Many prominent representatives of the rough and polished diamond business are apt to think that the market has hit the bottom and will rebound in the nearest future. Diamond stocks are gradually diffusing while diamond demand is starting to grow which holds out a hope of price recovery within three or four months to a level sustaining a positive profit margin in mining. It is expected that the next DTC sight will wind up selling $700 million worth of rough and by Christmas time or in the first quarter of 2010 at most the market will stabilize on price levels around 30-40% above the last February least values. If this soft and pleasing scenario will miraculously come true, we shall have to admit that the diamond market is peppier than other markets in weathering out the global crisis and consequently its current framework is thoroughly meeting the requirements of time and therefore does not need any fundamental modernization.
Some of the opponents offer a less rosy picture. Analysts of Frost & Sullivan believe there will be no short to medium term pick up in rough demand whereas South African diamond production is expected to continue to decline for at least the next year and a half. This opinion is shared by analysts of Royal Bank of Canada Capital Markets (RBCCM) saying the market has not yet bottomed. Israel’s bank community being clearly sympathetic with their RBCCM colleagues has curtailed crediting the diamond cutting industry for more than 30%. Banks do not believe in an immediate recovery of polished demand and it should be admitted they have all the unbiased reasons for that. Unemployment in the United States has hit a 25-year high, while the Japanese economy is plunging even faster – the spending power of the population in these countries accounting for about a 60-percent polished market share continues to go down. The first quarter of 2009 displayed an unprecedented profit slump in companies which own world-famous jewelry brands (for instance, Tiffany & Co. posted a net profit 62.7% down compared to one year ago). China is unlikely to set off this gap in some way – so far we can witness vigorous (though not very much successful as was the case with Rio Tinto) attempts of independent funds and companies in China to acquire primary assets worldwide but not at all stimulate domestic demand. Chinese export which provided for 50% of the country’s GDP is currently sliced by half and the actual unemployment level nears the 40-million notch.
These data are quite concordant with the pattern devised by Professor Nuriel Rubini of the New York University who predicted the current crisis as far back as 2007. Dr. Rubini believes the recession will take at least nine months while its aftermath in the shape of financial imbalances will have its impact for no less than two years. Besides, a second crisis wave appears highly probable since many countries are now raising their budget deficits. The currently observed stock market movement is just a short-lived speculative upswing, a way of utilizing the excessive funds injected into economies by central banks which skipped the production sector because it was dangerous to deal with it due to unreasonably high risks.
This rather pessimistic scenario suggests that we have to forget about any stabilization of the global diamond market until at least 2012. But what will happen to diamond mining if demand for polished diamonds in the United States, Japan and China will insignificantly oscillate near the current level in the course of two years? In other worlds, will De Beers and ALROSA controlling about 70% of the diamond market have enough guts to continue their existence unchanged in an environment where diamond mining will be plainly loss-making?
The safety margin of De Beers is evidently dependent on its relations with Anglo American plc. Will the latter be able to maintain its “diamond department” afloat for such a long term the way it is maintaining it now? Available information is clearly insufficient to give an answer to such a delicate question. To some extent this uncertainty is removed by the estimate given by Anglo American plc itself: judging by the LSE quotes the position of one of the biggest global mining companies is far from being excellent – currently its stock is traded 40% lower than last summer while the situation in the global automotive and metal-making industries does not offer any bright outlooks as far as price movements for platinum and coal are concerned. It is clear that at current prices De Beers’ own sales and its credits obtained from Anglo American plc make it hard to reach at least a breakeven point in mining.
Unlike De Beers, ALROSA has not stopped its mining operations and continued to supply rough diamonds to Gokhran, a state repository. The coming sale of its oil and natural gas assets later this year is to become yet another source of replenishing the Russian company’s budget. Totally, both sources give it about $1.7 billion which may be sufficient to maintain and develop its mining operations, fulfill its borrowing and credit obligations as well as social programs. It is noteworthy that the above funding sources and consequently the prices of the deals are not related to the market and stipulated by the protectionist policy of the Russian state towards the company it owns and on the list of strategically important enterprises. Protectionism is a benefit so far there is a reserve fund to rely on, but what will happen if Russia will have to finance its budget deficit from foreign loans?
