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Forging a Path Ahead for the Diamond Market

Forging a Path Ahead for the Diamond Market

Let us start by stating an unstated truth: The world has much less desire for gem quality diamonds. Consumer demand is shrinking and the $23 billion or so retail sales of yesteryear that the industry was used to are not taking place today. It is important to acknowledge that.

Decline In Global Demand

There are many reasons for the decline in this figure. The economic recovery in the US is slow and less is spent on luxury goods. When Americans buy diamond jewelry they prefer lower price point jewelry that dictates lower cost diamonds. 

In China, the introduction and enforcement of anti-corruption laws have cut deep into diamond jewelry sales in in the country. At the same time, the rally at the local stock exchange in the past couple of years has attracted money that may have otherwise been spent on luxury goods. Recently, much of the earnings in the stock market were erased in a painful fall of the market and now investors have a feeling of loss and are even less inclined to spend on luxury products, including diamond jewelry.

The drop in oil prices hurt the economies of the Gulf states and other countries that depend on oil revenue. Russia, another country that depends on oil revenue, is also suffering from international sanctions.

On top of this all is the strength of the U.S. dollar, which pushed up the price of diamonds in countries with weaker local currencies such as Japan. For those with earnings in dollars, it created opportunities for investments in countries where the local currency has an unfavorable exchange rate against the dollar, which competed with diamonds for investors’ money.

Finally, diamond jewelry is not being marketed enough. Testimony to the above was displayed in the trade shows that took place in the past few months. The March show in Hong Kong that caters mostly to the Asian markets was weak, the Basel show that caters to the European market did not go well for jewelry, and the Las Vegas show that serves the North American market was disappointing. The June show in Hong Kong was poor for all, except maybe the thieves that got away with nearly $1 million worth of goods.

It seems that diamonds have lost their momentum. Consider the following photo taken at the Hong Kong show. Is this how diamonds should be sold, like potatoes in a Sunday produce market?

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Problems In The Market

Consumer demand is weak across the globe. Demand in the US, the leading diamond jewelry market, is mostly for jewelry set with lower cost diamonds – pique goods. The problem is that these diamonds are often byproducts of polishing higher end diamonds as the main stones. This is a problem because the higher-end goods are not selling. Can manufacturers polish only pique goods without also manufacturing high quality diamonds? 

The problems of what grade of diamond to polish are just the tip of the iceberg. The latest business failures and the ongoing talk about another wave of bankruptcies is an ongoing issue. Firms that were able to somehow keep on rolling seem to be giving in.

According to reports in the market, debtors are using diamonds, land and even real estate as part of their settlements with creditors to settle their debts. How did land enter the equation? If these reports are true, then this phenomenon is only adding to the liquidity crunch.

The midstream adjusted to the new situation and aligned its mode of operations accordingly: buying rough from miners, polishing the few profitable items and selling the unprofitable rough to the secondary market on long credit terms with high interest. This last part in itself must raise an eyebrow – how can a manufacturer profitably polish rough that is expensive to start with, and at credit payment terms that make it even more expensive. The rest of the rough first hand buyers either reject, return or (mostly) defer delivery when possible. 

Buying and selling of rough has shifted its emphasis from the goal of manufacturing, to trading where the profit is created from credit payment terms that raise the cost by around 1.5%-1.65%.

Of course, after a string of bankruptcies, traders are concerned about clients’ ability to pay and are afraid of providing more credit. As this continues, more first hand buyers will prefer to defer supply from miners instead of selling, and at some point, simply refuse the goods altogether if market conditions don’t improve. 

First hand buyers are so concerned that they prefer selling the goods for cash at a 5% loss for the peace of mind of knowing that they have retained 95% of their capital. Yes, a known small loss is preferred over a risk of losing much more.

The hot business in the industry today is to buy heavily discounted polished diamonds from distressed manufacturers. Some claim this is the most profitable business in the midstream today. 

To keep their factories busy, Indian manufacturers are offering their facilities for outsourcing activities, a transformation seen all over the world in a variety of sectors. However, sometimes that is not enough. After doing most everything in their power to avoid layoffs at their factories, some manufacturers are finding that downsizing is becoming unavoidable and some layoffs are taking place. These layoffs ease the burden of salary payments and decrease the pressure to buy rough.

Trying to keep their workforce was one of the lessons manufacturers learned from the 2008-2009 crisis. Then, nearly 50% of the labor force was sent home and attempts to rehire them when the market improved was met with resistance. Hiring new people and training them proved costly. The recent round of downsizing staff is revisable, but will once again carry a cost.

