Rough diamond market report: accounting issues, price hikes and a quiet market

Edahn Golan

It’s never boring in the rough sector of the global diamond pipeline. De Beers is proposing a new contract – simplified, with important additions, but still troubling in a way. Alrosa is making apparent moves to protect itself from possible sanctions by the U.S. and European Union, while prices, oh the prices, they are a whole story in their own right.

De Beers price changes

De Beers’ Sight three was a good size Sight, estimated at $650-$680 million, included some price hikes for a total change of an estimated 3.5-4.0 percent and very few goods were left on the table by Sightholders. All this comes against the backdrop of a certain cooling in the market, which raises the question – why so many goods, at a higher price and with few refusals.

De Beers’ price hikes are viewed as a late reaction to the hot market in January and February. Then, De Beers took a moderating step of maintaining prices. Some buyers say that if De Beers had left prices unchanged, it would have had a stabilizing impact on the market and stopped, or at least limited, the annual seasonal price seesaw – rising in the first quarter, softening during the summer and declining in the last couple of months the year.

In the eyes of one seasoned trader, the March price hikes caused harm when the market is slowing. De Beers, on the other hand, feels that not raising prices would have resulted in wild speculative purchases ahead of price hikes in April or May. We will never know.

De Beers is proposing changes to the Sightholder contract in the next contract period, including foregoing the thick questionnaire known as the CPQ. Without it, all current Sightholders will likely remain clients and their supplies (Sights) remain the same.

If you are not familiar with De Beers’ supplies to Sightholders, you should know that Sightholders get allocations of specific goods (known as “boxes”). In the new contract, De Beers is suggesting that if a Sightholder refuses a certain box, he will lose that allocation. Because the contract is in the consultation stage, i.e., De Beers is consulting with Sightholders before finalizing it, Sightholders know of this idea and in reaction are not refusing any boxes at this stage.

The result: With less demand, a surplus of goods on the market and higher prices, Sightholders are stocking up on more and pricier goods. While international Sightholders (those that have a “London” Sight) refused very few goods, we heard one report that many goods were left on the table at the regional Sights in the producing countries. According to one account, as much as 20 percent were left on the table in Botswana and Namibia.

The decline in demand is also why Sightholders applied for very little ex-plan (additional goods). It’s important to note in this context that “cooling demand” does not mean a decline in rough prices across the board, but only that as one buyer put it, we reached the ceiling” and prices cannot and should not move any higher because the polished diamond prices don’t allow it.

One item that is seeing continued strong demand are the 4-8 grainers, which according to one report, are even seeing premiums increasing. Demand for 2.5-4.0 carat goods has weakened and according to one account “stopped.”

A noticeable decline in demand is seen for the smaller, lower cost items, priced at below $100 per carat, such as the 1 Col Rejections (H-L) +11/+7 box. They are among the items where prices were hiked by De Beers (in this case by 4.7 percent to $54.42 per carat) and created an odd situation. Every year before March 31, the last day of the Indian financial year, there is a rush towards the cheaper goods by Indian manufacturers. The reason is inventory balancing, as explained in the last Rough Report.

Now that a new financial year begun, the need for these goods by the larger firms drops and the price hike missed the tide. Worse, many of the polishers that use these goods (as in polishing them) are smaller companies with fewer financial resources that now can’t afford them, so the price hike may have actually harmed the little (real) demand there is for these goods…

Adding to the usual list of issues that concern Sightholders is one of payments. According to one Sightholder, payments are very slow.

The price increases were not limited to lower cost items that are now in lower demand. The price of a box known as Commercial 2.5-4cts was increased by 3.4 percent to $2,008 p/c even though demand for this item has decreased as the table below shows.

Other noteworthy price increases include Cold Fine 2.5-4 cts, up by 4.6 percent to $1,926 p/c; Select Makeables 2.5-4 cts that were increased 4.6 percent to $1,926.32 p/c and Spotted 2.5-4 cts, up 10.6 percent to $1,118 p/c.

Items where De Beers decreased prices include Preparers Low 3-6 grs, which were priced at $73.40 p/c, down 4.0 percent and the Brown Gem 2.5-14.8 cts box with prices decreased by 3.3 percent to $1,358 p/c.

New Sightholder contract

As early as last year, former DTC CEO Varda Shine said that the next Sightholders contract won’t include the CPQ, the in-depth questionnaire that was part of the Sight application that helped De Beers determine who will get a Sight, which goods will be included in the Sight and what percentage of a specific item will be allocated. In the eyes of many, the CPQ was overly intrusive.

What’s emerging today is that without the CPQ, it is understood that all current Sightholders will have their contract renewed (unless there is a major problem, such as a breach of Best Practices Principles – BPP). The issue is that without the CPQ, there is no way for De Beers to really assess the changes in Sightholders’ need, and therefore there is a good chance they will get the same or a very similar Sight. Some are grumbling about it because they are seeing a growth in their business and would like to get a larger Sight.

