The Leather Pipeline - 25.06.19
25/06/2019
The world is not short of news and action in politics and economics. It is quite difficult to prioritise what has happened in the past two weeks. The good news is that the majority of the public are taking things easy; even the threat of war is not creating the same kind of excitement we would have experienced two years ago.
This leads us to the subject that we consider to be the most important in macroeconomics at the moment. The conflict in the Persian Gulf between Iran and the US has developed into a situation that is close to a military confrontation. After Irani forces shot down a US drone, a retaliatory attack was pretty close, with an airstrike believed to be minutes from being executed before it was cancelled.
The situation has sent the price of precious metals, in particular gold, substantially higher. The oil price went up, although the levels are still pretty low when we consider the risk of an interruption to oil supplies from the Gulf region in case of a war. The attacks on oil tankers a week before had already made it very clear how fragile this supply could become.
The main national banks are beginning to consider lowering interest rates once again. The global economy does not look too favourably on the trade war, and the situation in the Gulf region is not positive for business either. The options for politicians and national banks are limited, with the most simple one being to simply pour more money into the markets in the hope that this will be good for the economy and the people.
There is serious debate over whether this strategy works. We have been doing pretty much the same thing since the financial crisis of 2008. It might have worked on the surface, but the big problem is that the asset classes perform completely differently. Real estate and stock markets have benefited tremendously; as these are typically the investments of the wealthy, they have become rich or super rich as a result.
Basic labour income has not risen and this is creating more and more tension, especially in Western societies. Another injection of liquidity into the markets could further accelerate the social imbalances. How long the people in societies can handle this is unclear, but the recent trends in many countries should serve as a pre-warning.
We have also seen a lot of political action. The trade war between the US and China is ongoing, but it has already become a footnote as India has now decided to also respond to the US tariffs. The president of China is travelling to North Korea, the UK is looking for a new Prime Minister who will decide on the next steps in the Brexit discussions, and there are a number of elections that will guide the way into the second half of 2019.
The US dollar bucked the trend and fell after the Federal Reserve indicated that it may lower interest rates. Crypto currencies are also back on the rise, which we consider to be another indicator that people are looking for alternative investments in order to spread their risks.
Market Intelligence
When sitting down to put together this report, it is becoming increasingly difficult to trace anything new or anything that has not already been discussed for a long time. Sometimes it is not nice to be right, but we can now see that our general paranoia about the leather pipeline is close to becoming a reality. The surplus situation is a fact, as is the congestion along the pipeline as well.
Our respected colleagues in business market analysis and reporting have now come to the same conclusions. Their business is a bit more day-to-day reporting, but many of them are now discussing what it going to happen to the raw material that can’t find a home, rather than talking about price trends and possible market changes. We get the impression that nobody is expecting any real change to the situation.
Destruction an option
After a number of reasonable weeks of sales, the US raw material suppliers tried out something new and asked for higher prices here and there. It doesn’t change anything in the fundamentals, so there was not really anything to lose.
Most other origins continue to struggle to clear their production. Given the situation in the major tanning centres around the globe, you can hardly find any region where leather production is not down by double-digit percentage figures. This means that more and more hide producers and processors are beginning to seriously consider giving up trying to prepare hides for the leather industry. The option of destruction is still the most likely alternative at the moment. This situation is being discussed, but we don’t know how serious people are about it.
It would be pretty easy at several locations around the world, especially if nobody turns up to collect the hides and there is no infrastructure to process them on site. The business around the by-products is not just an on or off decision. Deciding not to recover the raw material any more has long-term effects. An infrastructure to collect and process, once terminated, is not easily restored.
At this point, we have to say that we find it perhaps right, but pretty cynical too, that some are considering this to be the best and fastest option. We have also pointed to the market logic that if demand doesn’t return, supply has to be cut. This might be right in a purely scientific analysis, but fundamentally it would mean the global manufacturing industry and the consumer are willing to dump the raw material resource for no particular reason.
There was and continues to be sufficient market for leather if it is offered to the consumer. They cannot buy what is not on the market. It is even more frightening when one hears that even with the rapidly shrinking gap between the price of leather and alternative materials, a growing number of big brands and retailers are still threatening to switch their remaining use of leather to plastic if the prices aren’t lowered even further. This is a vicious circle as leather can never be price competitive in the total cost analysis, which includes manufacturing as well.
