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A Rare Opportunity to Heal the Industry

A Rare Opportunity to Heal the Industry

It has been clear to me for about a year that the diamond industry is in a state of crisis. It has also been clear that some of the causes of this crisis are internal industry issues that should be managed internally. In light of this, I concluded that we could and should take advantage of the opportunity presented by this crisis to change some of the fundamentals and heal the industry that puts bread on our tables

Have we seized this important opportunity? Recent events point to a return to the old ways that led us to our current situation. These same ways may drag us back into a state of decline. In particular: poor spending to income ratio, rising polished diamond inventories, and declining asset values. 

The small rise in business activity during the holiday season, together with shortages in specific polished products and a small rise in demand ahead of Chinese New Year, generated a positive sentiment in the market and increased demand for rough diamonds. 

The problem is that the demand exceeded real shortages. Large firms, many with contracts to buy directly from the large miners, perceived that the long-term scenario had not changed but made large rough purchases anyway. Not because they needed the goods but because smaller firms were interested in them. The recent supply from De Beers and ALROSA was largely sold on to the secondary market.

According to market sources and my own experience over the past few weeks, secondary market buyers were initially willing to buy goods at premiums of up to 12%.

To put this in context, De Beers supplied $540 million worth of goods and ALROSA supplied an estimated $450 million worth of goods. With the goods supplied by Rio Tinto, Dominion, Petra, and a host of other miners, an estimated total of $1.25 billion worth of rough diamonds was supplied to the market. Allow me to ask the question: Is there a $1.25 billion shortage in polished goods in the market? 

Given the minimum 13% addition for manufacturing costs and profit to the cost of rough (the standard calculation is 15% subtracted from the polished wholesale price, which translates to a 13% addition to the cost of rough), is the retail sector in need of an additional $1.413 billion worth of polished diamonds? In truth, far from it. 

As stated last week, the shortages in polished diamonds are mainly for 1.00-0.60 carat and 0.10-0.20 carat rounds, in HIJ colors and SI1-I2 clarities. However, the rough supply was a full range of run-of-mine goods. This includes everything that comes out of diamond mines and covers a far wider range than just the goods currently in short supply. 

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The only conclusion to be drawn considering the limited shortages and the inflated supply is that supply is surpassing demand! This is not my conclusion alone. The market (at least parts of it) understands it too. The proof is in the declining willingness to pay premiums on rough. In the week after De Beers’ Sight, premiums and demand declined. During the past week, buyers were unwilling to pay any premiums on rough from any source. 

However, the damage has been done. The large supply is in the market, either paid for with scarce own capital or with borrowed money. This signals a return to the vicious cycle we just nearly escaped: large and mostly unneeded rough supply, paid for with expensive financing, fed to large factories only to end up in overflowing stockpiles of polished diamonds that is slowly but steadily declining in value. 

We know why this is happening. Small and mid-size manufacturers with near-idle factories needing to show their banks continued financial activity were willing to buy rough with the hope that we’d seen the back of the crisis. The larger companies were drawn into buying vast amounts of rough, even though they know there is no real need for it, because they just could not pass on the opportunity to make a quick profit.

It must not be forgotten – the midstream is the gatekeeper of the diamond industry! Even if smaller and mid-size companies lack the foresight or ability to hold back, it is the responsibility of larger firms, those that do have foresight and a broad view of the market, to calculate their purchases in an educated manner. 

Playing a responsible role may come with a cost for the midstream, but it also comes with a wide reaching benefit – their continued and improved livelihood and the health of the industry as a whole. 

Buyers who paid a premium at the most recent supply cycle did so on the speculation that polished prices will rise. This will have been very harmful should they prove not to. Such a move will have set us back after miners finally heeded our call to reduce prices and volume. The downward momentum seen until December must continue, with further adjustments in price and volume lined up with real consumer demand in the US and elsewhere. 

Now that miners have followed market forces, it’s time for us to step up to the plate. We must buy only the rough we need, and only at sustainable prices. We can turn things around. Let’s not miss the opportunity!

The views expressed here are solely those of the author in his private capacity. No one should act upon any opinion or information in this website without consulting a professional qualified adviser.

 

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