One of the key issues brought up for consideration of the Kimberley Process (KP) this year, was the suggestion to put in place a rough diamond valuation system. At its core, the idea is to find a way to determine if the values stated on rough parcels shipped internationally are reasonable. The suggested methodology proposes that rough diamonds be valuated based on converting known polished diamond prices into rough prices, taking into account manufacturers’ costs and margins.
Much can be said about the pros and cons of having such a system in place. I feel that an important component of this discussion is the “how,” not only because it is an unknown to most, but it can also stimulate a wider discussion on valuation.
Breaking down rough diamond Valuation
A KP certificate includes a number of details, such as the names and addresses of exporter and importer, origin of goods and date of issuance. At the heart of the certificate are details about the exported rough diamonds it accompanies: the number of parcels; the HS code of the diamonds; the total weight in carats of the diamonds by each HS code; and their value in US dollars. The suggested methodology, commonly referred to as price reverse engineering, offers a system to check if the declared is dollar value is reasonable.
To do so, the following underlying calculation was devised:
The fair price per carat of a rough diamond equals the total price of its polished output, divided by its total rough diamond weight in carats less polishing costs and margin. Another way of stating it is:
Total Polished Price/Rough Carat Weight – Costs+Margin = Rough Price P/C
The proposed valuation system starts with tracking polished diamond prices on a regular basis and updating it constantly. The prices are actual transaction prices and not the asking prices found on the B2B trading platforms. This ensures that the price data is as close as possible to the prices manufacturers and polished diamond wholesalers are paid. Therefore, the data collection should ostensibly be what retailers and jewelry makers are paying for polished diamonds.
Together, the cost of manufacturing and margin are suggested to be 15%. Taking the above formula, let’s assume a 0.30-carat polished diamond that is manufactured from a 1-carat rough diamond and sells to retailers for $1,500 p/c or a total of $450:
$450 / 1 ct – 15% = $382.50 P/C
The value of a 1-carat rough diamond that a $1,500 p/c 0.30-carat polished diamond is created from thus equals $382.50 p/c.