Unlike many commodities, such as non-ferrous metals and steel that accelerated at the end of last year but slowed down in the spring and summer of 2021, the diamond market maintains the achieved high levels and is aiming at new ones. While for public and liquid commodities, the problem of limited supply is quickly resolved within the framework of normal market balancing, in the case of rough diamonds, the deficit becomes systemic. In July, ALROSA predicted the onset of a prolonged period of structural shortage, during which the supply would not match the demand. The inventories of rough and polished diamonds in the pipeline are at their lowest amid the continuing recovery in the jewellery sales markets, while the miners’ ability to ramp up the production is limited. The buyers are eager to fill the inventory gap, which has already driven a 16% rise in the rough diamond price index since the beginning of the year. Despite the fact that this growth significantly outstrips the dynamics of polished diamonds, and the stability of the market raises concerns among a number of its players, there are no obstacles on the way. Even the outbreak of the COVID-19 delta strain in India - although it made it difficult to sell diamonds in April-May - did not cause a full-fledged correction, thus, strengthening the conviction about the possible forming of a supercycle in the diamond market.
DIAMOND SALES
The diamond sales slowed seasonally in Q2, under the pressure due to the epidemiological situation in India. De Beers sold 7.3 mn carats at two its sights, compared to 13.5 mn carats at three sights in Q1, reflecting the impact of capacity cuts in India. The ALROSA’s sales in Q2 amounted to 11.4 mn carats, down 26% compared to Q1 due to its strong base.
The total sales by ALROSA and De Beers in Q2 turned out to be 15% lower than the historical levels for this period, VTB Capital notes, however, the two mining companies showed opposite tendencies in sales: the ALROSA’s diamond sales in May in the amount of $346 mn were 13% above its historical levels, while the De Beers’ sales were 31% lower. “The scale of the second wave of Covid-19 in India, where the majority of the world's diamonds are cut and polished, has led to reduced midstream capacity and subsequently lower rough diamond demand, during what is already a seasonally slower time of year for midstream purchases,” commented Bruce Cleaver, CEO of De Beers.
The COVID-19 situation in India improved in June, which reflected in the positive sales results. The De Beers’ June sight that fetched $470 mn was 23% higher than the previous month’s one, although it remained 16% below its historical average. ALROSA sold rough diamonds for $374 mn in June, which is more by 12% than its total sales in May. The final result was influenced by the auction held this month for The Spectacle, a 100.94-carat polished diamond. The rough diamond sales were 18% above the average for the period, slightly above VTB Capital’s expectations. The Q2 sales were $1.1 bn, 18% higher than the bank’s forecast.
The outlook for rough diamond sales in July-August remains optimistic, given that coronavirus-related restrictions in India have been almost completely lifted, and the diamond cutters’ inventory levels remain relatively low, VTB Capital says.
PROLONGED Shortage
In its notes to the results of the June trading session, ALROSA emphasized that the market was entering a period of a prolonged shortage of rough diamonds when supply will not match demand due to limited inventories of the mining companies and midstream.
“The demand for rough diamonds remains high. The inventories in the diamond cutting and polishing sector in India are still quite low, while the recovery continues in all key jewellery markets. At the same time, against the backdrop of a structural decline in diamond production at a number of deposits, the mining companies’ inventories approached their minimum values. Since the beginning of the year, the diamond price index has noticeably recovered from its last year’s decline returning to its “pre-Covid-19” level. At the same time, in our opinion, the possibilities of the mining companies to increase their production are limited,” commented Yevgeny Agureev, Deputy CEO of ALROSA.
The current limited supply of rough diamonds coupled with strong demand leaves no choice but to balance the market through higher prices, BCS said. “Such favorable market conditions combined with a seasonal effect towards the end of the year may support the ALROSA’s sales in the future,” says the BCS report.
differences IN ROUGH AND POLISHED DIAMOND PRICES
The shift in the supply and demand balance in the diamond market allowed De Beers and ALROSA to simultaneously raise their prices. In June, ALROSA and De Beers, taking advantage of strong demand and reduced stocks in the midstream, increased their rough prices by 3.5% to 5%; since the beginning of the year, the rough diamond prices have risen by 15%-19%. For De Beers, this was the fifth increase in the last eight months. Sources in the market expect ALROSA to raise the prices again in July.
According to Rapaport sources, the discrepancy between the demand for stones of higher and lower quality persists: the 1+ carat rough diamonds rose in price by 5% or more, while the smaller stones - by about 3%.
Compared to rough diamonds, the growth in polished prices is less - the Rapaport index for 1-carat stones has grown by 11% since the beginning of the year.
This discrepancy is alarming, the Rapaport agency writes in one of its July Weekly Market Comment. High rough diamond prices weigh on the profitability. “Rough prices surging out of control with some secondary market premiums over 10%. No assurance that polished prices will follow rough price increases. Manufacturing profit margins [are] under pressure,” the report says. Rapaport industry analyst Avi Krawitz writes that even the rough diamond price increases might be justified by the robust demand in the polished sector and activity on the secondary rough market, the price increases will hurt the market in the long run. According to him, there is some expectation that ALROSA will raise prices again at its July sale.
Traditionally, Rapaport cites the opinion of skeptical sightholders about the sustainability of the market. “The rough market is taking jumps that are not justifiable. Goods are being sold just because they are there,” says one of them.
