1st Quarter of 2015 in Review

All large sales periods – the November-December holiday season, Valentine’s Day, Chinese New Year, Hong Kong and Basel trade shows – were disappointing to diamond traders. Worse, looking forward, sales projections by chain stores in the US, Hong Kong and China are poor. Most are reluctant to replenish their inventories and are adopting a “playing it as it goes” policy.

A dark cloud hovers over the global economic landscape, indicated by: a strong US dollar; weakening Asian currencies; plunging oil prices; new regulations in China and Hong Kong; a fragile US economy; and political developments in Eastern Europe. The diamond industry is suffering against this backdrop. Confidence at all levels is shattered, from the manufacturer to the consumer. The only thriving sector of the industry, according to their own 2014 fourth quarter reports, are miners.

Is this the new face of the diamond industry? Mining companies thriving off high priced rough at the top of the pipeline, while loss-making manufacturers pay top dollar for rough only to sell the polished product at rock bottom prices? The industry is perhaps reconsidering its strategy and logic, indicated by the large level of refusing to buy rough.

Polished Diamond

State of Confusion

Market players report that polished diamond prices are in a “state of confusion,” as asking prices deviate significantly from what buyers are willing to pay. Manufacturers and traders sell at lower prices when liquidity is badly needed.

Confusion among industry leaders and market makers is contributing to the lack of confidence across all industry sectors. Contradictory statements about the current and future status of the diamond market, and current prices, abound.

Rising asking prices in a weak and falling market by two price benchmarks has contributed to the confusion mode. Could it all be because a few traders skewed the benchmarks by uploading their inventory lists to the platforms with full list prices, and not at the common discount prices?

Boosted Liquidity and Financing

More and more financially sound rough diamond dealers who profit from selling rough on short payment terms are now offering longer payment terms, allowing the secondary market some breathing air, while providing sellers with a chance to boost sales and collect payments on time.

Manufacturers prefer buying either smaller, cheaper goods or run-of mine – the full range of sizes and qualities produced by a mine. Cheaper goods allow manufacturers to run their factories with relatively low capital investment, while buying run-of-mine enables production of a wide range of polished diamonds. It has become difficult to predict what type of diamonds will be easier to sell. However, having a whole range reduces the risk, enabling manufacturers to sell at the highest demand.

Manufacturers prefer to purchase from primary sources – bank-financed transactions – or to buy only what they need in the open market or at tenders, at prices that allow their factories to cover expenses. They buy rough diamonds only to fill the volume gap necessary to run their factories.

The silver lining is that while Antwerp Diamond Bank is closing and other banks are reducing credit and financing, Indian and Israeli banks stayed firmly committed to the industry. Furthermore, Dubai banks have stepped in to fill some of the gap in the industry’s financial needs. Bloomberg recently reported that Barclays Plc has started lending to diamond dealers as it seeks to expand in southern Africa.

Have the diamond industry’s financing issues been resolved? Not entirely. But a breath of fresh air has certainly pumped into the industry’s liquidity pipes. This may explain why rough purchases persist despite small volumes of polished sales.

Lack of direction

In similar situations in the past, large players made significant purchases of rough diamonds to inject liquidity into the market. Sadly, there is no such leadership in today’s market.

The industry must act with caution. Any major price decreases, of rough or polished diamonds, will decrease inventory prices. Such situations have been overcome in the past. But it remains to be seen whether the industry can withstand the pressure without leadership or liquidity.

Representatives of the major diamond producers/miners held a meeting in London. The participants met to discuss key issues facing the diamond industry: lab-made goods and marketing.

According to a Bloomberg report, attendees included representatives from De Beers, Alrosa, Petra Diamonds, Gem Diamonds, Lucara Diamond, Dominion Diamond, Lukoil and Rio Tinto, which hosted the meeting.

According to the report, few details were divulged about the meeting, which focused on diamond marketing, industry research, and the threat to consumer confidence from undisclosed lab-grown stones entering the market.

Is this a first sign of regenerated leadership?

