Rough Economies

Avi Krawitz

Two trends have emerged at the start of the second quarter that will likely influence ‎diamond trading for the remainder of 2012. One, rough prices have increased while the ‎polished market continues to tread cautiously. Two, growth is being spurred by demand ‎in traditional markets while the emerging markets are relatively restrained, thus reversing ‎the trend of the past year.‎

The second trend may be easier to explain. The pace of economic growth in emerging ‎economies is expected to slow in 2012, declining slightly from their strong performances ‎over the past few years. In contrast, there is some encouraging data coming out of the ‎U.S., although growth there is compared to a weak base from a year ago. Reports ‎indicate that U.S. retail sales are growing and consumer confidence is up.

Citing some of those same reasons, the International Monetary Fund (IMF) this week ‎offered an improved outlook for the global economy, which, it said, is “slowly improving ‎but remains fragile.” Those same words could describe the diamond market. ‎

The IMF said it expects world output to increase by 3.5 percent in 2012, raising its ‎projection from the 3.3 percent growth stated in January. ‎

Despite rising confidence in advanced economies, particularly the U.S. and Japan, which ‎helped lift the revised forecast, there was an underlying theme of caution contained in the ‎report. “For the past six months we’ve been on a rollercoaster ride,” said Olivier ‎Blanchard, the IMF’s chief economist. “Our baseline is that growth is going to be slow in ‎advanced economies; sustained, but not great, in emerging market and developing ‎economies. But the risk of things turning bad again in Europe is high.”‎

We are therefore by no means out of the woods. But things have been worse and the ‎improvement, while “fragile,” is reassuring. Discussions with diamond dealers reflect ‎similar concerns. For them, the European debt crisis remains the crux that could throw ‎the diamond market out of balance. ‎

Those in the trading centers report improved demand for polished diamonds from the ‎U.S., while other markets are relatively quiet. There is no boom and requests are focused ‎on sourcing goods for existing orders. Encouraged by the price stability seen in the past ‎month, suppliers appear willing to hold off on sales as they expect polished prices to rise. ‎Their hope is based on increases in rough prices that took effect in the first quarter. ‎

Gem Diamonds this week reported that its Gem Diamonds Price Index, which measures ‎prices achieved at its Letšeng and Ellendale mines on a like-for-like basis, is up 7 percent ‎so far in 2012. The increase is about in line with the hikes implemented by the Diamond ‎Trading Company (DTC).

DTC was able to raise its prices as De Beers continues to hold back production levels. ‎The company reported that its first quarter output fell 16 percent year on year to 6.208 ‎million carats. Manufacturing levels are similarly below capacity and liquidity in the ‎cutting centers is tight.

As always, sentiment in the trade is being influenced by cutters’ ability to profit on the ‎rough they buy and the resulting polished they sell. They consider rough expensive, and ‎their margins are slim. They either need polished prices to rise, or rough to soften, or for ‎rough to at least remain stable for a sustained period. ‎

However, Gem Diamonds said it anticipates rough prices will continue to rise in the ‎second quarter. And others in the market do too, which has spurred expectations that ‎polished prices will follow. ‎

This is a dangerous assumption. ‎

The trade’s ability to raise trading volume, and translate firm rough prices into higher ‎polished prices, is dependent on whether there is sufficient consumer demand to warrant ‎the increase. Higher rough prices alone are not healthy for the market unless they are ‎accompanied by justifiably higher polished prices.

In essence – and in an ideal world – the rough market should be taking its cues from the ‎polished and not the other way round. If rough prices are pushing up polished, there must ‎be sufficient customers for the end product. ‎

The question is whether any short-term price increases will be influenced by real ‎diamond demand or a shortage of supply. It is far better to increase the supply of ‎diamonds to meet the level of demand. Raising rough prices in isolation will fuel ‎speculative demand that will ultimately fade, or crash for that matter, when it becomes ‎clear that prices are out of sync with demand. As the market learned in 2008, speculative ‎rough price increases are not sustainable. ‎

Therefore, with the economic outlook restrained, the diamond industry ought to take its ‎signals from the IMF report. It should pay attention to the overall caution in the market, ‎both in advanced and emerging economies. Despite the mild improvements in the U.S., ‎there is not yet sufficient evidence that demand is pushing polished prices higher. 

The prospects for 2012 therefore call for a continued conservative approach by the trade ‎to ensure that prices reflect this market reality. Further rough price increases would be ‎justified only if the polished market signals an expanding market. Any considerations to ‎the contrary in the coming months could upset the equilibrium, and ultimately diminish the ‎‎2012 outlook for the industry.

Source Rapaport