Market Intelligence - 08.09.20
Macroeconomics
Political tensions remain in place. As far as economics are concerned, the analysis of the corona crisis is slowly being evaluated. Many countries report contractions of between 8% and 15% of gross domestic product for the second quarter.
Governments continue to discuss how damage can be limited and what must be done to keep the economy afloat. Unless a successful vaccination becomes available, certain business sectors such as travel, entertainment or anything based on large gatherings of people may lose their customer-base.
Despite these negatives, there are plenty of positive signs too. Production and business activity in many countries continue to rise and several politicians and analysts still dare to forecast a ‘V’ recovery. What needs to be observed is how real these trends are. The biggest progress has been made in China, where the purchasing manager index rose back to levels above 50, generally considered to be proof of an expanding economy.
Global car sales in the month of July were only marginally lower year on year, but numbers for the various countries were once again relatively uneven. In some markets serious declines were recorded while others saw significant rises.
The strong rise of many commodities came to a halt and even precious metals experienced a setback. A similar trend was seen for oil, and stock market values also saw corrections.
In the currency market, the US dollar was a very weak performer and saw its lowest levels for several years. Against the euro, the dollar fell quickly to levels above $1.20 before rebounding a little to finish the period at the $1.18 level.
Market Intelligence
The sectors we have previously identified as dragging themselves positively forward from the crisis, automotive and furniture, performed pretty well over the past 14 days. In the raw material market, quality and extra-heavy hides had the best performance. Those parts of the industry that are in need of these materials have been readily purchasing and absorbing a growing part of the overall production of those hides.
This activity has triggered the usual standard reflex among sellers of raw material or, more accurately, the meat industry. The increased interest and better volumes came at the right time to stimulate ambition among by-product sellers in the beef industry across Europe. Sharp increases and high prices were asked and triggered the usual cocktail of fear and annoyance in the tanning industry. Some processors and traders tried to join the party; perhaps they saw a possibility of achieving a successful outcome for the inventory many of them still carry.
We have seen in the past that industry players sometimes depart for the summer holiday period with certain ideas and expectations that frequently lead to disappointment in the month of September when, traditionally, all the necessary information about leather demand for the winter half is still not available. Many of the serious discussions about budgets, volumes and prices along the pipeline have only just started. This applies in particular to the upholstery sector. For shoes the month of September is not really game-changer. Only automotive is in a position to deliver clear production indications: factories reopen at the end of August, there is a ramp-up in production of new models and a regular run for current models. And in 2020, the backlog in orders created by lockdown guarantees a high level of vehicle manufacturing for the months to come.
This is definitely the best of all news in the leather business. However, it does not mean rising demand and a jump in prices across the board. There is much more to watch and monitor and the traditional quick action and ‘we want it now’ mentality of the beef industry doesn’t fit well into these circumstances. The trend is positive, but not yet completely stable. The production lines at the car factories are still facing the risk of renewed interruptions. The world is returning to normal but a number of supply chains are not yet completely stable. A sudden new outbreak of covid-19 can put everything on hold again quickly.
There is no question that automotive leather producers can afford higher raw material price levels, but they need production to be stable and run smoothly. Costs have increased and a rise in revenue for lime splits has come to an end. Price increases leather producers were able to secure before the summer holidays are being erased again now.
The logic of the raw material suppliers now is that if customers can pay, they should pay. This might be fair if the normal supply-demand balance were in place again. However, the high volume of existing stocks sitting in storage creates a different market situation. Tanners are aware that there are still hides looking for a home. Consequently, they see no real need to bow to excessive asking prices. Sellers, on the other hand, are hoping that they can recoup some of their losses by raising prices and, thereby, putting a higher value on their stocks. Both are right. That is why the situation needs sensitive handling.
Several of the big tanneries we have spoken to are willing to consider a revaluation of the raw material prices, but not in one big jump. They are ready to accept moderate price increases, of 5% to 7% from the low levels of the summer, and to consider further moderate adjustments in the months to come on the condition that orders from the automotive industry continue to be stable or improve.
