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“Clash of Civilizations”

“Clash of Civilizations”

Contrary to optimistic assessments by primary rough sources, people in the various diamond centers and markets are reporting that business has not been as usual since the start of the year.

 

Dark Clouds Overhead

All large sales occasions - the November-December holiday season, Valentine’s Day, the Chinese New Year, the Hong Kong trade show and the just concluded Basel trade show – were disappointing to diamond traders. Sales projections by chain stores in America, Hong Kong and China are poor. Most of them are expressing reluctance to replenish their inventories and are adopting a policy of “playing it as it goes.” 

Is this the new face of the diamond industry – thriving diamond mining companies and very profitable primary rough sources at the top of the pipeline, followed by money-losing manufacturers that are forced to pay their last dollar for rough diamonds, only to then sell their polished at the lowest possible price at events formatted like bazaars or on online platforms? Now it is to the industry to reconsider its marketing strategy and logic.

A strong US dollar; the devaluation of currencies in some of the Asian countries; a dramatic drop of oil prices; new financial regulations in China and Hong Kong; the Federal Reserve's hesitation in raising interest rates, thus signaling that the US economy is still fragile; and the political developments in East Europe are all part of a dark cloud hovering over the global economic landscape. This cloud is affecting the diamond industry. It shatters confidence at all levels of the diamond sector, from manufacturing to the consumer.

According to market sources, an estimated $700 million worth of rough diamonds will be offered at the Sight this week, a quantity that is expected to flood the rough diamonds market. Does the market really need all these goods? That is doubtful. Some of this volume is due to the deferrals accumulated in the last few months. These are goods that Sightholders were scheduled to buy as part of their contractual commitment, but preferred not to for different economic reasons. 

Manufacturers have been able to accumulate some cash by reducing rough diamond purchases, manufacturing capacity and other expenses. These little pockets of cash might meet an excess supply of unreasonably priced rough diamonds. Sightholders are waiting to see the goods so they can make up their minds. To buy or not to buy? This is the question.

 

b2ap3_thumbnail_Ehud-Laniado---Courtesy-of-Baselworld.png

Courtesy of Baselworld 2015

The Non-Representative Positive

We might be getting the wrong message when we hear reports about a record number of participants at tenders or a high level of activity in the open rough market (also known as the ‘outside market’). One might erroneously conclude that there is very high demand for rough. However, the outside market supplies only about $100-$150 million of rough diamonds per cycle, or around 10% of the $14 billion annual supply. The overwhelming majority of rough diamond supply comes from the major miners

In reality, the strong activity we see is all about looking for a way to make up for the losses caused by buying high-priced rough in order to recover some of the expenses. The rush to tenders and open market sources is what manufacturers rely to get goods at a more reasonable price. It also enables them to choose only the rough diamonds that they can sell after polishing and make a profit that helps them maintain their operations during difficult times. 

They rush to tenders in hopes of buying parcels that fit these needs. This has been the reason for the buzz around demand for outside goods – those not sourced from the primary suppliers.

 

Rough Supply is “Pushed”, not “Pulled”

The cruel reality is that the buzz has diminished. There is a lack of confidence affecting the industry, and it is caused by a few factors. One is the fear from an overflow of rough diamonds expected to be poured into the market by primary sources, supply that is not driven by market demand but only forced upon Sightholders because of a their contractual commitment. 

Another factor is the drop in polished diamond prices expressed by a major polished prices platform and the reportedly poor results of the Basel show that has undermined the last strongholds of confidence. In Antwerp, Ramat-Gan, New York and Hong Kong, the markets’ sentiment is weak.

Analysts say that when business is as usual, the global rough diamond annual production of around $14 billion is all absorbed by manufacturers: an average of $1.4 billion per cycle, 10 cycles a year. Once polished, the value of the polished diamonds rises to around $22 billion per annum. Manufacturers sell about 60% of the polished soon after manufacturing directly to the retailers, representing the direct diamond market needs. 

The other 40% are used in other marketing channels such as jewelry manufacturing, auctions, private clients and to fulfill programs with retailers. In regular times, manufacturers do not have a problem with this marketing structure because they can make a profit on all selling venues. 

It is very different when manufacturers lose money on the majority of their output, as it is in the current market. For manufacturers, to stop losing money and start making a sustainable profit - the basic economical equation should solve the issue - rough diamond prices have to decrease.

Because of the polished diamond market, the manufacturing capacity since October 2014 has been reduced by at least 40% in terms of value. In light of the low level of polished sales and the reduction in manufacturing capacity, the market cannot absorb more than around $840 million worth of rough – 40% of the $1.4 billion per cycle supply – even at reduced prices.

Manufacturers complain that with the weak sales of the past several months and the sliding polished diamonds prices, it is time for rough diamond prices to be adjusted accordingly. Despite a certain reduction in the fourth quarter of 2014, rough diamond prices are still much too high compared with the current polished diamond prices. 

 b2ap3_thumbnail_Ehud-Laniado---Rough-Diamond.jpg

Rough Diamond

The Clash of Civilizations 

A clash is expected, a Clash of Civilizations. In one corner, we have the rational civilization of producers and primary suppliers who are maximizing profits for their shareholders. In the other corner is the Midstream, the civilization of the manufacturers who are at times reacting emotionally, driven by their fears of losing a source of rough or bank financing facilities instead of by real commercial needs. 

Normally, market forces should affect primary sources of rough by decreasing the high prices of various goods. However, when Sightholders are forced to buy because of contractual obligations – and not because of rational economic needs - the familiar economic forces of supply and demand are not at work. 

In both cases, offloading them on the manufacturers’ wagon in the current market might turn into a disaster. Another way might be reducing the volume of rough supply to the truly needed volume despite the contractual agreements. Reducing volume is of course the preferred method because simply reducing prices might have a counter effect of devaluing existing inventories and causing a loss.

Primary sources may sell reduced volumes at the same prices sold during the last sales cycle. This could lead Sightholders to accept their allocations, paid for by bank financing. Banks that provide financing to the diamond industry prefer to provide credit for purchasing rough from the large miners rather than to purchases at tenders or from outside sources. For these more profitable goods, manufacturers need to rely on their money.

 b2ap3_thumbnail_Ehud-Laniado---Polished-Diamond_20150323-073856_1.jpg

Polished Diamond

The Emperor Has No Clothes

The clash of civilizations might go to an extreme in a scenario of a mass resistance by clients to a big volume or high price supply by the majors. 

A crucial week is ahead for the diamond industry. Will manufacturers continue to make emotional purchases due to their fear of losing their source of supply? Alternatively, will they continue to purchase rough diamonds guaranteed to generate losses? Instead of polishing the rough, will they choose to sell it in the secondary market for a price that covers the interest on the credit they got from the banks to make the purchase? On the other hand, will someone stand up and declare that the emperor has no clothes?

In 1477, Archduke Maximilian of Austria proposed to Mary, the Duchess of Burgundy, with a ring set with thin, flat pieces of diamonds in the shape of an “M”. Since that early and possibly first proposal with a diamond ring, the industry saw its highs and lows, wars and financial crisis, failures and successes. 

Despite it all, diamonds have continuously been sold as a symbol of love and appreciation. In the near future, they may become more of a means of wealth preservation. The diamond industry is here to stay. Make no mistake; we will come out from under the dark cloud. We are better off making it happen sooner than later.

 

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 advisor.

 

 

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