Macroeconomics

Over the past two weeks one major centre of interest has been the outcome of the US presidential elec-tions. It might be a little while yet before everything has settled down and the new president can start work. In the western world, there seems to be a belief that relations between the US and its partners will be more relaxed and predictable in future. The transfer from the old administration to the new one may still face some difficulties and so it may still take some time until there is a clear picture of new strategies. This usually starts with the people who are going to represent the new administration.

Conflicts such as those affecting Armenia, Azerbaijan and Ethiopia show, once again, that it’s not all just about elections and the pandemic.

However, the pandemic continues to govern many people’s lives. With the exception of a handful of countries, infection rates are either still rising or remain high. In particular in Europe many governments have implemented a new lockdown and, at this stage, it seems unlikely that we can expect a normal Christmas season. Day by day, it seems more obvious that politicians are not expecting to re-move restrictions for the Christmas season.

However, there has also been good news. The first vaccinations seem to be close to being ready for public use. From the information that has been published they offer more than 90% protection, which would be a big step forward. However, to be realistic, if we are lucky and everything works well, we can perhaps hope for these vaccines to make an impact next winter.

Statistics for the third quarter were generally promising. GDP in many parts of the world recovered nicely. But in most parts of the world the full-year results for 2020 are going to be negative. It will, with the exception of China, be a year of sharp contraction in most economies.

The oil market recovered by several dollars per barrel. This is not considered to be a big swing and pundits predict that OPEC will have to cut production once again to protect prices, but for the moment the oil price is back into the $40s per barrel.

The price of gold has suffered as a consequence of the news and the US dollar continues to trade in very narrow ranges because nobody expects any major changes in the policies of the Federal Reserve or any other of the big national banks around the globe. Economies are far from being on safe ground and all players expect interest rates to remain very low, possibly even heading for further declines.

Market Intelligence

The leather pipeline could be heading into difficult territory again. Circumstances are unclear, the future is insecure and the chances of sustained, positive results seem slim. 

There has been a much appreciated rebound and recovery after the lockdowns of the spring, but the picture for the whole year remains negative. This applies also to the leather pipeline. If business contracted by 30% in the second quarter, a recovery of 15% in the third cannot really make anyone happy. 

We have bright spots, as we all know. China is performing fantastically and the numbers for consump-tion and production are higher than a year ago. This applies to the whole economy, including leather production and consumption. Factories are producing and people are shopping.

Side leather tanners and shoe factories in China may not agree. The production of side leather, shoes and leathergoods is still lagging behind the numbers for 2019. To obtain reliable data is very difficult and so we have to live with guesses. If you talk to the better performers and optimists it might be down by 10%. If you talk to the less successful companies and pessimists they claim that business is down by between 20% and 30% versus a year ago. 

The opposite applies to furniture upholstery where the cheap price of hides and of finished leather have really triggered additional demand and growth. This means that the image of leather, at least in China, and also in some export markets like the US, continues to be strong. The word leather sounds good and, if the price is competitive, manufacturers are readily switching back to this material. This is the positive news, but in the end sofa manufacturers are not selling any material; they are selling sofas and will keep tabs on what  brings the best results, factoring in the cost of production and the potential selling price.

With the pandemic seemingly under control in China and the support of the government, manufacturers and retailers are very happy to bet on the future. They were not driven in summer by the same concerns European or American retailers and manufacturers had to face. In China companies saw the op-portunities, so the cheap prices helped them decide that the time was right to step in. This generated demand along the leather pipeline. Tanners bought raw material and their offerings were readily accepted by their customers, triggering strong demand.

In the beginning, with prices so low, tanners bought the best hides available. They were still cheap enough to make a decent profit. When markets began to rise they became more price conscious and began to buy cheaper hides in larger volumes.

A similar situation applies in automotive leather production. Not only in China, but starting from there, vehicle production rose after the summer holidays in Europe. One just has to have a look at the results of the automotive companies, which are quite nice for the third quarter. Also here, under the lead of China, production is on the rise and so is leather consumption.

Long-term leather consumption in automotive production is still in danger. We still expect that into the mid-2020s the total consumption of leather in this industry will shrink. However, for the short term, leather’s performance is very positive. One has also to assume that margins for automotive leather producers are healthy because their prices are far less elastic and changeable than in other sectors. Cheap hides and good demand must have pleased many players very much.

To return to side leather tanners, volumes as well as prices will have given them little to cheer recently. We would guess that not much more than the normal seasonal increase in production has happened and this is far less than what is needed.
What does all of the above mean for the leather pipeline and the markets?

