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A call for change, a call for hope

A call for change, a call for hope

The diamond market is returning to business at full steam following the summer vacation. Now, in addition to issues that plagued it prior to the break, the industry must face those that have been troubling the global economy.

Global challenges

The global economy is encountering challenging times. The sharp decline in Chinese stock markets, the devaluation of the Chinese yuan, and the recent weakening of the Indian rupee together form a worrisome combination for the diamond industry, which depends heavily on these markets. The economic aftershocks felt around the world left consumers with a sense of uncertainty.

Market players are reporting declines in demand for diamond jewelry in China and Hong Kong. This is a troubling trend in all respects. 

Diamond market changes: a mixed blessing

Changes evident in last week’s sight were a mixed blessing for internal diamond market players. De Beers’ prices were reduced on average by 9% and the volume of supply was also reduced. Where previous sights had seen $600-$800 million, the August sight has been estimated at about $250 million. Both shifts – the gradual reduction in price and the reduction in volume of supply – were welcomed by most of the market, and correspond to moves that I have suggested in the past.

While most were happy with these changes, some regarded the reductions as having come too late. Some Sightholders also claimed that it was too little. They claim that while the price reduction for mid-sized goods was appropriate, the reductions for smaller and larger goods were insufficient. These Sightholders would like to see their prices reduced further. 

Alrosa maintained prices, but allowed contracted clients to turn down goods, contributing its part in reducing supply and avoiding less-than-necessary purchases. 

These are important steps taken by both major suppliers. Alrosa, it seems, is not reducing production. Instead, it is selling surplus goods to the Russian state repository, Gokhran.

Positive long-term outlook

I am optimistic about the positive long-term outlook for the diamond market and the reduction in rough diamond inventories is one reason why. However, the road to improvement is fraught with challenges. One such challenge is the expectation downstream that now, following the reduction in rough prices, prices of polished should also drop. Why should the price of polished be reduced even further? If that happens, instead of margins improving, they will remain at their current razor-thin levels – and we already know that the current levels are far from being profitable.

Retailers going bust

A recent string of closures – retailers in the US and Dubai leaving behind debts estimated in the tens of millions of dollars, and a number of midstream companies in the main diamond centers – are signs that the crisis is not yet behind us, and that many companies are struggling to keep their businesses afloat. Testament to that is that one of the companies that closed down specialized in I1 and I2 goods, which are selling well right now in the US.

How did retailers, which mostly remained one of two profitable sectors of the pipeline throughout the current crisis, generate such debts? The U.S. chains and other large jewelry retailers are making it through the crisis by selling price point goods. Independent retailers – commonly referred to as “mom and pop” stores, which often offer higher-end goods – are faring less well. 

Will these closures impact the banks in Dubai, which only recently started to provide financing to the industry? And if so, in what way? How will the veteran diamond-financing banks react to these closures? With even stricter conditions for providing financing? I hope not. This financing is the industry’s oxygen and lifeblood. 

Marketing campaigns lead the way forward

De Beers announced that it is going to make a “major investment” in a holiday marketing campaign to increase consumer demand for diamond jewelry during the year-end holiday season. This campaign will come in addition to Forevermark’s “a Diamond is Forever” holiday campaign. The generic diamond marketing will run in the US and China, the two leading consumer markets. This is another important and very positive initiative

These concerted marketing campaigns are designed to tackle another major challenge for the industry. That is the reported large volume of polished diamond inventories and a sense that global demand for diamond jewelry is not rising, and has perhaps even declined in the recent past. The generic advertising campaign, which will target men purchasing diamond jewelry as gifts for their partners for the holiday, is welcome and needed – as are any other advertising campaigns. For example, a campaign promoting diamonds as a potential store of value will hopefully result in an increase in demand and thus decrease polished diamond inventories.

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Fundamental issues need to be addressed

A closer examination of this entire diamond pipeline raises a number of questions. How is it that after all the price reductions, most of the sales to the secondary market are on credit? After all, these credit lines are one of the major issues hurting businesses. When we look at changes in the price of polished in inner industry trade, we see that companies lower prices to generate cash flow ahead of payments, and raise prices back after those payments have been made. 

Rough diamond price reductions started in 2014. Haven’t the prices been reduced enough to allow manufacturers to buy profitable rough diamonds with their operating capital? After all, an accumulated rough price reduction of some 12-33% has taken place since mid-2014, according to a Mercury Diamonds™ study, and confirmed by others. Manufacturers should have been able to generate positive working capital by now. 

Constantly borrowing means that there is always a lack of sufficient cash flow and financing payments that "eat" a company’s financial resources. Why did the drop in rough diamond prices not show growth in capital? How can a company grow if it can’t increase its own capital? Have polished diamond prices fallen as much as 25%? If so, there are more challenges for the entire pipeline yet to come.  

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Concerning credit

Sales to the secondary market are still typically made on 90-day credit. Not only do buyers still need credit, sellers may still feel that they have to sell for credit. While these credit terms are incorporated into the price, they may not cover their operational costs, and sellers may even lose on the transaction. 

The continued use of credit is not the only issue here. Despite the declines in rough diamond prices – for contracted clients buying from main producers, for goods sold at auction and in the free rough market – as well as continuing (albeit reduced) polished diamond sales, the only purchases being made aim to maintain the manufacturing business’ "head above the water." Moreover, if the major issue was their very low margins, then the reductions in price and volume should have given the midstream the ability to operate economically and generate a worthy profit. 

To underscore this point, think of the following: In the past few years, rough diamond supply was around $15 billion annually, or about $1.5 billion per cycle (there are 10 rough diamond cycles a year, about once every five weeks). In the past few months, the supply trend has indicated purchases in the region of $450 million per cycle. This includes supply from the major producers, rough diamond auctions and free rough diamond markets. This is not a volume of purchases for growth, only for rolling forward to meet obligations. 

The oligopoly structure of the rough diamond sector raises another question: should rough diamond prices be determined by a free market mechanism where prices rise or fall based on changes in demand by the consumer market for polished diamonds, or should rough diamond prices be influenced by reductions or expansion in supply by producers? This question plunges deep into the efficiency of the industry and its ability to respond quickly to the consumer market. 

Looking forward with hope

I may sound pessimistic at times in this column. I’m not. I’m mostly worried about the state of the industry and its members, our wellbeing as a viable trade. After every period of slower activity comes an improvement. My thoughts expressed here are geared at creating a healthier business in the long-term. Fundamental changes today for a better tomorrow for which we all strive. 

We have just returned from our summer vacations, rested, invigorated and full of energy. Right now we are looking forward to a period of prosperity. The September Hong Kong show is just around the corner, and most of the industry is looking forward to it with hope (some more, some less). It is true that the entire industry has been looking forward to trade shows and special sales occasions since September of last year. Let us face reality as it is, and never stop trying to improve our industry, whatever the situation might be. Only by understanding and analyzing the challenges, can we hope to find solutions. 

With reduced rough diamond supply, better rough prices, consumer-marketing initiatives, and a holiday season fast approaching, the entire diamond industry should be ready now to move onward and upward. 

The views expressed here are solely those of the author in his private capacity. None of the information made available here shall constitute in any manner an offer or invitation or promotion to buy or to sell diamonds. No one should act upon any opinion or information in this website (including with respect to diamond values) without consulting a professional, qualified adviser.

 

Hong Kong’s Rise to Diamond Fame
Diamond Centers – Dubai

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