Market update - The diamond industry's psychological Volatility Index

The diamond sector has a Volatility Index. Unlike the S&P 500 VIX (Volatility Index) it cannot be accurately measured. But it is very much felt in the gut feelings of diamantaires and it can become a fear factor.

When times are good, diamond traders have a near euphoric feeling which pushes prices of rough diamonds high, creating a disconnection between rough and polished diamond prices. When uncertainty reigns market sentiments, it causes depression, decreased prices and an unreasonable psychological slow down.

In the last few weeks, we have witnessed uncertainty and therefore depression among diamantaires. Polished diamonds are selling in unusually low volumes and rough diamonds are being traded at a much lower pace and price than just a few months ago.

If we could have correlated this virtual Diamond VIX to the S&P 500 VIX, diamantaires would have described the current market situation as ‘black’, an expression used in the financial markets. All traded indices would have stopped and/or crashed.

Diamantaires, especially manufacturers, in the midstream of the diamond industry, are professional survivors. They have had to survive the hardship of rough diamond purchases and polished diamonds sales. They are squeezed between the rough diamond producers, the jewellery retailers and the banks. These experienced survivors do not see ‘black’, they do not stop buying rough diamonds or selling polished diamonds, they are good at living in the ‘grey’. This is how I describe the current diamond-trading scenario - it is grey. This is the reigning colour and the current diamond market is moving along, all in grey. Grey rough purchases, grey polished sales, grey cash flow, grey bank financing, grey market sentiment. Grey as in bleak, uninspiring, unexciting, with no bright prospects, yet not a standstill. The diamond industry is in a grey limbo for the moment.

On the one hand, manufacturers are completely dependent on steady suppliers. Suppliers that steadily demand high prices for rough without adapting their prices to the changing demand for polished, or they react to these changes very slowly, while remaining out of tune with the market’s needs. Suppliers offering their rough diamonds through tenders are complaining that the prices they secured in the past month are not good enough because prices declined, driving them to consider holding off their tenders until prices rise again. The open rough diamond market is lingering due to limited capital and the natural reaction of the players in this market is a wait-and-see attitude. 

So how can a manufacturer ever buy rough at a real-time right price? If the interconnection and communication between the sectors of the excellent model of the value chain won’t change, they will never be able to make it. The value of the rough should be determined by consumers and their willingness to pay a price for the end product – the polished diamond - and not by any artificial factors. The reaction of diamond producers to current market conditions is rigid. They do not adjust fast enough to the feedback of the midstream manufacturers who are struggling to sell polished diamonds and create a cash flow that will allow them to buy more rough diamonds. The S&P VIX would have fallen to adjust itself to the polished diamonds market condition, but the diamond industry midstream is struggling with no external support.

Polished diamond sales are currently low. Most of the goods sold are the low cost goods which are suitable for fashion jewellery (as described in my article Creating crystal clear value for diamonds). It might be a good number of carats, but a low volume of capital. As a result, not enough capital is being accumulated to continue a reasonable level of commercial activity. The lack of proper financing and cash flow pushes the secondary market to buy on long term credits (90 to120 days) from those who have paid cash for their goods. It is very rare to find a secondary market client who will buy goods and pay cash even with substantial discounts offered by the supplier. The result is that after three rounds of rough diamond purchases the market might sink to a standstill because the generated cash cannot match the cost of new rough arriving in the market. 

The privileged firsthand buyers have paid the three largest diamond suppliers, tenders and the open market around $1.2 billion a month in the last three months - $600 million to DeBeers, $400 million to Alrosa and the rest through tenders, Canadian producers and other sources. According to my estimate, that totals around $3.6 billion paid out of their pockets.

Part of these goods are being polished, a process that takes 3 to 4 months, while the rest are sold into the secondary market with 100 days credit on average. But these diamonds too will enter a lengthy polishing process. No wonder that the market is what one might dare call constipated.

Unlike banks, which lend money against collateral, the secondary market is given credit based on reputation, trust, past performance, and size of company. Therefore, when rough suppliers to the secondary market leave now for their holiday vacation, they do so with worries about being paid. At the same time, the secondary market buyers see the relatively low level of polished diamond sales and ask themselves if they will meet their financial commitments to their suppliers or whether they will be able to finance their future rough diamond purchases.

That said, the midstream is composed of experienced survivors. They will make any effort to get through the current grey times. They keep their hopes strong, despite the dull results of Chinese Golden week, Diwali sales, trade fairs, Valentine’s Day, Black Friday and Cyber Monday. Being experienced survivors they are hoping for good sales in the last days of the Christmas and New Year shopping and the coming Chinese New Year which are still ahead. And when this is over, the 2014 cycle will end and the cycle of 2015 will begin.

Despite manufacturers’ survival instinct, producers should not think that this is business as usual. The current situation should lead rough diamond producers to do some soul searching, re-examine their position and initiate a program that will ease the pressure on the midstream. Retailers should also reconsider their position of always trying to reduce purchase prices instead of making an effort to add value in creative ways and by that take part in the efforts of easing the pressure on the midstream. Banks should join the effort and support the midstream players to overcome these grey times.

We all should remember that it is the midstream that is making most of the effort to deliver the end product at the cheapest possible price.  It is the midstream that transforms rough diamonds into polished diamonds and they are doing it bravely and efficiently. We should all join forces to support them. 

Demand levels for rough diamonds

Meanwhile there is not much of a change in rough diamonds levels of demand since our last update:

10 Carats (yielding 4 carats and larger in terms of polished diamonds) prices of high quality are softening while demand for speculative stones remains.

Demand for 5-10 Carats (yielding mainly 1 to 3 carats in terms of polished diamonds) is weak in better qualities due to a decline of prices in 2 and 3 cts polished yielded from those sizes, but speculative goods which need high expertise and extensive preplanning and preparation are in demand.

2.5-4 Carats (yielding mainly 0.75 to 1 carat in terms of polished diamonds) are weak due to a decline in the prices of 1 cts polished. It seems that inventories are piling up with 1cts polished stones.

2 Carats (yielding mainly 0.50 to 0.75 carat in terms of polished diamonds) prices of high quality are softening while demand for speculative stones remains.

1, 1.25 and 1.50 carats rough (yielding mainly 0.20-0.30 carats and up to 0.50 carat in terms of polished diamonds) are still in demand although the better qualities are a hard sell.

Melees and ¾ (yielding mainly 0.07-0.25 carats in terms of polished diamonds) are in demand, although the better qualities are a hard sell.

Smalls (Yielding 0.005 to 0.03 carats in terms of polished diamonds) are weak except for -6 industry sieve which are selling well at the moment.

Cleavage – complicated stones that need preparing and are priced under $100 p/c, are in demand.

Polished diamonds are being sold but at volumes which are too low and at decreased prices.

The markets are getting ready for the New year closure with high hopes but the sentiment is grey.

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.