An alternative view – Hidenet editor-in-chief Don Ohsman14 August 2015
In a break of form from the usual monthly round-up of the US and international markets, Leather International has an in-depth conversation with Hidenet.com’s editor-in-chief and publisher Don Ohsman ahead of the company’s forum on leather, and international hide and wet-blue markets to kick off ACLE in Shanghai.
Leather International: Based on the industry climate at the moment, with some hide prices at a fraction of what they were this time last year and a teetering Chinese economy, what are the macro trends at the moment, how long do you see them sustaining and what are your predictions for 2016?
Don Ohsman: The decline from the markets peak at most origins was close to 50%, and it was enough to stress the industry; perhaps to an extent that has not been seen since the Second World War.
Quite simply, the markets' plunge should not have come as a surprise, as the rational for the historic highs that were reached were suspect at best. The industry convinced itself that there was not enough supply in the world to meet consumer demand, and thus the justification for previously unheard of price levels.
In my view, China was the culprit as tens of millions of relatively 'nouveau riche' consumers, for the first time in their lives, had disposable income that afforded them the ability to buy luxury goods, many of which were leather. As the Chinese economy retreats, those consumers' discretionary buying power has eroded as well and at least for the next year, and quite possibly a good number of years, this trend is not likely to be reversed.
Leather, as a result of hide prices, and the collapse of wet-blue split prices, should encourage footwear brands and other leather goods manufacturers to begin to use more, but to the contrary, it takes at least six months, and quite often 18 months, to restyle products where leather was 'styled out' in recent years due to cost. The ability of leather to regain lost market share will take a very long time as synthetics have taken hold of too many formerly all-leather products.
This means that, as it appears now, hide prices are more apt than not to stay within 10% higher and lower of their current price range throughout the first half of 2016, if not longer. Interestingly, slaughter in Brazil and North America, the two largest origins of exportable hides, wet-blue and splits, should remain near the low records seen in the first half of this year. Herds will start to be rebuilt but that is a multiyear cycle.
While China remains an indispensable market, especially for US wet-blue exporters, how can it best position itself to mitigate risk?
Risk is inherent in any business be it hides or leather or otherwise. However, when prices reach such levels as seen in the past few years, the trade's exposure increased accordingly. US exporters have learned which of their former customers were 'good' and which ones were not.
One phenomenon that occurred in other severe market drops, and again this time, were threats by the producers to their customers that if they wouldn't honour the higher priced contracts, they would not sell to them again. A good number of tanners walked away from their obligations and then went to different suppliers, who were unaware of their previous malfeasance and were able to secure their raw material.
While China is still the largest single market for US hides, Vietnam, especially, and Thailand as well, are growing destinations. A large percentage of US wet-blue - that now comprises roughly a third of all US hide production - also goes to Italy on a regular basis
It seems the best way for an American exporter to mitigate risk is to develop the closest relationship possible with its customers, as is the case between many of the largest producers and largest tanners, and always keep an eye on geographical as well as political exposure. The Chinese Government's crackdown on pollution and corruption instigated the economic decline, but this is much easier to ascertain after the event than before it.
Building up to the Hidenet forum at ACLE, what makes topics like supply and demand, and prices versus volume particularly pertinent right now?
An unusual phenomenon occurred in the first six months of this year. Supply declined, in some cases like Brazil, extremely so, and even in the US where early expectations were for a 3% or so decline in slaughter, is currently running close to 7%. Regardless, we've just come through one of the most rapid and severe declines in the history of the hide market. Supply declined but so did demand, and even more so. This is why the title of the forthcoming forum in Shanghai on the eve of ACLE opening is 'Do supply and demand still matter?'
Has the market bottomed? What are arguments for and against this?
A difficult question. For the moment, yes the bottom has been reached for hides at most origins, and only in the past few weeks. This does not factor in the European market, which is still on holiday as this is being written. However, all origins typically rise, and fall in synch, so with Brazil and North America bottoming, the EU is more than likely to follow.
Some say that hide prices got too cheap, but what is cheap? Here's where demand comes in. Some informed estimates are that compared with 2014, leather consumption of all types is about 20-30% less. However, until last March, when new leather orders are traditionally placed for the next three to six months by major footwear brands, (about 50-55% of all leather consumption is used for footwear), the market did not realise that the volume ordered was sharply reduced. Tanners simply did not need the square footage as they had in the previous season and the market collapsed.