Many hide prices have gone up. However, a hide that was $10 and did not cover the cost of collection, processing and shipping might have doubled in price, but that does not mean it is generating  much profit for the seller. With a steep price rise, the situation has become a lot different now. Tanners who had the courage to buy at the right time and fill their inventory during the summer have  a head start now and can make a healthy margin. If they have continued to buy in the rising market, they will still be able to offer a good average price for their finished leather. For late-comers the situation is different and they are struggling to get a piece of the cake.

What is the same for everyone is the old story that leather prices are so much less elastic than raw material prices. What was calculated on a healthy margin three months ago is tight today. With the rising average price of raw material, the margins are shrinking quickly and this can be seen by the increasing resistance to higher raw material prices now. Sellers, in particular packer firms, have not proved to be exceptionally sensitive to the idea of safeguarding product flows and sales through adequate pricing. The more aggressively they push raw material prices up, the more demand shrinks. There is no ap-proved correlation between a certain price rise leading to a certain percentage decline in demand, but there is a relation.

In the past there was frequently a shift between sectors. When one sector lost steam and had to step out for price reasons another sector took over and pushed forward. Well, the sector that could and should take over the position from upholstery and automotive is side leather. Unfortunately with the conditions we are in we cannot predict strong use of leather in the manufacturing of shoes or a massive boost in handbag demand from fashion houses. So, we don’t think it’s very likely that when the price ceiling has been reached one should bet on the hope that another sector will take over to continue to support the price trend.

From all what we can collect we have to understand that the volume of raw material sales continues to fall. Several suppliers may still thrive on forward positions which had been developed in the past, but follow-up business does not show the same performance and volumes needed to confirm the next price rally.

Look at the raw material price levels of some major categories and at the same time the real prices for their wet blue counterparts. A strong market with a shortage situation is always demonstrated by an equivalent demand for semi-finished product, in addition to the raw material market. If the same hides are available as wet blue and at a substantial discount, you had better worry.

We are now heading into the end of the year. In the western world production will be interrupted by the Christmas season. The performance of Christmas sales is still completely unknown, because the clas-sic Christmas shopping downtown or in the shopping malls will certainly be significantly less. People will still spend online, as we can see from the performance of e-commerce companies and general online shopping, but the shopping is going to be definitely different. What this means for major products made from leather we have absolutely no idea. 

Top brands will most likely be able to engage their customers. Customers know those products, they know the brands and they have a clear idea of what they are buying. The shopping experience may be missing, but the decision can also be made easily in front of your computer or phone. For products that people usually decide to buy while they are out shopping having looked at all the options and al-ternatives on offer in the mall, the situation is far more difficult. We will learn a lot for the future from this shopping season for Christmas, and also for Chinese New Year, which falls on February 12.

It is very likely that a lot of the demand steam is going to be lost now. We might still have a few weeks to go, but we are already entering a time when people plan for the slow season and the second and third quarters of 2021. The only thing that could change that dynamic would be a very quick disap-pearance of the pandemic and a quick and solid return of consumption outside China. Perhaps that’s possible, but it’s certainly too early to know how likely it is.

We really don’t have much news from the split market. There is demand for certain products, there’s demand for good prices, but in general splits face the same trouble as hides. We fail to see the real road towards improvement. We were a bit surprised to hear from China about a sharp rise in prices for lime splits owing to strong demand for gelatine. This is contrary to what we understand about the market in Europe. We will study the situation and try to gather more information for the next report.

The skins market is a bit of a mixed bag. Specialty skins for certain particular uses continue to per-form relatively well and to obtain reasonable price levels. For standard skins the situation is still as bleak as it has been for more than a year. Quite significant volumes of European skins have been sold into China, but at prices that do not cover costs. In many European countries we estimate that about 20% to 30% of skins production is ending up in rendering. We have been quite optimistic in regard to the garment sector. However, as good as it may be it is still by no means good enough to absorb all the skins that are produced.

As a logical consequence of what we describe above, we think that we are now entering a phase of settlement. The price for raw material will not collapse, but the situation of demand being strong enough to allow sellers to squeeze a little extra out of the market every week is certainly fading. We tend to believe that the harder sellers push, the more they will regret it in the future. In the best of all cases, prices would now stabilise and settle for a while until the entire global situation is clearer. No pronounced movement up or down would do any good for the leather pipeline now.

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