Demand driven diamonds

Avi Krawitz

De Beers is talking up the market and downplaying its production, as one expects it needs to do in the current economic environment. And it is not alone, as other miners follow suit.

As a result, the company has stressed two distinct messages since it reduced prices at the Diamond Trading Company’s (DTC) August sight. De Beers stated it will not make any further price cuts and that supply will be low in the short term. Philippe Mellier, De Beers chief executive officer (CEO), told a press briefing at the Hong Kong show this past week that DTC will not meet sightholder applications for the remainder of the intention to offer (ITO) period through March 2013.

Limiting supply will help De Beers maintain its price levels and Mellier drove home the company’s underlying message that despite the tough market, “the industry needs to be optimistic to ensure that prices will increase.

One expects higher prices to be a feature of the new De Beers shareholder structure as Anglo American’s shareholders want the best value for their investment while Botswana, which owns 15 percent in De Beers, needs to boost its budget.

But what is good for De Beers may not be good for the industry, despite the company’s proclaimed leadership position. As this column has noted before, mining companies are unable to trade down in a declining market in the same way that diamond traders can and should. Therefore with fixed costs to manage, their only option is to adjust supply to keep their price points in order to maximize their profits.

However, the fact that De Beers is limiting supply as a result of lower production is misleading. Rather, it has reduced production as a result of diminished demand. As one sightholder responded to Rapaport News, “DTC is not meeting its ITO’s because sightholders will [otherwise] continue to reject their goods.” Ultimately, the market is demand – not supply – driven.

Similarly, rough prices are inevitably a function of demand. Should sightholders lose money on their rough purchases they will eventually reject the goods and force suppliers to offer more affordable prices.

Such has been the experience in the past few months. Sightholders rejected DTC goods from the May sight until DTC adjusted prices in August. Since then, rough dealers have experienced improved margins while manufacturers are seeing some light at the end of the tunnel but report they are still losing money from cutting. It was clear at the Hong Kong show that it is simply more profitable to buy polished than cut rough and manufacturers are keeping their factories operating at lower capacities.

Mellier stressed that rough and polished prices are in equilibrium and next week’s DTC sight, which begins on Tuesday, October 2nd is expected to be relatively small with little-to-no price adjustments.

Therefore, De Beers proclamation in Hong Kong to lower supply through the next six months should be taken as a word of caution. Other miners have echoed that pronouncement.

ALROSA sales are down about 7 percent so far this year and its production is down by approximately 15 percent. Harry Winston said it has held back $65 million worth of rough to sell when the market improves, while Petra Diamonds noted that the market is expected to remain under pressure in the short term due to prevailing economic uncertainty.

Traders at the Hong Kong show expressed similar sentiment even as they left the event in a fairly positive mood. It seems they have grown accustomed to the lower level of demand that has been prevalent throughout 2012. The fair, which ran from September 19 to September 25, brought buyers who were selective – seeking mainly lower price point VS2-SI goods – and price sensitive – doing a lot of price comparison before making their purchase.

Traders estimate that consumer demand for diamonds will grow by low single-digit percentages this year, but recognize that retailers are realigning their inventories to hedge a prospective downturn. De Beers agreed with that assessment. Mellier said he expects China’s growth will be driven by expansion to tier-3 and tier-4 cities, while consumer demand in the U.S. remains stable and may get a boost from the recent decision by Ben Bernanke, chairman of the Federal Reserve, to inject capital into the U.S. market with another round of quantitative easing. The recent rise in consumer confidence may be testiment to that but time, and possibly fourth-quarter sales, will tell if that is indeed the case.

For now, there is business going on. But buyers are not building inventory and are testing prices. Suppliers at the show were prepared to adjust prices down slightly in light of the strong competition to obtain orders. During the week of September 20 to September 27, encompassing the show, the RapNet Diamond Index (RAPI™) for 1 carat diamonds fell by 0.6 percent (see graphs on page 1 of this report).

As a result, polished dealers and manufacturers are caught in the middle of a tug-of-war between mining companies intent on keeping their rough price points, and the lack of urgency for goods among polished buyers who sense that the market hasn’t yet bottomed out.

De Beers has put the onus on sightholders to hold their polished prices stable. But the polished market is only as strong as its weakest link among the major players. Or, rather it is the savvy polished dealer who is best working the downward market by selling cheaper to initiate future profitable turnover that sets the tone of the industry.

For as recent market trends have proven, culminating in this week’s De Beers announcement, the diamond market is demand driven and its outlook is therefore cautious. Reduced polished demand will ultimately translate to softer prices and result in lower supply throughout the pipeline.

Source Rapaport