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.