The positive point in the opportunity to get government aid is by far offset by ALROSA’s obligation to maintain the extremely cost-consuming infrastructure of Western Yakutia and not very modern construction projects of capital-intensive underground mines to say nothing of the fact that the company has not pursued its own independent marketing policy during the whole history of its existence. There are many other objective and subjective circumstances affecting ALROSA’s economy though the three mentioned above appear quite enough to acknowledge that at the current price level diamond mining both in Yakutia and Arkhangelsk is unprofitable.
If we consider the situation exclusively from the business point of view, then support rendered in any way to both miners at the existing prices for their products appears deprived of any sense making it necessary to stop their diamond mining operations. The problem is that such a decision will not be limited to bringing about serious social consequences in the diamond-dependent countries of Africa and in Yakutia. If the major diamond miners will leave the market it will virtually mean actual elimination of the “diamond mining pipeline” and liquidation of the market as such. Of course, consumer demand for diamond jewelry depends on spending power of the population, but in no smaller measure it depends on marketing impelling consumers to buy these things. It is impossible to overestimate the contribution made by De Beers in this kind of marketing; ALROSA’s participation was also worthy – at least expressed in the profit obtained by De Beers from its longstanding partnership with the Russian company. Annihilating this factor accompanied by a prolonged decline in rough prices is capable to convince the consumer that diamonds are by far not for ever.
The pessimistic scenario for polished demand recovery suggests the only solution capable to preserve and further develop the world’s rough and polished diamond market, which involves a comeback to monopolistic price control. And the most efficient way in this context, although the least probable as it should be admitted, would be a merger between De Beers and ALROSA resulting in a super-monopoly known capable to guarantee the existence of the “diamond pipeline” for many decades to come. The number of obstacles on the way to such a merger is enormous, but staying apart these companies risk to fail in their efforts to survive the crisis, while their alliance would bring the market back to its canonic shape in which it continued its successful existence for over one hundred years.
There is a good reasoning that the current market has enough diamonds coming from Africa and ALROSA’s problems may well be left to this company and they should not bother De Beers very much. To some extent it is true but it bears calling to memory what gave the start to broad-scale cooperation between De Beers and the Soviet Union (at the time, the USSR and the Republic of South Africa had not even maintained diplomatic relations). The business foundation for such cooperation was laid by the gigantic reserves of the Mir Diamond Pipe which could either wildly inundate the market or make the Soviet Union part of the global diamond cartel. This was what virtually happened. Any solutions based on the “stand alone” strategy will inevitably bring the diamond-mining companies to competition which will drive rough prices down and provoke such “surprises” as one-time dumping of huge stocks accumulated by either of them to the market. That would be good if it were grain, but who needs price unpredictability in the luxury symbol?
For ALROSA a merger with De Beers would allow optimal implementation of its technological projects, first of all in underground mining, and significantly improved marketing of Russian diamonds. In its turn, De Beers having gained access to Russian raw minerals on a partnership basis would forge quite a mighty argument in its dialogue with African colleagues as well as obtain support, including financing, from the Russian government in the period of recession.
So far at least one of the parties (ALROSA is a state property) has financial leverage for such a project – it is proved by the fact that Sberbank bought a stake in Opel. In the beginning of June, IG ALROSA (ALROSA’s subsidiary) said it was capable to invest about $10 billion into building a large metallurgic cluster in Southern Yakutia. This investment choice taking into account the state of business and outlooks in the world’s iron-and-steel industry is far from being obvious. One half of the above amount would suffice to make De Beers’ technology and marketing potential coupled with ALROSA’s promising mineral resources base set a stable tack in developing the diamond market. The only problem is formalities including stereotypes of bureaucratic institutions (like the European Commission, for instance), positions taken by national governments in diamond-mining countries and private interest. The diamond market history displays only one law: diamonds should be predictably expensive for consumers. Hence, diamond miners will be forced in one way or another to try and avoid price competition with each other. It means the problem is just to find a facade…
Rough&Polished