Rising slaughter numbers as more we move into the last quarter of the year will play a part here. The tanning capacity for automotive hides has a natural limit, determined by the number of drums that can take the hides that leave the slaughterhouses. The sharp rise in the kill that we usually see in the last six weeks of the year means a surplus of fresh hides anyway. If we agree that it is unlikely that automotive leather production will return any time soon to the record levels of previous years, it is even more advisable to take a sensible access to pricing for the rest of the year.
Everyone is aware that moderately higher raw material prices are not only necessary, but also desirable. At the moment, the tanners with the necessary cash resources, courage and a clear vision for their leather business in the coming months can continue to buy at the top of the quality range. At the price for which quality hides can be purchased at the moment, there’s little need to look at cheaper hides.
From everyone we have spoken to, we have learned that business in China has been improving in the past two weeks. Chinese tanners realise that the time for bottom-fishing has passed. However, as usual they have been very tough in price discussions too. On average a few dollars were added to the lowest price levels of the summer but, with currency and freight costs, any real improvement remains limited: somewhere between 5% and 10% is the best one can hope for. Also the Chinese are buying from the top of the quality range and buy the best quality and heavy US hides they can get for their money.
Upholstery tanners obviously hacve positive expectations about demand too, and there is also a logical desire for them to buy at the better end of the raw material market. People who see the glass as half full see this as a trigger for a general recovery of business and prices but it could be simply seasonal because these tanners had to come back into the market and so did their customers.
Having talked about the positive recovery, we have no choice but to have a look at the negatives too.
Nobody has definitive figures for how global leather production is divided between the different sectors at the moment. However, even with the decline caused by the fashion for sneakers and other shoes made from plastic, it must be fair to estimate side leather production at between 40% to 50% of the entire industry production. The shoe leather business is not really seeing much of a recovery. The pre-corona situation is still in place. Nothing has changed except that demand for formal shoes has been substantially down in the last six months.
No matter how optimistic the luxury leathergoods manufacturers may be, they have taken a fair beating too and a recovery to normal volumes will take some time. With a simple calculation that 50% of leather production is on the way back to normal levels (without having yet reached those normal levels), 50% continues to underperform; it would be naïve to believe that any real substantial and sustainable recovery is under way. We can only hope and take as much positivity as possible from the seasonal cyclical rise in production and demand. At the same time, everything possible has to be done to stimulate demand for leather as a material in the long run. There is no change to the fundamental problems we were facing in February.
The focus of the above is mostly on the European situation. However, globally it’s no different. Demand recovery reached the Americas a bit earlier because their main market is Asia. With longer lead-times, Asian tanners had to react four or six weeks earlier. Prices in the US advanced a couple of weeks ago. The kill in Australia, for various reasons, is underperforming and in South America there is still a lot of stock and the same buying pattern as everywhere else. With cheap prices, you buy the best and for the rest no solution has yet been discovered.
The split market, which was being driven by the collagen and gelatine market, is returning to troubled times again. Wet blue splits at a certain price still have some market potential. Lime splits are reported to be under serious pressure in China and now also in Europe. The rise in leather production means an increase in available splits. The stocks that the collagen and gelatine industry built up during production lockdown has created a new balance that is not in favour of the raw material. This will be the situation for some time.
The skins market is still going through the same catastrophe as it has been for a long time. The recovery in garment leather demand had been stopped by the corona crisis, but at the same time the supply of skins has not stopped. The Eid al-Adha festival in Muslim countries in late July and early August boosted the offer of raw materials and many skins found no buyer. For the majority of skins there is no real price level. On a global level the number of skins going into landfill has been rising once again and without a miracle these are the market conditions that will apply for some time to come.
In the coming weeks we expect that the market situation will cool down again. For the tanners that can realistically expect leather orders for the winter season, raw material price levels are still comfortable. We all agree that we need a further increase in leather demand but we all have to understand that this cannot be achieved with an exaggerated and fast rise in raw material costs. This would prevent hides and skins from moving through the leather pipeline and would make it difficult for leather users, designers, brands and retailers to consider using more leather in their product ranges.
Let’s hope that all the players handle the situation with care and at least understand that a careful step-by-step analysis might be the most healthy way to support a general recovery.