Unreasonable Rough Prices

Manufacturers expect the price of rough diamonds to fall. They are unsure what price to buy at, but they will seek to spend what’s left of their cash flow in return for the best possible value.

The value of rough should be determined by what consumers will pay for the end product – the polished diamond. Diamond producers’ reactions to market conditions are rigid. They don’t respond fast enough to feedback from midstream manufacturers struggling to sell polished diamonds, to create cash flow that will allow them to buy more rough diamonds.

Rough Diamonds

In the Hands of the Manufacturer

Have manufacturers understood their power in paying cash? Are they willing to forego their fear of losing a source to turn a profit? Perhaps, if they realize that by making only “political” rough purchases they will not survive. They won’t continue to buy from sources that are trying to maximize profits by narrowing midstream margins without analyzing repeated negative feedback from manufacturers. Those manufacturers have had to buy at any price to preserve their positions with major suppliers.

The optimal solution may be a careful price reduction. While this would ensure a healthy margin for manufacturers, it won’t cause severe damage to the value of existing inventories, which could be disastrous. A balanced price reduction could help reduce the average price of inventories at a moderate pace and even lead to positive cash flow.

Since October 2014, De Beers Sightholders have hoped for relief from their supplier. They claim to have paid very high prices for six months, making them unprofitable. De Beers does not agree. When Rob Bates of JCK asked Mellier in an 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 maximize their profitability.”

Major producers repeatedly declare that manufacturers should take responsibility for their margins by conducting more competitive business. Some producers are involved in every aspect of the industry pipeline, from mining to running retail shops. According to analysts, their retail activities are not profitable. What does this mean? Isn’t this just what’s happening across the industry pipeline?

Polished Diamonds Bottleneck

Manufacturer inventories appear high. According to many manufacturers, they have paid very high prices for rough, yielding expensive unsold polished diamonds, which has resulted in large inventories and negative cash flow.

The polished diamond pipeline is overloaded. We estimate that some $8 billion worth of polished diamonds is on offer on trading platforms and a further $2 billion worth of polished diamonds is awaiting grading at gemological laboratories. This is one of the reasons that most companies are in tight financial positions. Until these diamonds are sold, cash flow remains a major issue.

Polished Diamond

Reduced Manufacturing Capacity

According to Indian market sources, manufacturing there has dropped some 40% in value since late November. Factories are closing on weekends, working hours reduced and manufacturers are polishing smaller and cheaper goods, requiring less capital.

Indian manufacturers say they intend to reduce polished diamond inventories until they align with demand. Market forces are likely to push the industry to reduce inventories and buy less rough until the pipeline clears.

Falling Polished Prices

The mood in the diamond market is hesitant. This is unsurprising considering decreasing prices and that China and Japan, leading polished diamond markets, have been consistently weak. More and more goods have been directed to America where sales are strong. Could this see supply outstrip demand in America, leading to further decreases in polished diamond prices?

The Clash of Civilizations

A clash of civilizations is expected. In one corner are the rational producers and primary suppliers that maximize profits for their shareholders. In the other corner is the midstream – manufacturers who can react emotionally, driven by fear of losing a primary source or financing facilities instead of by real commercial needs.

Market forces should affect primary sources of rough by decreasing prices. However, when Sightholders are forced to buy because of contractual obligations – not because of rational economic needs – the forces of supply and demand do not apply.

Offloading product on the manufacturers’ wagon could prove disastrous. Alternatively, rough supply could be reduced to the actual needed volume despite contractual agreements. This is the preferred method because simply reducing prices could devalue existing inventories, causing a loss.

Primary sources may sell reduced volumes at the same prices as the previous sales cycle. Sightholders could then accept their bank-financed allocations. Banks that finance the diamond industry prefer providing credit for purchasing from large miners rather than at tenders or from outside sources. For these more profitable goods, manufacturers must rely on their money.

According to market sources, some $730 million of rough diamonds was offered at De Beers Sight 3. This quantity is likely to flood the market. It is doubtful that the market needs all these goods.

