was the decision from Donald Trump to impose further tariffs on Chinese imports from September 1. The negotiations with the Chinese are not developing the way the US president would like to see and, in keeping with his usual reaction, further pressure is the answer. Knowing how sensitive the Chinese business people are, this will most likely slow business and investment decisions in China. This came just after a time when one had the impression that things were normalising a bit in China.
The oil price suffered and lost almost 6% in a day. Gold got a serious beating which was pretty much short lived and prices went quickly back to the levels we saw two weeks ago.
The currency markets remain quite unimpressed by the cut in US interest rates and the dollar has firmed up.
Market Intelligence
It is summer and traditionally the time when these reports are a little bit shorter. The industry normally takes a break, knowing that in the months of September and October it is high season again, attending trade fairs or just having appointments with regular customers, suppliers, designers, retailers or whatever.
The time between now and the end of October is traditionally the time of decisions and if anything fundamental in the leather pipeline is to be changed, it is now. This applies less to leather for automotive and upholstery, but much more to side leathers, for which fashion and seasons play a much bigger role. The opener for the time after the holidays is the All China Leather Exhibition in Shanghai (September 3-5), which is no longer very important for the international business, but for the local situation in China it can still offer some indications. Not that the Chinese tanners will know more at the end of August, but in a way they are more willing to take positions without orders so that, in particular for raw hide suppliers, the show is still the first indicator for the rest of the year.
We have started a review of the automotive industry and have tried to speak to as many people as possible to get an impression of what they expect for the rest of the year. The industry has fed the leather pipeline with misleading, if not deliberately wrong, information. We have to assume that this was actually for investors and the usual game of ‘think positive’ rather than any real analysis of the situation. Until the end of the first quarter, the automotive industry still wanted to make us believe that business in 2019 was going to be at least as strong as it was in 2018, with numbers picking up in the second half.
Now the tone has changed and the industry has become much more cautious about its predictions, blaming global conditions and Brexit for an expected descent in car sales in 2019. In particular the Chinese market is showing a slowdown and most manufacturers are predicting no big recovery soon. For the rest of the world it depends a little bit on models, but in general we have to consider a single-digit decline in manufacturing this year.
The biggest unknown today, at least for us, remains the question of leather penetration in vehicles. Sales is definitely one aspect and we have come to the conclusion that the amount of leather consumed is declining significantly as well. To make it simple: on average it seems that automotive leather production has declined somewhere in the region of 20%, while the decline in sales of the models that traditionally use leather have only declined by around 5%.
In the automotive industry you have traditionally very strong supply chain effects. From raw hide to tanning, from tanning to cutting, from cutting to sewing and from sewing to the finished interior it can take a long time and the material can travel a long distance. If the decision is taken that the product flow along the pipeline and the inventory should be reduced, the general effect is always more pronounced than the simple facts. The same applies when things begin to speed up again. It might still be very unclear what is going to happen in car sales, but we have not found a single player who was particularly pessimistic for the time after the summer break. Most people we spoke to were admitting that the indications and the budgets they have got from their OEM customers have been positive and they have to get ready for a better time after August. What ‘better’ actually means, we could not verify.
The big worry we have is the balance of selections and leather types. This might apply to the other sectors as well, but it seems that it is most pronounced in the automotive industry. The balance between the demand for better-quality leathers and commodity or corrected ones has been out for a while. More than ever before, this is a significant problem. We have large stocks of low grades around the globe and one cannot really believe that it’s acceptable to let those increase still further. The other side of the coin is that there is no option if the OEM is asking for delivery of better types. They have to be supplied and they have to be produced. Sounds easy for the outsider but this is a big problem for the insider. The availability of medium and better grades is low, probably below usual levels.
If the demand for better-quality selections picks up, it simply means that tanners will have to buy more suitable raw material to satisfy the orders they are likely to get. This would and could create a pull effect for special items only, quickly trigger expectations within the raw material community and at the same time intensify the problem for the lower grades. Not that there is any straightforward solution to this problem, but when have we ever had a simple solution to any problem along the leather pipeline? What can be said is that this will trigger very strong and new challenges for the industry.
For the other sectors we see a similar possible scenario. However, the volumes in furniture upholstery are not that large and for shoes there are plentiful alternatives so this is not a real threat to the business.
The US beef industry has been smart enough to invest some of its profits in the sale of by-product. They lowered their hide prices and kept them low for so long that they were able to gain market share and to attract sufficient interest to clear their backlog and production of better-quality hides. The traditional response to this is to raise prices. Nobody knows the extent to which sales of US hides are being driven by real orders for leather or if it was more a question of speculation and good hope. We all know how this game is played and both parties will play their cards in the coming weeks and in Shanghai.
Some concern may rise from the new tariffs that Mr Trump has announced for imports of Chinese products. Tariffs of 10% will apply on about $300 million of imports and a number of products made from leather are on the latest list. Generally, Chinese producers had been more relaxed about the trade war in the last couple of weeks and so the announcement at the end of last week came a shock. The relation between the two major economies is not getting any better.
The coming weeks will definitely show us how the leather industry is going to react. If we take the reaction to previous rounds of tariffs as an indicator, we have cause to be quite concerned. Yes, it is true that we still have the same number of consumers and a lot of production has already left China for lower-cost centres of production, but China remains the dominant manufacturer of consumer products for the world.
There are now several weeks to study and monitor the situation before everybody returns to regular business. We should know more by the time the trade gathers in Shanghai.
There is not much news in the split market where the same conditions apply as in the hide market. We still get positive news about the demand for standard suede articles and that gives us some optimism. However, apart from this we wait now for September to really understand the situation in the collagen and gelatine markets, which we believe will have a major impact on the split market for the rest of the year.
For skins the situation has not really changed. Every positive indicator is swept away quickly although like in the hide market we still trace a lot of interest for top-quality material. Whether it’s wool-on skins, high-quality lining, special nappa for various luxury or high-fashion products, all is in good shape and there is no talk of crisis.
The coming weeks will most likely be quiet. Politics will certainly dominate, because the situation in the Persian Gulf, the trade war between China and the United States and the progress of the Brexit negotiations will have a pretty large impact. Generally the global economy is slowing down and this is not the best situation for the leather business. At the same time it is also not the biggest problem, which we consider still to be the acceptance of leather among finished product manufacturers and retailers.
We think that the first step in a big breakthrough for leather will a technical one: leather must be seen to be as easy to incorporate into current shoe production set-ups as plastic is. This will help close the gap. Step two would be more successful consumer information. There is no reason to hype leather up, but there’s no reason to condemn it. We can only repeat that it’s not the consumer globally who is refraining from buying leather shoes, it is the retailer, the brand and the manufacturer who find it so much more attractive to make plastic shoes. They need a nudge to make them consider leather, at least for a part of their production.
There is no conflict between leather and non-leather. We just have to return to a normal co-existence between leather and other materials to allow us to use the by-product from the meat industry as it should be in a circular economy, which claims to be so conscious about nature and sustainability.
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