Excess capacity of manufacturing infrastructure, plus excess capacity of manufacturing, plus excess capacity of financing, minus production demand, equals price of production decline! This is the rule we need to remember, as it not only applies to today’s diamond market - it is also a rule to live by.
As stated here time and again, an excess of bank financing leads to both excess in rough diamond buying and excess in manufacturing capacity. The combination of these with apparently a lack of caution on the part of several manufacturers led us to where we are today.
The excess in bank financing is to my knowledge most visible in the Indian market, where borrowing and credit results in an over-leveraged diamond center. The excess in manufacturing capacity takes the form of very large manufacturing facilities in India and China. These facilities are so large that often only in the best of times do they reach full capacity. But the “best of times” are brief peak periods – not the norm, as the past decade proves.
Moreover, the number of such facilities is high, making this not a company issue, but an industry issue, because of how they draw on industry resources. It makes it difficult to protect jobs and maintain a high quality, well-trained cadre of polishers that generate goods in excess of commercial demand.
The result is rising inventories to the point of excess supply of polished diamonds.
In the early part of the year, rough diamond sales surged forward in response to better-than-expected jewelry sales during December in the US. This was helped by lower rough diamond prices and a rise in demand from China ahead of the Chinese New Year.
It was clearly not the end of the crisis that the industry suffered in 2015, but rough diamond purchase were wide and deep – a wide range of goods and at large quantities, so much so that the leading miners, most notably De Beers, limited their own sales.
When the missing polished diamond items in demand were replenished, and demand subsided, you would have expected that purchases of rough would subside as well, but that was not really the case. Rough diamond supply continued to rise and only started to decline early this summer.
To date, De Beers alone supplied more than $3.5 billion worth of rough diamonds to the market. Together with ALROSA, about $5 billion worth of rough diamonds were supplied to the market. All of this while demand for diamond jewelry in the US saw no improvement, Chinese demand during the New Year did not meet expectations, and sales in Japan continued their decline. Only in India are sales steady, but they are not rising in a meaningful way.
The result is a return of the buildup of inventories in the midstream of the diamond pipeline. The basic supply/demand rules of economics apply to the diamond industry in the same way as everywhere else: when supplies increase and demands decrease, prices come down. And that is what we saw happening in the recent past, as the Mercury Diamond Global Tracker™ shows:
The RAPI index of 1 carat round diamonds and the IDEX Online polished diamond index show the same trend. Conversely, equity and bonds are rising, as the indices in the following graph shows. At a time when the markets are generally rising, diamonds should rise with them, but that is not the case.
Part of the issue is a lack of marketing – without it there is less demand, but the excess in supply is an important component of the problem.
It is important to understand that the miners sell what they have, and that is the full range of a mine’s output. Unfortunately, demands are limited to specific goods. Therefore, the midstream is buying almost anything offered, and polishing all of it, but are currently only selling the specific items that are of interest to the consumer market.
The rising inventories and limited demand are going to stay here for a while – if nothing changes. Sadly, I see continued purchases of rough diamonds and during Sight week trading is at a high enough volume to create premiums, which further fuel demand for rough diamonds.
Most of the demand for polished diamonds (by volume) for the November-December holiday season is behind us. Jewelry manufacturers are already deep in their season to meet delivery deadlines starting in late September. This means that many of the sales for 2016 are largely done, even though it is only August.
There are a few positives on the horizon. Most of the demand for larger goods, loose items that are at stores ready to be set on demand, is still ahead of us and could surprise us. The diamond centers in Belgium, Israel and US are on vacation, creating a cool-down in business. In late October, the Indian diamond industry will go on Diwali vacation, slowing rough diamond purchases and polishing to a great degree. These periods, when traders are away on vacation, are when prices are fairly steady.
If we take a wide and rational look at the business environment that the diamond industry as a whole is operating in, we can’t help but conclude that a slowdown in rough diamond purchasing is needed until inventory levels decline. As long as inventories are high, demand limited and financing continues as usual, we will suffer from a poor competitive edge and even desperation to generate a cash flow to support the continued rough purchase/manufacturing/financing costs combo. Basic economic pressure will force continued polished price declines in the future.
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 adviser.