Market update - Mixed reviews and growing tensions

Retail sales results from Christmas 2014 are in. Mixed reviews and uncertainty dominate the picture. Against a backdrop of potentially concerning global issues, we are also seeing a growing tension between diamond producers and manufacturers on issues of pricing and stock.

According to the US Bureau of Labor Statistics, specialty jewellers sales in November 2014 declined by 7.1% year on year. Tiffany’s chairman and CEO Michael J. Kowalski echoed this in a statement about the company’s November to December holiday season. ”Clearly, the holiday period was disappointing overall,” he said, prompting Tiffany's stock to drop considerably. The Wall Street Journal stated overall retail sales were slower by double digits than the previous year. 

Positive news emerged from reports indicating many independent jewellery stores have done well. Signet reported sales at stores open more than a year increased by 3.6% during the holiday season. Diamond jewellery sales at Amazon were up this holiday season by 12%. 

Meanwhile, diamond trading activities are picking up in New York and the general sentiment is on the rise. However, this needs to be substantiated by sales, which may take longer than usual because major retailers are still holding on to their older inventories and new orders may come in later compared to previous years.

The Asia Pacific markets have generally been solid during 2014 with a slight decline in the second half of the year as Japan and China showed a relative weakness. 

Hong Kong diamond dealers are back to work and a slight improvement is palpable in anticipation of Valentine's Day and the Chinese New Year. 

But the reality is that amongst diamond traders and manufacturers no-one really knows what the right price of polished should be. The diamond trading centres in India, Belgium and Israel are in a kind of stalemate due to a very uncertain future. Clarity will come after the results of the holiday season diamond jewellery sales are announced, revealing the extent of demand levels and with it the orders for polished diamonds. We are also awaiting news of the level of supply and prices of rough diamonds from De Beers and Alrosa. 

Thanks to weaker than expected sales, likely to result in high levels of inventories, it is reasonable to assume that there is a lack of liquidity in the diamond markets. 

The diamond industry has experienced similar limbo situations in the past. Simple rules of market forces were imposed on the major producers then. They had to sell less and lower their prices if only on limited volumes.  In turn, manufacturers had the opportunity to offload their old inventories and buy rough diamonds at prices which allowed them to make a profit. After a while, manufacturers started to pay premiums for rough diamonds and producers brought their prices and production volumes up again. This of course was linked to consumer demand.

Another direction in which market forces settled this limbo situation was by making producers freeze their rough diamond prices, reduce supplies, and allow manufacturers to defer buying goods, which in turn helped them with their cash flow. An improved cash flow was created and prevented manufacturers from decreasing polished diamond prices sharply. Gradually, manufacturers were able to improve their cash flow and buy rough diamonds again. When producers eventually reduced sale volumes for a while, manufacturers did not have to rush and sell polished at all costs and polished prices decreased moderately, while rough diamond prices were kept at reasonable levels with no premiums paid. Manufacturers used their positive cash flow to purchase new rough at reasonable prices until premiums were up again and producers then raised their prices and the cycle continued. This was again linked to consumer demand for diamonds.

Analysing the reactions from De Beers and Alrosa to the current situation in the market, in seems that market forces are playing their role. According to initial reports from the De Beers sight this morning, De Beers has reduced prices by 3 to 5%, depending on the type of goods. The assortments of the boxes according to these reports are better, which means that the price reduction is possibly even larger. The sight is currently estimated at $400   million to $450 million with no ex-plan. Because the sight started just a few hours before publication of this article, a different picture may eventually emerge. Unlike De Beers, Alrosa has not lowered prices, according to traders.

Prior to the sight, De Beers sightholders had hoped for consideration by their supplier. Sightholders say they have been paying very high prices in the last six months and now say they are unprofitable and deserve some relief. De Beers does not appear to agree. When Rob Bates of JCK asked Mellier in a recent interview “What is your sense of how much Sightholders are making on their boxes?” Mellier responded: “Customers’ profitability is important to me. I want sound and healthy customers. But I am not responsible for the margin of my customer. They are responsible for their margin. It is down to them to maximise their profitability.” 

Major producers repeatedly convey the message that diamond manufacturers should take the responsibility for their own margins by conducting a more competitive business one way or another. Some producers are involved in every aspect of the pipeline - they mine, sell rough diamonds, manufacture polished diamonds, make jewellery, provide their own certification for diamonds and run their own retail shops. According to market analysts, their financial reports do not show profits from their retail activities. What does this mean? Isn’t this a mirror image of what is going on through the entire pipe line of the diamond industry? 

Manufacturer inventories appear high at the moment. What’s more, their balance sheets are in the red. According to many manufacturers, they seem to have paid very high prices for their rough, yielding very expensive polished diamonds which they are now stuck with. All this has resulted in inventory losses and a negative cash flow, according to many manufacturers. 

Let us review the current market situation:

According to market sources the strongest polished diamond market these days is the US. Goods sold in the US are of the smaller and cheaper price points, which refers to goods serving the fashion jewellery market. This means that in order to appeal to a wider range of consumers, jewellery items are sold at the lower cost range of the scale, which does not help cash flow.

Many of the sales of the larger and better diamonds occurred among traders and therefore no new money entered the system. 

With the tightening of regulations in China, sanctions on Russia, the bad mood in the Gulf Countries due to falling oil prices, blocked financial markets and last week's explosion of the Swiss Franc, probably causing a sharp increase in the price of Swiss made watches and jewellery - world sentiment seems gloomy.

This sentiment has pushed the Indian diamond industry to regroup and reduce its manufacturing capacity by around 30%, according to local market sources. Indian manufacturers say they intend to reduce polished diamond inventories until they are aligned with demand. The upcoming closure of the Antwerp Diamond Bank, which has been the talk of the market, is now impacting it.

Market forces are now likely to push the diamond industry to reduce inventories and buy less rough diamonds until the pipeline is cleared up. 

All of this will be tested over the coming week when the leading miners hold a week of sales. If sightholders pay and take the goods and secondary market manufacturers pay premiums, it will be business  as usual. But will they? Manufacturers are experienced survivors and will hopefully pull through again. The question is - at what price? 

As in the past, market forces will take their course.

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. Nothing on this website can be construed or constitutes an offer or a recommendation to sell or to purchase diamonds or the solicitation of an offer to purchase any diamonds nor does it constitute an offer or a recommendation to sell or to purchase any security or financial product or the solicitation of an offer to purchase any security or financial product.