The diamond industry’s current situation feels worse than the 2008-2009 crisis and not without reason. One major difference is that the ‘08-‘09 crisis was due to external economic factors, while it seems that the current crisis is a combination of several internal industry factors, which can be summarized (in a nutshell) as follows:
- Shrinking profit margins over the last two years, mainly in the midstream of the diamond pipeline.
- Increasing need for bank financing, particularly among manufacturers and polished wholesalers, against a backdrop of a shortage in financial sources willing to back the diamond industry.
- High prices of rough diamonds leaving manufacturers unprofitable.
- Accumulating inventories.
- Decreasing demand for polished diamonds.
- Declining polished diamond sales.
- Low tolerance among traders for favorable payment conditions given a fear of defaulted payments.
While the 2008 crisis lasted about nine months, the current crisis has been building for the last two years, and yet, according to overall market sentiment, the industry might not have hit rock bottom. Last week's industry benchmark price list again indicated a decrease in polished diamond prices. To make matters worse, the falling Hong Kong Hang Seng and Shanghai SSEC stock exchanges do not bode well for the industry, very likely creating negative consumer sentiment and impacting on the availability of cash flow for consumers in South East Asia and elsewhere. It seems, in light of the above, that the end of the current crisis is not yet in sight.
Furthermore, unlike the 2008 crisis, which came after several profitable years for the midstream, which in turn absorbed the downturn and enabled ongoing sales of polished diamonds (though at lower prices and for less profit but still allowing the business to survive), the current crisis has left manufacturers almost unable to keep their businesses ticking over. Manufactures are being offered large volumes of rough diamonds by primary sources – including types that have low demand when polished – and at high prices given current market price achievability. The situation described above paints a clear picture – losses are inevitable.
Therefore it is not at all surprising that manufacturers prefer to bid in tenders. This method has several advantages: it grants them more control of the value and quantities they bid for; it allows them to opt for better assortments; it enables them to fence off potential losses and in return, to result with polished diamonds that are more likely to be sold while helping to keep their factories active.
Primary sector shows goodwill
Last week there were rumors that Indian diamond players were discussing a temporary halt on purchases of rough diamonds. Eventually, they decided to exercise self-discipline. That same day, some of the major rough suppliers announced a set of measures to support the midstream, allowing them to alter their purchases in accordance with their needs and capacity.
De Beers said that it "appreciates that it is currently a seasonal quiet period of trading," so for next week's July sight it provided sight-holders with the option to defer 25% more than the regular deferral allowance of the total allocation (excluding whole boxes of ex-plan). Unlike regular deferrals, which need to be requested in advance, decisions on these additional deferrals can be made at the sight after inspecting the allocated boxes and being quoted the price.
Alrosa has offered up to 20% rejections and another 20% deferrals for July. According to market sources, Alrosa is not reducing prices and apparently has increased prices for 5-10 carat diamonds. Rio Tinto Diamonds has decided to lower prices and has offered clients the option not to buy the goods at the two upcoming sales without repercussions.
Midstream caught in the middle
Despite the goodwill, rough diamond prices remain high. The fear is that a decrease in rough prices might cause a tsunami of bankruptcies. After two profitless years and exaggerated leveraging, the midstream is stuck with polished diamonds inventories that come from rough stock bought previously at prices which are considered now to be high . Now manufactures and polished wholesalers are left with stockpiles of polished diamonds, some of which were manufactured a year ago, with the full knowledge that their rough prices have most likely dropped by 20-25% in terms of current prices.
Meanwhile, credit facilities provided to manufactures by banks continue to cost, and it seems that transactions are being carried out just to serve these financing expenses.
Market players are currently questioning the assumption that the market can continue to absorb $23 billion of polished diamonds annually, as has been the case in the past. These same market players place the sum to-date as likely closer to $18 billion.
Towards a brighter future
So, with this in mind, it seems that a new approach should be considered.
If polished sales are slow, polished inventories might be too expensive and a decrease in rough prices might cause further losses. This makes it all the clearer, that a new approach is indeed required.
Whether it is the production or the sales of rough diamonds that should be accommodated given actual market needs, a major diamond marketing initiative is also required to help release the overload of polished diamonds inventories. This will kick start business and generate demand and cash flow.
These temporary measures will benefit all stages of the diamond pipeline until consumer demand is revived. Reducing diamond production, instead of reducing prices, may help producers protect the value of their stock.
The intermission in rough diamond sales will help the midstream overcome the current crisis and ensure miners of their clients’ continued existence. It will ease the pressure on their liquidity, and reduce the volume of their inventories as they sell off goods at the same time supporting current polished prices. Finally, it will minimize the threat of providing credit in a volatile market.
The downstream will not suffer from a reduction of rough supply as the pipeline has more than enough goods, including a wide range of diamonds in practically every category. Therefore, we should not expect a shortage in the coming months, but rather leading up to the important holiday season retail sales.
This may be a real win-win situation for all parties involved, including consumers.
Although it might seems as if these are austerity measures it may just serve as a key step towards a brighter future.
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 diamonds values) without consulting a professional qualified adviser.