The Leather Pipeline - 27.11.18
27/11/2018
The end of the year is approaching fast. There is just one month to go until we draw a line under 2018. Until the end of the third quarter, it appeared the endless upward cycle of the global economy would continue. There was already writing on the wall that things were preparing to change, but most people were too busy trying to keep up the positivity to notice. This is not really a surprise as few are interested in any sort of negative economic developments. Since then, things have started to change, the reality has started to become clear and the general excitement has started to fade.
In terms of politics, the main topics are the trade war between the US and China, Brexit and the returning worries about tensions in Europe. These things are not positive for the mood of investors, who are beginning to realise that they could change the economic fundamentals. They are becoming much more cautious due to problems in emerging markets, rising interest rates in the US, the slowdown in the automotive market and various political changes.
Investments by corporations and private consumption are slowing down, leaving imprints on the global economy. Most institutions are revising down the growth rates and investors are wondering whether it would be better to save their money. The majority of stock markets are declining. The declines are moderate so far, save for the well-known technology stocks which have seen some major declines.
Due to low interest rates, enormous sums of liquid money have boosted production and consumption. This led to growth that is difficult to sustain indefinitely. It is unclear if this is at an end or if it is just a temporary break. However, there is a lot to suggest that the normal cycle of up and down is simply continuing and that we might be entering the ‘down’ after a long ‘up’.
In the general markets, the massive correction in oil prices was probably the most remarkable news in the past two weeks. There are plenty of explanations why the price per barrel has lost almost $25 from its peak, but in the end it is the previous rise that is difficult to explain rather than the present correction. The sanctions on Iran have been a good excuse for speculators to justify the price rise.
The general economic slowdown, a US economy that is still doing well (rising interest rates aside) and the expansion of renewable energy, have triggered a major sell-off. This could end in production cuts by OPEC in order to stabilise prices again.
The ongoing Brexit negotiations and the situation in Italy are again weighing on the Euro and the Pound Sterling, not to mention the difference in interest rates which makes US Dollar investments much more attractive. So far, it has only had a minor impact on currency rates, but the trend has been and is moderately weaker. Gold, which is normally the defensive investment, can at times like these be really beneficial. It continues at levels around $1,200 per ounce.
Market Intelligence
The leather pipeline is entering the final lap of the year. However, the situation is a little different this year. The highly season of leather production, which normally comes from October to April, is proving slow. There is no real upturn in production levels in this winter season, or at least we cannot trace one.
In Europe, many tanners start to wind down their production by mid-December. What one major automotive tanner has made public is happening in private for many others. Soakings have been reduced and three or four working days in the week are common. This has been well hidden, but many of the raw material suppliers are complaining about reduced shipments at the time of the highest kill in Europe. A look at the USDA export statistics also speak for themselves. As well as confirming that current production levels are low, these facts also show that tanners are not expecting a major uptick in leather demand in the first quarter of 2019.
The situation in Asia is dominated by the upcoming Chinese New Year break. Shipments have to arrive by mid-January at the latest and will not be accepted again until mid-February. Although the holidays only cover two weeks, tanners are not willing to accept any more hides and are desperately needing to cover production. We understand that very few clients are asking for quick shipments, which means letters of credit for material have to be opened by next week. Otherwise, shipments will not arrive before Chinese New Year. With all the problems related to timely payments, it is unlikely many shipments will take place in 2018.
According to the saving lists of international shipping companies, vessels are travelling much lighter and they are managing their roundtrips by slow steaming. The hide and leather industry is not a big factor for shipping companies, but it confirms that the general exchange of goods is slower. The usual shortage of shipping space and the challenges related to shipping schedules are not being seen this year.
Other destinations in Asia are showing more regular performance, but this cannot compensate for the continuing struggles in mainland China.
Compact analysis
In our general market monitoring we have come across a review that a European supplier sent to Asia in response to a question about how he thinks the market is going to perform. Although there is nothing new, it is a compact analysis that we share here:
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The fact remains that the demand for leather and hides is underperforming; not all the hides produced globally are covered by the demand for leather.
The decline of leather consumption, in particular in the shoe industry, has met a rising production of beef, and consequently more hides. However, at the same time leather demand and production is not zero. Consumption might be down 10-30% and we also had an overcapacity of production, especially in China, which needed to be adjusted. As a result, we might talk today about a net decline of 20-40% compared to two years ago. This leaves 60-80% to be supplied.
The decline is unevenly spread and has different causes. The decline in shoe leather is clearly caused by the change of fashion and material use. In upholstery it is mainly the correction of the overcapacity in China (Hebei province), which is the result of environmental decisions by the government. Automotive is steady with a weaker outlook. The handbag sector is in pretty much the same situation as automotive.
Consequences:
a) A surplus of general hide supply let prices fall for the last two years, with the decline accelerating during that time;
b) Demand for quality types is far more stable than demand for other types. They only adjusted prices due to market sympathy. Substitution can only be done in very lim-ited ways, but the price spread cannot be sustained;
c) We have temporary seasonal effects, due to Christmas and Chinese New Year;
d) Tanners in their expectation of ever falling prices have been delaying regular pur-chases and run low inventory (of hide qualities they need, not the stocks of low grades);
e) The congestion will last until February at least;
f) Price declines for many items (cows and heifer) will now slow down because we have reached minimum levels, but males still have potential for correction;
g) Leather demand will not rise for the coming season, and likely not for the coming two seasons;
h) A market always returns to balance, even if it is only due to the destruction of mate-rial. This will reshape things eventually.
Prices will stay within low ranges. Better quality hides will stop their descent in the first quarter of 2019 because they will win market share due to falling prices. This will bring them back into balance soon. This will apply mainly for females at the beginning. Males still have potential for correction before it applies to them as well. 2019 will be on thin ice for at least the first half until the congested market has restructured itself. Unless the recent drop in oil prices is reversed, alternative materials will remain increasingly competitive.
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Seasonal influences
No matter how you look at it, things are definitely not getting better. We have entered a vicious circle and, so far, nobody can find the exit door. As a result, we will keep this report a little shorter. With the holidays ahead, we will now begin to analyse the options and alternatives available.
One can be critical of beef consumption, with plenty of talk about sustainability and animal welfare, but it is obvious that wasting the hide by destroying it rather than making leather would show no respect towards the beast from which it came. The logic behind the decisions to raise animals was to not waste anything that nature had to offer. This means that any campaigns against leather are actually illogical.
We can skip our analysis of the split market as there have been no changes here. However, if and when global leather production shrinks, which look likely at the moment, the supply of gelatine and collagen raw material bovine splits will also decline. Consumption is not really shrinking, which is more a capacity issue than a question of market demand.
With regards to skins, the seasonal effect in Europe has completely faded and prices for ovine material have fallen again. Demand is so low that prices now barely cover processing costs. There is no sign of demand recovering and so there will be no major changes. The niches continue to perform well, but this does not change the fundamentals of the market.
We will have to deal with the seasonal slowdown in the coming weeks. For suppliers, the situation will not ease. Their biggest challenge will be to deal with the congestion of raw material. All eyes will now turn towards the final outcome of the trade war between the US and China. Will all the tariffs come into force on January 1 as expected? Only time will tell, but this would mean rising pressure on the prices of US raw materials. At the same time, it could open up small opportunities for other origins.
Companies will soon be busy preparing their end-of-year balance sheets. More than ever before it seems that most corporations are trying to keep their inventories as low as possible, which means things are pushed back into the pipeline. Almost all raw materials are in a surplus situation. Beyond the general market balance, we are now also facing the seasonal influences on top.
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