Market Intelligence - 15.12.20
Macroeconomics
The crazy and terrible year of 2020 is coming to an end. Exactly year ago, everything was in perfect order and everyone was looking forward to a great start to the new decade. Holidays were planned, generally the economies were performing well, incomes rose, unemployment was not a factor and businesses were planning for growth and better results. And then it happened. The covid-19 pandemic started its global tour and changed everything.
Although the virus is the all-dominating topic of 2020, there have been a couple of other issues that should not be forgotten. In January the UK left the European Union and is coming to the end of its transition period. We had a summer of social unrest and street protests in the US and elsewhere. After the summer interest shifted to the presidential elections in the United States. Tensions are still growing around the globe. Big egos have been dominating and will remain a factor. And finally, in December, successful vaccines were released, which have the chance of bringing change in the coming year.
The US dollar began a decline which has almost cost 10% of its value against the euro. Oil prices at the peak of the pandemic were very low, but with all the hopes for the global recovery they have returned already to prices of around $50 per barrel, just $10 less than before the outbreak.
The gold price went up almost $600 per ounce to reach levels just above $2000 before correcting a little. In times of uncertainty and in a very justified fear of rising inflation, the price rise is no surprise. Metal prices have reached levels above those of a year ago.
Consumer prices and inflation have been depressed this year owing to reduced local shopping and the desire of many consumer product suppliers to sell inventory to raise cash. This is really creating a big risk for the future. Replenishment and transportation costs pave the way for sharp price rises. When businesses sit down and do proper calculations on basis of present cost levels, shoppers could face serious surprises.
The basis is in place for an exciting 2021. It might be wise to shake 2020 off a little bit and to try to focus with no emotion on possible scenarios for the years to come. They will be different in many ways.
Market Intelligence
The pandemic has and is still creating many big changes for everyone. The situation continues to be different in many regions around the globe. Europeans were optimistic after the summer that the level of infections would remain low and that the worst was over. However, those who warned about a second or possibly even third wave were, unfortunately, right. In China where it all began the situation is completely different. The government did what only governments of this kind can actually do: restrictions, controls, sanctions, a clear strategy and no discussion about its execution. This has led the country out of lockdown and has created an environment close to normality again. This means that private and public life has normalised and the economy is back on track.
Several other countries, in particular those that cannot strictly control their borders or those whose populations are willing to follow government instructions closely enough, have also been able to keep the number of cases relatively low. This is separating the world into two major blocks. One is in the position of being able to deal with a manageable number of cases; in the other the behaviour of people and the decisions of the governments have created a swing up and down in cases and the hope that vaccines will end the problem in the coming year.
Lockdown almost paralysed industrial and economic activity until summer. Thereafter, led by China, global activity began to resume. China is back to normal and is even beating the numbers of 2019; other countries are back to base levels. There are large numbers of people around the globe who, with the help of governments in many cases, have not yet felt a major decline in income. In many countries, holiday trips had to be cancelled and that has left more income to spend on general consumption. However, how the massive budget deficits are going to be repaid might be the next big question of the 2020s.
The situation around the pandemic has changed a lot around the leather pipeline. Many trends and situations have become disruptive, at least in particular regions or sectors.
After the global economy came to a standstill and the interruption of many supply chains, raw material prices were in freefall and this went as far as large volumes of hides and skins being destroyed in early summer. Fortunately, the recovery of industrial production in China in combination with the recovery of private consumption and the massive boost of money injections from governments helped avoid a complete collapse. Chinese tanners and manufacturers realised the success of the government actions and the return of business normality. With plenty of money around and cheap loans available for small and medium businesses (including leather manufacturers), we saw a repeat of 2008 and 2009, when those who were courageous could take full advantage of cheap raw material costs. They began to reload their pipeline already from mid-summer at the cheapest price levels ever seen in many parts of the world.
What might have been speculation in the beginning turned quickly into a winning formula. Tanners were able to offer leather at very attractive price levels and, fortunately, consumers in China were willing to see leather once again as a premium option in finished products. This can definitely not be said for all leather applications, at least not at a global level. Two markets paved the way. Chinese consumers began to purchase automobiles and the industry resumed production in the late spring when most of the supply chains in the automotive industry in the Americas and Europe were still interrupted. Later in summer, the trend moved into furniture upholstery. Once again, the leather pipeline must be thankful and happy, that the anti-leather and anti-beef campaigns have, until now, made little impression in this market of 1.4 billion consumers. Quite the reverse: beef consumption is strong and leather as a material still has a positive image in China, something we wish were also in evidence in Europe.
Orders for upholstery leather for this season rose quickly. With very cheap raw material prices, tanners were able to reach comfortable profit margins that invited them to remain active in raw material procurement even when prices began to rise again. The average cost was still sufficient to preserve profitable production. The same applies to the automotive industry, even though the pricing system there for the finished product is less flexible than in many other markets.
Demand for raw material and adequate margins triggered enough demand to absorb accumulated and congested raw material stocks form many origins and allowed sellers to raise prices step-by-step from mid-September on. As stocks cleared and the market for the upholstery sector improved, the market regained its balance, and sellers became much more ambitious.
