The Leather Pipeline - 29.05.18
29/05/2018
The past two weeks were once again not very exciting in terms of politics and the economy. Politics made more headlines than the financial markets.
We considers the main events of the past fortnight to be the continuing of the zigzag course US President Donald Trump is taking in his foreign policies, and the setting up of a new Italian government. The third main topic in politics is the rising military presence of China in the South China Sea and around the Indian subcontinent. Considering the megaprojects like the new Silk Road, China’s presence in geopolitics and territories continues to rise.
Most international analysts fail to understand the reasoning behind President Trump’s decisions at the moment. He cancelled the meeting with North Korean leader Kim Jong-un, which was expected with great hopes by the international community. A day after his decision he indicated once again that there might still be an option for this summit on June 12 in Singapore.
Italy almost got a new government and the make-up of the new coalition sent the Euro tumbling on the international currency market. Another government in Europe run by nationalist and populist figures could become a great threat to the EU community and in particular to the common currency. The new government had asked for a write off of €250 billion of foreign debts, which has not done any good for confidence in the European currency.
Looking at the promises the government is making to the Italian people and what they will cost, re-payment is unlikely and Italy would become a high risk for the Euro due to the size of its economy. The consequences of problems or failure would be much bigger than the ones of Greece and would make the final collapse of the community even more likely.
On Sunday night, the formation of this government was stopped by Italian President Sergio Mattarella, which gave some hope to pro-Europeans. The future is now open and a new election could deepen problems if anti-EU parties gain, as polls are suggesting.
China’s growing hegemony in the South China is starting to worry several of its neighbours. China has claimed islands also considered the property of a number of nations and is establishing military bases there.
The oil price continued to rise, reaching levels of above US$80 per barrel. Towards the end of the period we saw a correction in prices again because several oil producing countries were said to be willing to increase production to ease market tensions. Various think tanks were ready to indicate the potential negative effects on the global economy if oil prices continue their price rise. With the global economy already looking a bit more vulnerable, a decline in global growth would definitely not be in the interest of anyone at the moment.
Most other commodities continued to walk along with the development in the currency market. In general, this means the more the US dollar rises, the more the price of commodities suffers. For the leather pipeline, the falling value of the Turkish lira should also be mentioned and monitored. Companies which are solidly financed should take advantage because production costs in Turkey are set to become significantly more competitive. The next important step in the currency trends will be the elections held in Turkey at the end of June.
Stock markets are generally sidestepping as they have been doing for some time.
Market Intelligence
The leather pipeline continues to suffer and benefit at the same time from the unchanged situation. For those who are successful in the production and marketing of leather the situation has got its usual problems and concerns. In general, it is fair to say that everyone involved in the successful segment of the leather industry continues to enjoy regular and steady business. We are heading towards summer, the low season, and we have the same annual issues regarding raw material supply and finished leather orders. This is not significantly different to what this group are used to every year.
For the others, who are mainly located in the commodity leather business, the situation remains ugly. Leather demand is insufficient, leather prices continue to tumble, split returns are poor and selling the very low-end of the selection ranges is nearly impossible. The cyclical nature of the leather business means such things can happen, but the main problem at the moment is that many people have started to lose confidence and a growing number are starting to talk about at least a possibility of a market collapse in the medium and lower quality section.
Our regular readers know that we have been discussing this situation for quite a long time; nobody can claim the current situation is unexpected or unforeseen. Nevertheless, being aware of the problems at an earlier stage may not have changed anything. It is unclear if early acceptance of the conditions would have offered the opportunity to change the situation.
As pessimistic as we have been, we must now deal with the situation as it is. In the past, the majority of market players were unwilling to share our concerns. Today, the situation has changed and lots of people are beginning to wonder if we are entering a period where all the raw materials being produced can no longer be absorbed by the leather pipeline.
Several reports suggest that raw material prices are at their lowest levels since the financial crisis in 2008. This comes at a time when the global economy and global consumption have been constantly expanding. The global financial institutions are sending messages that the global economy might not remain in such a positive trend in the coming years, so one has to be worried about the leather pipeline too. Considering the current political risks, the concerns are even bigger.
The question is if the industry should accept and prepare for the worst, or if there are realistic scenarios that could lead us out of the present doldrums. We need to increase leather consumption and we need to inspire the consumer to show more interest in products made from leather. Although this has become more difficult because the consumer no longer seems to care about which materials are used, we don’t believe the battle is completely lost. The good news is that with almost eight billion potential consumers around the globe we only really need a small evolution in spending to change the situation.
