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Time to Stop and Reassess

Time to Stop and Reassess

January saw a rise in demand for rough diamonds. All market players, including myself, expected this demand to quickly fizzle out before February. Lo and behold, the increase in demand has been sustained. This gives us some serious food for thought.

A picture of the current market

This is what we are currently seeing in the market: 

• In light of demand from De Beers’ Sightholders, the Sight opening today (Monday) is expected to be similar in size to the January Sight, i.e.  approx. $500 million.

• Attendance at rough diamond tenders seems to be breaking records and recent tender results have been higher than expected.

• There are still polished diamond shortages in several specific categories, which has appeared to flame demand for rough diamonds.

• The small volumes of supply in the fourth quarter of last year, together with the better than expected retail sales during the holiday season, have improved cash flow for diamond manufacturers and wholesalers.

• Credit line usage in Belgium has decreased to an estimated 50% according to market sources.

• Indian banks have recently been supplying local traders and manufacturers with large quantities of financing, estimated in the hundreds of millions of dollars.

• The prices of polished diamonds in the 0.14-0.50 carat, one-carat, and several larger size categories have increased in recent weeks, in some cases, significantly so.

The retail sector is not improving

These all appear to be signs of an improving market. But are they? Let’s stop and take a closer look at the situation described above, specifically regarding retail sales and polished diamond prices. The rise in retail sales in the US was, overall, not so large, estimated at only 2.5% during the holiday season. A nice change of pace, true, but not enough to give rise to a larger spike in rough purchases or a huge increase in polished diamond supply to the market. 

In China, Preparations for the Chinese New Year was another driver of polished diamond demand during January. However, jewelry sales in general, and diamond jewelry in particular, suffered from a sharp decline and did not meet expectations for a shifting trend. The largest Chinese jewelry retailer, Chow Tai Fook, reported a 20% year-over-year decline in overall gem-set jewelry sales, and a 30% year-over-year drop for mainland China. Clearly, the demand generated in January is not sustainable and so the optimism felt in the midstream should be short lived.

The improving prices relate to goods that are in short supply, not for any other goods. Therefore, demand for rough diamonds that yield the polished items in short supply is reasonable. Demand for all other rough goods is anything but. Inventories, we all know, remain bloated. 

Possible prognosis: oversupply

Some $1.25 billion worth of rough diamonds were supplied to the market in January. If supply during the second cycle of the year will be similar in size, manufacturers will need to absorb $2.5 billion worth of rough diamonds. Now, let’s assume that supply in March will be very small, only $500 million. This means that in the first quarter of 2016, the midstream will be flooded with some $3 billion worth of rough diamonds.

If more than $3 billion worth of rough diamonds are to be supplied during the first quarter of the year, they will be ready to be sold as polished during the second quarter of the year, traditionally a slow quarter for diamond jewelry sales. 

So here is the question: How will the midstream – manufacturers and wholesalers – sell polished diamonds worth some $3-3.5 billion? Can the April-June period provide such a  market? We have just seen that the market is hardly growing during the most important selling periods. How do we expect to sell as much during a slow period? 

The second quarter is slow, but the third quarter, July-September, is traditionally the slowest. If the midstream is unable to sell most of the goods during the second quarter, is it reasonable to expect that retailers will absorb a large supply during the third quarter? Not at all. During the third quarter, most traders, buyers and jewelry makers are on vacation. Consumers are also on vacation and during this time many of them are focused on back-to-school expenses.

Are we heading towards another year of oversupply for rough and polished diamonds? Will consumers once again turn their backs on diamond jewelry, opting instead to spend their hard-earned cash on other consumer items?

b2ap3_thumbnail_Ehud-Laniado---Heart-Polished-Diamond.jpg

Time to reconsider our priorities

I am not alone in my concern. Many others market players have expressed anxiety over this trend. We must take a moment to ask ourselves many important questions and now is the time to do so, before we fall back into potentially harmful patterns. For example, does not the decline in credit usage in Belgium, while financing spikes in India, indicate a contrast between the cautious and the risk takers? Is this risk worthwhile and beneficial in the long run? 

I do not believe so. The proof is in the small number of business failures in Belgium over the past year compared to the very large number of business collapses, bankruptcies and closures in India over the same period. 

If diamond miners see the growing demand from the midstream, a demand that comes with sizable premiums paid by the secondary market, won’t they increase prices? Of course they will, especially if they are public companies desperate to provide shareholders with some good news (and returns). 

Where are the gatekeepers? If the situation described above is understood by the midstream’s top companies, then they should know that now is the time to slow down and avoid short-term gains made off the backs of less-informed and short-sighted companies! If the weaker companies and those acting with excess capacity for financing buy expensive rough and find themselves stuck with inventories they cannot sell, not only might they themselves fail, but their closures will hurt the stronger companies with which they do business. This means that primary buyers that sell oversupplied and overpriced rough to these weaker companies are shooting themselves in the foot! 

We saw how well-considered marketing initiatives promoted business in the US during the holiday season. It was enough to generate a small improvement in sales, but it wasn’t enough to make a large change. Should we not start thinking about marketing for the 2016 holiday season?

These are some of my concerns and thoughts on the current state of the diamond pipeline. What are yours? Do you also feel that now is the time to continue the change by reducing supply, dropping prices, trimming excess financing, investing in long-term marketing plans and finally turning the industry around?

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.

 

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