The Manufacturer’s Dilemma

Manufacturers have accumulated some cash by reducing rough diamond purchases, manufacturing capacity and other expenses. These cash pockets might meet an oversupply of unreasonably priced rough diamonds. Sightholders were waiting to see the goods so they could decide. To buy or not to buy? This was the question.

According to Sightolders, Sight 3 was one of the most difficult in many years. With $730+ millions of rough diamonds offered at the sight flooded by deferred, unwanted rough diamonds from previous sights, they faced a huge dilemma as we reported in previous updates: “To buy or not to buy?”

ITOs (Intentions To Offer) for the forthcoming contract period were announced based on Sightholders’ acceptance of the March allocation. Refusal of goods may impact their ITOs for the upcoming contract period. This created the pressure to buy as much as possible.

If 35% of the sight of $730 million was refused, will manufacturers again turn to tenders and the open market to fill the gap between primary supply and the real needs of the industry?

Trade Show “Bazaars”

Evidently, the diamond industry’s mood now depends on the next trade vent. With Chinese New Year, Valentine’s Day, Hong Kong and Basel trade shows behind us, the focus shifts to the upcoming Las Vegas Show.

Our day-to-day professional life has become preoccupied with the next sales event. In a market with undefined polished diamond prices, the next trade show could be the one that lifts the fog.

Trade shows have become a way of life in the diamond industry. Huge halls packed with thousands of exhibitors presenting their diamonds – from the simplest goods to the most extraordinary.

Are trade shows the proper venue for such precious and rare a product as a diamond? After the huge efforts involved in purchasing rough, recruiting and training a work force, massive capital investment and extensive financing, we bring our inventories to exhibit in hangars. Is this the way to sell a diamond?

Competition between exhibitors can become intense. Well-established manufacturers – strictly regulated and closely supervised on ethical issues while facing high overhead costs, R&D investments, and an expensively trained work force – find themselves in the same hall as small manufacturers with hardly any chance of covering costs. The small manufacturer is hopeful, wanting to break into the big league. Knowing that he has very low overheads, he offers lower prices. A buyer may not care if his supplier has a large and sophisticated facility or small and rackety one, since the buyer’s chief concern is spending less.

This is an unhealthy situation. When competition is on price alone, everybody loses: the small company won’t recoup its show costs, while the large company is forced to sell as though at a Bazaar, and may have to offer longer credit terms or buy-back procedures. Clients lose because they will never get decent service and do not stand on their own feet, relying on inner-industry credit. Were these issues discussed in the producers' London meeting?

Beneficiation

Governments believe they should generate economic benefit from rough-diamond production on top of royalties and taxes. They call it "beneficiation.” They expect manufacturers to build factories, train and employ local workers, construct buildings, pave roads or otherwise contribute to the local economy.

However, it seems that the existing models are not functioning well. Recent reports have indicated that three major diamond-polishing factories in Botswana have had to close operations.

Many other countries experienced the same fate. First Sierra Leone in the 1960s, then the Central African Empire in the 1960s and ‘70s, followed by Canada some ten years ago and Namibia in the early 2010s. In each case, factories were built, staff trained, rough diamonds supplied, but high costs and inefficiency proved these ventures economically unfeasible.

In order for beneficiation to work, manufacturers must be able to buy reasonably priced rough diamonds. They should have close control of production lines with the necessary infrastructure and support of a knowledgeable and professional workforce. These elements are apparently more important than lower wages. The efficiency and experience of the midstream must be heeded.

Disclaimer:

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.

About the author

Diamond industrialist Ehud Arye Laniado is a man passionate about diamonds. From his early 20s in Africa and later in Belgium honing his expertise in forecasting the value of polished diamonds by examining rough diamonds by hand, till today four decades later, as chairman of his international diamond businesses spanning mining, exploration, rough and polished diamond valuation, trading, manufacturing, retail and consultancy services, Laniado has mastered both the miniscule details of evaluating and pricing individual rough diamonds and the entire structure of the diamond industry. Today, his global operations are at the forefront of the industry, recognised in diamond capitals from Mumbai to Tel Aviv and Hong Kong to New York.

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