Footwear opportunity
Most will agree that the main segment of concern is the shoe industry. Consumption in this market has the biggest effect on demand and so it would require a return of consumer interest in buying leather shoes. We may have given the impression that we have given up on making leather attractive enough again, but that it definitely not the case.
The rapid decline of raw material prices and the rising price of oil has made leather more competitive again. It may not be fully competitive when one factors in the production costs, lead times and supply chain rules, but the crash of the leather market in China might be the start of a new period. The endless and cheap production capacities in China made the leather pipeline lazy. It began to rely on the cheap and volume production in China and the unlimited potential for consumption. This has definitely come to an end, and not for the first time in history.
It is true that China’s capacity cannot be simply relocated to another country, but there is an opportunity for the production which has been concentrated in China to spread into different parts of the world. It is worth mentioning that leather production capacities are expanding in parts of Africa. We also see that production is growing in Russia and in other countries from the former Eastern Bloc. Some are producing for large consumer markets over there, while others are making use of cheaper production costs and shorter delivery times to serve markets in Western Europe.
Discussing the situation with people familiar with the leather industry in these countries, it seems they are surprised by how solid and sustained investment in production expansion has been in recent years. This is all a bit hidden because they are mainly isolated tanneries and shoes factories which are being built or expanded. When one asks those in charge why they are making these decisions and investing money, the reply is almost the same everywhere: they see a strong growth in sales of leather shoes in their regions; the aggregate cost of leather production and shoe manufacturing is more competitive than China; they are closer to important markets in Western Europe; and they have a better understanding of the fashion tastes of consumers.
When we mention the global domination of the athletic and casual footwear brands which only use plastics for production, the reply is also pretty uniform; yes, this is true for quick fashion and it may continue, but they also claim to see a strong interest for more formal leather shoes in their part of the world. They believe that with lower costs and higher flexibility, there is good market potential there.
We know that this argument cannot be generalised and might just be the consequence of local conditions. It is true that the big global brands and retailers may not allow this trend to reach Western European consumer markets, but in the end it will be the consumer who decides.
We believe fashion is cyclical and there has been a long trend of athletic and casual footwear made from plastic. Why shouldn’t we believe that a move back towards creative design, higher quality and sustainability is on its way? Considering the price trend of sneakers and their almost unchanged design for a number of years, there are great opportunities for something new. The leather industry, together with its customers, is strongly asked not to miss the train before it leaves the station. Without doubt, the next trend must be leather, but we believe it is in pole position to take this opportunity.
Splits and skins
The trouble also continue in the split market. There remains an abundant supply of splits but insufficient demand to clean them all up. The decision of many tanneries to switch from wet blue split into lime splitting in the hope of finding more and better markets has not been very successful. In the leather industry there are still the same specific items which require specialty splits. As in the hide market, materials with specific demand continue to have a ready market.
The situation in the skins market is slightly better than it was a few months ago. The problem is that several of the larger suppliers in Europe have made the same mistakes again. Following good interest and enquiries for new season lambs, many have been too optimistic about the price they can ask for raw material. They have set prices far too high at the beginning of the season and have scared off potential buyers from China and Turkey. We have spoken with suppliers who have set moderate prices, at the high end of the range from last year, and they all confirmed they are happy with sales to regular and reliable customers.
The new season production in Europe is in full swing and we will have to wait and see if this market can find a balance. In the case of Turkey, the slump in value of the Turkish Lira will make those producers with sufficient resources of US Dollars and Euros significantly more competitive due to falling production costs.
On the fence
It is unlikely there will be any fundamental change in the next two weeks. We understand that many suppliers have decided to refrain from offers to China. There is general frustration that there is no serious interest to discuss or any kind of realistic price levels. There are some sales, but a real market balance has not been established for many origins.
The volume buyers in China are still sitting on the fence is and nobody knows what they really have in mind. They may push the raw material prices even lower, but this has nothing to do with the leather market and demand. Even if they can buy hides at 10% or 20% lower than asking prices, this will not put any additional leather orders into the books at this time of year. Raw material sales are irrelevant if it is not backed up by physical leather demand.
Under normal market cycles we should expect another four to six weeks of low activity. If there is any significant volume of leather business ahead, decisions will have to be taken by the end of June and in July. If buyers choose to watch what their neighbour does and do not manage their business properly, an uptick in leather demand would leave many tanners with low-priced leather contracts, insufficient coverage and suddenly rising raw material prices.
If leather demand doesn’t pick up in the volume sector, all of this will be irrelevant and the oversupply in the medium and lower section will continue.
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