In addition to complying with BPP, applicants will be measured on past demand such as ex-plan purchases, meeting their ITO, and buying from auctions. In that context, the $3 million threshold of purchases of a certain box at the De Beers auctions (formerly Diamdel), may increase to $10 million, a much higher hurdle to leap over.

Financial requirements

An important component considered for the new contract is a more rigorous financial compliance criterion. De Beers wants to require Sightholders to adopt a stricter financial reporting standard, IFRS compliant.

This is something that the financing banks are demanding as well as part of their desire to better track the money they have lent. With a growing need for transparency, Basel III requirements, the rising cost of lending and higher risks, banks want their borrowing clients to adopt corporate accounting standards that would make it easier to understand what is happening in a company. Banks want to know how the financing is used, what is bought and where the goods are going, as well as to track payments to understand how the money is flowing in.

I’ve reported about this in the past, calling the banks the New Custodians of the market. They took responsibility for the situation in several ways (including a decision to cut back on financing Sight purchases) and started to lead a change that may eventually result in a far healthier industry.

This requirement cannot be underestimated. If De Beers enforces this, it will trickle down to mid-size firms and sideways as a demand by other mining companies as well from their clients.

For example, those without IFRS reports, have a comment by the auditors that they cannot attest to the value of the diamond stocks and relying on company statements and expertise. This allowed companies some leeway in terms of the value of their stocks. Under IFRS, auditors will need to sign on the value of the stock. Because they are not diamond experts, external assessors may be needed or auditors may rely on internal inventory management software, all of which will result in narrowing a company’s ability to play with the stock’s value.

Another aspect of the financial demands includes a company’s leverage and debt ratios. One idea on the table is that the turnover-to-equity ratio will be 20 percent. For the very large companies, those with an annual turnover of hundreds of millions or billions of dollars, that could be a tough requirement to meet as it would be for dealers that turn their money 10 times a year.

This means that these changes may usher in a new era in the diamond industry, one of clearer financing, improved reporting standards and a further decrease in financial wrongdoings.

Alrosa sales and new options

Alrosa may have a closer ear to the ground than De Beers. At a time when there are many goods in the secondary market, Alrosa offered fewer goods and did not increase prices, much to the relief of its clients.

When a large miner, such as De Beers or Alrosa, has a long-term supply contract with a company, it delivers the rough diamonds to where the company is based. The exception is with De Beers’ Sights in beneficiation countries.

Alrosa, perhaps worried about possible sanctions by the US and EU as a result of Russian intervention in the Ukraine, has circulated amongst its contracted clients a questionnaire asking about other legal entities that are part of the clients’ group of companies and where they are located. The idea is that if an Antwerp-based client has a company in Mumbai, the goods could be delivered to India instead of Belgium in the event that the EU imposes sanctions on Alrosa.

This is possibly bad news for Antwerp as a center. Antwerp imported 22.8 million carats of Alrosa diamonds worth $2.8 billion, accounting for 25 percent of Antwerp’s total import of rough diamonds, according to the AWDC.

From Russia’s perspective, Antwerp accounts for 50 percent of its total rough diamond exports in terms of both volume and value. According to our calculations, those figures may be a little lower, however the important take away is that sanctions by the EU against Alrosa would have a horrendous impact on the company. That is why it is already considering the contingency plan described above.

What should worry the AWDC is that changes tend to be long lasting. If allocations are diverted from Antwerp to Mumbai, they may never return to Antwerp. That should be a cause of concern for Antwerp – and one of joy for the Indian diamond sector.

Demand for key DTC boxes following march Sight
Article Demand Remarks on demand
Fine 2.5-4 cts & Fine 5-14.8 cts Medium demand Lower demand compared to previous Sight
Crystals 2.5-4 cts & Crystals 5-14.8 cts Medium demand Same demand compared to previous Sight
Commercial 2.5-4 cts and 5-14.8 cts Medium demand Lower demand compared to previous Sight
Spotted Sawables 4-8 gr Medium demand Same demand compared to previous Sight
Chips 4-8 gr Medium demand Lower demand compared to previous Sight
Colored Sawables 4-8 gr & Colored 2.5-14.8 cts Good demand Same demand compared to previous Sight
Makeables High 3 gr +7 Medium demand Lower demand compared to previous Sight
Preparers Low 3-6 gr Medium demand Lower demand compared to previous Sight
1st Color Rejections (H-L) +11/+7 Low demand Lower demand compared to previous Sight
1st Color Rejections (H-L) -7+3 Low demand Lower demand compared to previous Sight

Source Idexonline