As noted before, regaining lost market share takes at least six months and in some cases 18 months. Therefore, leather consumption is not about to increase for footwear and other leather goods. However, upholstery business seems fine, for furniture and automotive, which use large quantities of leather, but the slowdown in Chinese auto production, which is likely to continue for quite some time, will eventually have an effect on demand.
So prices can still fall through the just-established bottom, especially due to the decline in split credits, which will force tanners to buy below current levels. Furthermore, leather orders are traditionally lower in the second half of the year than in the first and second quarter, meaning that any pick up in the volume of leather tanners can sell is not likely to increase.
On the other hand, we do not sense that there is any abundant inventory of hides, and even as the market was at its worse, in the case of the US, new sales still managed to be concluded to the tune of 75% or so of slaughter. In other words, even at its current reduced quantity, there is still a lot of leather made and sold every week, and it is likely to be enough to keep prices in their current trading range for the most part.
How much is hinging on ACLE in terms of global market trajectory and decisions tanners need to make?
We do not foresee any fireworks in Shanghai. Instead, we think that buyers and sellers will be sizing up and trying to ascertain where the market will go in the final months of the year. Producers and traders will have visited their most important customers on route to the fair and will likely have sold some volume before ACLE. In general, unless the market is 'hot', which is certainly not the case at present, the fair is an opportunity to renew and establish relationships between buyers and sellers, and get a market feel.
Is the Chinese economic bubble bursting right now?
We at Hidenet are not economists, but in my mind there is no question that the current downward trend in the countries GNP will continue on its present course for some time. It's like trying to turn a huge container ship around in a narrow passageway. I don't think there is any chance of collapse or recession, but the pronominal growth seen due to government policy and fostered by what we in the West consider cheap labour is a thing of the past. While it's good that the economy enabled the population to have the ability to improve their standard of living, and while they still have the manufacturing infrastructure that their Asian or African competitors do not, its days as the 'factory' to the rest of the world are rapidly becoming a thing of the past as a low-cost manufacturer. The government policy is to not rely on exports, but to focus on domestic consumption for its future growth.
You said in a recent 'Market Report' on Hidenet.com that there are fewer supplies and lower slaughter since APLF, especially in Brazil, and the market still collapsed. What's happening in Brazil?
As anyone who is interested in that country has seen, their economy is in poor shape, with high inflation and a lack of support among the population for their current government. This has meant that the general public can no longer afford to eat as much beef as before, which has reduced slaughter. The lower slaughter has been exacerbated in the recent past by drought and floods. Our Latin American editor David Holz says cattle slaughter in 2015 could be as much as 20% below 2014.
Regardless, Brazilians have found that they are not competitive on a world basis in finished leather and even crust due to tanners cost such as outlandish electricity bills, for example, or taxes. The only thing that their tanning industry is competitive about is the production of wet-blue. However, their costs in this production also make it difficult to compete because the lower slaughter has increased the cost of the hides they must buy. Few are operating at capacity, and due to the general malaise among the world market, even at lower price levels, sales are difficult at present. Bottom line: costs are too high and buyer demand is diminished.
In the US, does the need to buy still exceed the need to sell? Are US warehouses still at capacity?
Yes. Our sense is that the bounce in steer prices seen in the past month has been led by traders covering shorts and building long positions to sell on route to ACLE in Shanghai as they visit their favoured customers. By the same token, seeing the market rise has caused producers to reduce their forward-sold positions in order to have hides, and to sell on their pre and post-ACLE travels - and during the fair.
How can you describe the 'bull and bear' divide? What is each side saying at the moment?
If anyone knew for sure which way the hide market was headed all the time, they would be among the Forbes 500 richest people. Bulls are basically optimist and look for signs/signals showing increased demand for various reasons. Bears tend to think that this current rally is overdone and they cannot see enough tanner support at these prices. Furthermore, they think that all of the hides not being offered for sale at the moment will show up at about the same time, overwhelming tanners' needs to buy and create a retreat from the gains witnessed of late.
At APLF, PrimeAsia's Jon Clark spoke a lot about adjusting to skyrocketing labour costs while maintaining the highest levels of quality and assurance to customers. How are industry efforts for transparency and traceability, in China and Vietnam for instance, affecting hide prices?
I have not seen any evidence of the industry efforts in this area affecting hide prices. It simply increases tanners operating costs, which they either absorb, or have to add to their leather sales price. For the right leather at the right time from the right tanner, those brands that need to be concerned about transparency and traceability are willing to pay the price.