VTB Capital also draws attention to the fact that the dynamics of the rough diamond price is far ahead of the dynamics of the polished diamonds (by 5-9 percent on average). In this regard, and due to the possible seasonal lull in the coming months, VTB Capital expects the price growth to stop for some time. “With high retail sales (despite the lagging dynamics of the diamond jewellery sales) and the inventories lower than normal, we believe that the polished diamond prices could close the gap in growth compared to the rough diamond price growth in the coming months,” the investment bank’s report says.
In June, the polished price growth accelerated to an average of 2.2% against 0.7% in May, with preference also given to larger stones. 1 to 3 cts polished diamonds rose in price by 2.4-4% compared to the previous month.
MIDSTREAM
In the coming months, the polished diamond price will also be supported by the situation in the Indian cutting and polishing industry where backlogs and labour shortages persisted in June due to travel restrictions. The market dynamics have improved compared to May, responding to the improved epidemiological situation.
India’s net rough diamond imports in June grew by 1.9 times compared to 2019, to $1.64 bn, reflecting the growing rough diamonds sales and supplies to the main cutting and polishing hub. A month earlier, the growth in the rough diamond imports was less, by 33%.
India’s net polished diamond exports grew by 14% in June compared to the same period in 2019 (up to $1.91 bn) after slowing down (5%) in May, but still below 35% in April.
These statistics allow us to speak of the decreased inventories, and, according to VTB Capital estimates, the Indian cutting sector has avoided a significant accumulation of inventories during 5 months of intensive rough diamond purchases.
RETAIL
The end-user demand remained consistently high in May in all key markets. In the United States, the jewellery sales in May grew by 51% compared to 2019, in China - by 49%.
The sales made by Signet, the largest diamond jewellery retailer in the United States, are up 18% year-on-year. The figure hit a record despite a decline in store traffic, which was more than offset by higher prices. The Chow Tai Fook’s like-for-like gem sales in April-June rose by 14% year-on-year on the back of the buoyant consumer sentiment. At the same time, the dynamics in this segment were inferior to the gold jewellery sales, which soared by 66%. The Luk Fook’s gem sales rose by 27% in Q1.
The inventories in retail, according to the VTB Capital estimates, remain below the norm. The turnover of the largest publicly traded diamond jewellery retailers in the US and China in Q1 2021 was by 12% below their historical average. A quarter earlier, the turnover was 5% lower. These dynamics suggest that the retailers still have insufficient inventories, which improves the outlook for the polished diamond demand.
As vaccination rolled out, the US consumer confidence bounced back to near the pre-pandemic levels in June, but the spread of COVID-19 delta strain makes the outlook very uncertain. The dynamics of the COVID-19 infections in July-August may be crucial for the sustainability of the sales recovery in the retail sector, VTB Capital believes.
GOKHRAN’s SALES
This year, a significant event in the global market may be the sales from the Gokhran stocks motivated by the rise in rough diamond prices. The Gokhran’s sales stipulated by the Russian budget’s plan are rather low and amount to $70 mn (including the potential sales of precious metals), but in July, Gokhran spoke about the possibility of selling the previously accumulated rough diamonds for a larger amount in order to benefit from the post-pandemic recovery in the global demand. The exact volumes and terms were not announced.
According to the VTB Capital estimates, over 13 years, Gokhran has accumulated diamond stocks worth about $1.1 bn, which is equivalent to almost 60% of the total market shortage in 2021-22. So far, Gokhran has not carried out any significant sales: the sale of the Gokhran’s rough diamonds fetched under $100 mn. But large-scale sales - worth $500 mn or more - will become an obstacle to further growth in the rough diamond prices and may create a risk of accumulating the inventories by ALROSA, VTB Capital believes. One of the scenarios may be the ALROSA’s purchase of the entire volume of the rough diamonds that Gokhran wants to sell. The Aton investment company also believes that Gokhran’s sales are an opportunity for ALROSA to replenish its inventories, but intensive sales, over $50 mn a month, may contribute to a decrease in the world rough diamond prices during a seasonally calm period.
INCREASING the PRODUCTION
The production of the largest producers in Q2 and H1 of the year turned out to be restrained and the inventory level reached another minimum, which supports the thesis of a limited supply.
The De Beers’ production forecast for this year, despite the growth in Q2 by 15% compared to the previous period and by 134% compared to the same period last year, slightly decreased, from 32-34 mn carats to 32-33 mn carats, depending on the market situations and the scale of any further failures associated with COVID-19. The company has already cut its annual forecast twice due to the operational problems at its mines.
In Q2 2021, ALROSA reduced its production by 8% compared to January-March, to 7 mn carats, mainly due to a seasonal increase in the processing of sands with a low diamond content. During H1 of the year, the company’s production increased by 6%, to 14.5 mn carats, due to a low base last year when operation was suspended at a number of its low-margin deposits.
Some of these assets returned to full production last year (the Aikhal and Severalmaz mines), the production at the rest mines resumed this year. In June-July, ALROSA resumed its production at the Zarya and Zarnitsa pipes that were under care and maintenance last year. Despite their low production (in 2019, Zarya and Zarnitsa accounted for less than 3% of the ALROSA group’s total output), this move may indicate that the company is accelerating the restoring of its pre-crisis production level of 37-38 mn carats by 2022, Aton believes.
Meanwhile, ALROSA still plans to produce 33 mn carats this year, the company’s baseline scenario assumes an increase in its production to 37-38 mn carats by 2024. The company has considered ramping up its production in the medium term through a number of operational improvements, but its potential appears to be limited.
By the end of June, the ALROSA’s inventories decreased to 8.4 mn carats from 12.8 mn carats at the beginning of April, thanks to the sale of about 4.5 mn carats of its inventories in Q2.
Sergey Bondarenko for Rough&Polished