The conclusion many are arriving at in the market is that the companies with the strongest prognosis are mid-size companies, operating with little to no bank financing, with good knowledge of the manufacturing process, healthy capital and without operational bloating. The rest are facing uncertainty.

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Statistics Suggest More Problems Ahead

  • So far, most analysis about the diamond industry was done internally, by the trade press and a few others. Now, even CNBC and Bloomberg are talking about the industry’s hardships, the business failures and the unclear future. The banks, which are clearly aware of the situation, may find themselves forced to respond to increased public awareness of the problems. 
  • One of the last companies to close dealt in yellow and brown goods of the kind that are in relatively good demand in the market today, which suggests that even the stronger sectors of the market are in trouble. 
  • The market is practically flooded with expensive (meaning polished from expensive rough) 0.30-0.40 carat goods. What will happen to companies that hold large inventories of these goods, especially if this is their area of specialty?
  • Orders for the smallest goods (0.01-0.20 carats) are anemic.
  • An estimated 100,000 polishers and other staff members were laid off from factories in Surat, India’s diamond polishing center.
  • The upcoming Sight is estimated at $650-$700 million, however Sightholders have already asked to defer about 25% their allocations. In addition, a high level of refusals are expected as the industry’s needs are estimated by some to be only $250 million.
  • Rough diamond prices are slowly descending, but not at a rate that reflects the declines in the retail sector or the drama in the manufacturing sector. 
  • Prices at tenders are also slightly lower, but are attractive mainly because they are composed of smaller parcels, which makes them affordable to smaller manufacturers.
  • Clients of another major supplier say that the goods are expensive and not moving, and therefore refusals are expected there too.
  • Jewelry retail sales in the US have been declining continuously since October of last year.
  • Jewelry retail prices are declining, and lost more than 11% in a span of under a year.
  • Most of the activity in the midstream today is collecting debts and credit to prevent exposure to future bankruptcies. At the same time, everyone is asking himself, who can you trust, to whom can you extend credit?
  • Until recently, a significant tactic of the trade has been to roll its debts. Making enough to make the necessary payments and maintaining credit lines. At some point, as everybody knows, this game of musical chairs will end when the music stops, and at that point the banks will need to act.

 

The solution: market realignment

If the consumer market fell below ~$23 billion, then clearly everything needs to be realigned. Until now, the mines produced about $14-$16 billion worth of rough diamonds and sold them for cash to manufacturers. Even though it paid cash for the rough diamonds, the midstream sector had to finance the polished diamond output, as buyers got credit terms, and many retailers want the goods on memo with the option to return the goods. The midstream bankrolled the downstream. 

Today, after polished sales declined 30%-40% according to market players, the midstream sector cannot afford anymore to finance a growing polished inventory. 

There are two possible short-term responses to this problem: if global demand for polished diamonds sank from ~$23 billion to about $18 billion, adjustments in production should be considered in accordance with this decline. In this scenario, production levels would be reduced to reflect real supply needs.

The other option is to keep production at current levels and restrict supply to meet actual supply needs while the rest of the produced goods remain in inventory, as Alrosa did in 2008-2009.

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The proposed temporary period of reduced supply will give the economy of the diamond industry a chance to recover. Simultaneously, a comprehensive marketing campaign to rebuild demand at consumer level and restore it to the $23-$24 billion level needs to take place.

At the same time, the miners may consider credit facilitation, especially for those clients that have a proven track record and meet the highest banking standards. Ideally, manufacturers would like to see a complete moratorium on rough supply for three months – a step the Indian industry is already considering. That will help clear the pipeline, support polished diamond prices, create a few shortages in the market and serve as the first practical step to recovery. 

 

The Need for Realignment

The problems detailed above are not presented to depress anyone. These are facts of the market today. A path ahead is needed. Manufacturers are taking the straight forward options available to them – buying less rough, reducing work, cutting on workforce, making focused purchases at tenders of small and specific parcels. 

If the consumer market is below ~$23 billion, then the need for realignment is obvious – the entire pipeline needs to adjust to the new market reality. Rough diamond supply should be aligned with the goods that are needed and at a volume that meets current levels of demand, even if demand is as low as $10 billion annually or even less. Supply must be dictated by the consumer market.

If the entire pipeline works on the basis of credit, then so should the main suppliers. Making this change will serve as an expression of trust in the industry. At the same time, a substantial marketing campaign needs to be launched on the consumer level. Together, these steps will help clear the pipeline, support prices and – provided competition and any applicable principles are kept – will take the entire industry, across the value chain, on a path to recovery. 

 

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.

 

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