The side leather business and the shoe business are travelling on a different train. Some recovery of demand and production is visible in China in this sector too. However, this is not widespread. In the western world demand for the classical dress shoe has substantially eroded. Social events are cancelled, working from home usually requires less dressing up, older people, who are more inclined to shop in the traditional way, are not going out. People simply need fewer shoes. Quite a lot of the base demand has moved online and it remains a major problem that leather shoes are relatively complicated so that, with the restrictions on travel, simpler, mass-produced footwear has been easier to design and order by videoconference than leather shoes. Supply chains and lead times are long too and, with uncertainty about the future, one cannot blame brands for refraining from the adventure that a change of material would imply.
The luxury market has also not seen the recovery many were predicting. Big brands want to publish successful sales figures, but if you look at the net numbers their sales are well down on a year-on-year basis. The lack of travel and shopping tourism is much bigger than the gain from a recovery in China and online business. The luxury leather pipeline is also hit by the adjustment of inventory levels along the pipeline.
Going back one year, the outlook in this industry was for a double-digit percentage rise in sales almost everywhere. Budgets and plans were based on this and the pipeline was extremely well filled. This sector was extremely hard hit by lockdowns in the major production centres in Italy and France. It might still take a little while until this is straightened out. The prestigious raw material, in particular high-quality calf skins, needs to secure a regular flow for the season to come. Eventually, high-quality raw materials and luxury leather will become scarce again and buyers will pay extraordinary premiums for them, but this will most likely still take, perhaps until the second half of next year. Talking to people who live and operate in the main production centres, in particular in Tuscany, activity is set to remain at very low levels for some time yet. We understand that brands are busy trying to clear stocks. Only after that will a serious refill will begin in this sector.
To draw a bottom line, we can say that for the bovine sector the drama seems to be behind us. The road ahead might still be bumpy and the dream of the beef industry that hide prices will just continue to rise in a straight line will certainly not happen. However, a certain volume of supply has been taken out of the market because of the destruction of hides that took place in the summer on the one hand, and by the recovery of demand in China for upholstery and automotive leather on the other. This has led to a recovery in price levels. As a matter of fact, for quite a few hides around the globe, prices are not far away from their pre-corona levels.
For the future everything depends less on general global consumption or the effects on consumer business of the pandemic, than on leather as a material achieving solid appreciation again. We need customers to understand that leather is one of the most sustainable materials we have. The effects of pandemic are economic, but also psychological. This will, to a certain extent, change consumption patterns around the globe. The links between consciousness about the climate, psychology and levels of private consumption are under-researched. For those who get their predictions right and modify their products and offers to the post-pandemic world, there are a lot of opportunities are around.
If leather becomes appreciated again and the consumers specifically opt for leather, there will also be a chance to bring the sheepskin market out of the doldrums. Apart from certain niches, general consumption of sheepskins remains very poor.
We continue to destroy a lot of skins around the globe and those that are still being processed are, in many cases, unable to secure prices that justify the cost of turning them into leather. This is an absolutely unacceptable situation. We continue to see plenty of garment leather in women’s fashion. However, we still fail to see a reflection of this in mass-market demand. So far, none of the big retailers has had the courage to offer leather garments in volume. Of course we are not completely neutral, but we really think that the fashion industry and the retailers have missed a great chance; if they want to take advantage of it, they should act quickly.
The split market continues to be a reflection of the hide market. For specific uses, wet blue splits still find a market and can even fetch more money than before. Niches, such as veg tan or high-quality suedes still do fine. Due to the very low prices, we have also seen a recovery in some of the extra-cheap materials, which are used in work gloves and similar items. The gelatine market is still under-supplied in China, while in Europe raw material suppliers abound. The imbalance as a result of the African swine fever and pork continues and is setting relatively uneven price levels in the different regions around the globe.
The tone of the market just two weeks before the year ends is pretty firm. Sellers continue to be optimistic and tend to believe that they will be able, with a bit of patience, to squeeze more money out of the tanning industry. Since we are in the last cycle of the high-production season, they might be successful to a certain extent. However, the headwinds continue to get stronger. For the existing leather price levels, raw material prices have gone up too far and too fast. Only cost averaging is allowing the majority of the standard leather producers to sail on. Within the cycle and within the season you can’t change horses.
We continue to see a great risk with regard to prices. For a sustained position in the market, leather has to be competitive. Except in the luxury sector nothing has really changed. Leather is one of a number of material options and its use remains complicated: making products from leather is expensive and involves a long lead time. It its functionality and sustainability credential fail to make it successful, it is price that will determine its use. The moment leather becomes less profitable is the moment when it will lose out to other alternatives. To prevent another sharp setback in demand and disqualification of leather in mass consumption because of price, sellers of the raw material should really work closely with their customers and show sensitivity in pricing. This is absolutely not in the character of most of the players, but they might be advised to have a think about this.
For the rest of this year it’s hard to imagine that too much will happen on the price front. The books are closed, buyers are hoping for an easing situation on the raw material markets and at the same time sellers are hoping for more demand, which would allow them to go for more money. The battle continues in 2021 will not be any different. However, until mid-January we will most likely see a ceasefire.
We can do nothing more now than wish readers a very Happy Christmas, a very happy New Year and, for the world, an end to the pandemic and a return to normal life.