We need not return to all we have already said about leather. It cannot win in a simple price competition with plastics; the fundamental parameters would have to change dramatically. This seem unlikely under the present conditions. Even a sudden and severe jump in oil prices would need two production seasons before the price difference might favour leather. Manufacturing processes would then need to be changed again.
Accentuate the positive
This leads us to the only option we have. Leather has to be distinguishable; it has to be used for its specific properties, which are totally independent from what most people mean when they say ‘quality’. Quality has become a synonym for optical defects on the grain side of the hide. Cutability, due to non-existent or corrective defects, has been a driving force behind the decision to use or not use leather.
The industry was willing to kill the positive specifications of leather rather than use them. We fail to see any real sign along the supply chain that efforts are being made to deal with this situation. Quite the reverse, in fact, with finishing technologies now more popular than talking about how a natural and sustainable material could be produced and marketed.
As a consequence, we will unfortunately have to get used to the fact that the hide and skin industry is going to shrink, as will the leather industry. Shrinking means fewer hides and skins being processed and less raw material available for the leather industry to make leather from. It means a strict analysis will need to be done of where leather can find a market at an adequate price. There are still many options, so the quicker this is done the better. The successful ones may trigger a new round of leather use, but at this stage we fail to come to a clear decision.
An important question now is what is going to happen to the existing stocks of raw material. What will happen to all the low grades in wet blue and crust that have built up so far? If the cheap leather on offer today cannot beat plastics, what will happen to the stocks? We would say that a clear answer to this question can only be given later on this year when it is confirmed that, even at rock-bottom prices, leather cannot attract the necessary demand to clean the stocks up.
As negative as we may sound, we are not yet willing to give up all hope that the large brands and retailers won’t dump leather as a material. This is simply too much if we think rationally about what still speaks clearly for leather. They should allow the industry to focus on the advantages of leather, rather than forcing them to continue with this plastic lookalike contest.
Splits and skins
There is not much new or positive in the split market. We are hearing rumours of rising interest in PU-coated split leather. These rumours appear to be pretty accurate, but we fail to see any reason why PU-coated split leather should suddenly become a new option. It is not that much cheaper than real leather and it shares more of the specs of plastic. It would crown the stupidity of the product manufacturers if they moved their demand towards PU-coated splits and would confirm how little consumer product manufacturers really understand about leather. We will closely monitor the situation because decisions will have to be made soon about which materials are going to be used for various products.
The skin market is still suffering. The niches are still doing well, as is high quality nappa. Light and dense, fluffy double face and lining articles are still doing reasonably well. A few other specialties on top, but there is far from good demand for ovine skins. China is again the problem. The tanning centres are still very quiet and several types of garment tanner continue to struggle to raise sufficient demand to fill their production.
The trade war between the US and China weighs especially heavily on this sector. It is hitting not just the demand for ovine leather, but also the wool business. With the current prices for skins, the return from a normal wool market would be enough to run a reasonably profitable business. However, weak demand, especially for coarser wools, has blown away any sufficient interest. The percentage of skins being destroyed is likely to continue to rise.
No guarantees
The end of the first half of 2019 is pretty close. Those who had hoped that these six months would clear the air and show the way to a better second half must be disappointed. Nobody really knows how the consumer markets are going to develop into the generally more busy winter season. The decisions of manufacturers and retailers in terms of their order activity is also completely unknown at the stage. This means we have to get ready for a difficult and quiet summer.
The industry pipeline has absolutely no reason to get active in preparation and so they will refrain from raising stocks. They are convinced there is no hurry and that there will be sufficient raw material available until the finished product order situation is clarified. They may be completely right.
However, amid the pessimism, some people should be prepared for surprises as well. When the production of raw hides and skins declines, for various reasons, this will not touch just the medium and low selections. It will also hit the supply of raw materials that still see sufficient demand from the industry. Leather production is not going to fall to zero. As a result, those leather manufacturers and leather users who depend on specific qualities are well advised not to believe that sufficient raw material and leather will always be available to them.
Although we don’t think the adjustment of prices is finished, those who depend on selected and quality material should keep their eyes open and make sure their supply is secured. The comfort that mass producers have at the moment can absolutely not be guaranteed for the others. Nobody should be surprised if the spread between low and high is suddenly showing an oversupply on one side and a shortage on the other, even if many may not think this is a realistic scenario.
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