In Russia, there is an omen: you will live the new year the way you celebrate its advent. If we project this omen on the diamond market, its players may face quite an equivocal year. On the one hand, rough prices (after 6 months of rapid growth and several months of torpor and decline) seem to have stabilized and come into line with polished prices. On the other hand, the forecasts for the global economy in 2012 do not give a positive sparkle at all. You may also add here the fact that the major market players - De Beers and ALROSA - are in the process of great change.
Roller coaster
Before the beginning of 2011 experts, of course, predicted a rise in prices for rough diamonds. But hardly anyone could have imagined that reality will surpass the optimistic forecasts in such a big way. In January, the market was gently "gathering pace", but in February, it "shot up." At their first sight, DTC raised prices for rough diamonds: according to the official information they went up by 8-9%, while market players said they soared up to 22% in some categories.
The momentum picked up from the beginning of the year was maintained during the next few months. The company raised prices for rough on a monthly basis, and often at double-digit values at a time. "Indian goods" were particularly quick to go up in price.
Remarkably, the soaring prices were optimistically treated by the participants of the diamond chain and stayed unchallenged. Although just a couple of years ago, even a singular move to raise rough prices by 10% caused a lot of resentment. But this time the market seemed to be bathing in euphoria: rough prices were recovering after their crisis fall of 2009, and this recovery seemed to confirm that the streak of bad luck had passed, and all saw just a bright future ahead. Similarly, recovery from the crisis was confirmed by the global economy: up went global indices, industrial production and consumer spending. Rough prices reached their pre-crisis level as early as the first months of the year, but the buzz in the market was further fueled by lack of rough, available credit and optimism about the future – this is why the growth was never thought to stop. As a result, diamonds rose in price by more than 50% in the first six months.
However, the growth was more based on speculative factors, rather than on fundamental reasons. Of course, rough was evidently in short supply, but this was not associated with reduced output of global manufacturers - just the opposite, they were reporting about their plans to ramp up production. And demand from the real consumers, diamond cutters, grew much more slowly than prices.
According to market experts, on average, the global output of rough diamonds is about $12 billion, and these are used to manufacture about $80 billion worth of luxury goods. In the process, manufacturers and diamond cutters earn some 10% margin – in other words, a major increase in price occurs in that part of the diamond pipeline, which is engaged in reselling the stones. The more so that the ground for such activities is more than gracious. For example, a DTC “box” includes diamonds of different categories, quality and earning power, but buyers may take it only as a whole, without the right to select suitable materials only. As a result, there is sufficiently high demand for services of dealers assorting certain diamond lots to meet the needs of particular diamond cutters - but, of course, such stones get more expensive. And again, the list of sightholders is not so long – so, those who missed the opportunity to be on it (or on the list of long-term contracts with ALROSA) have to buy rough at auctions, which automatically means a premium to the initial price of diamonds (since you have to “outbid” your competitors).
In short, slowly but surely the market saw another speculative bubble being inflated after the same pattern as it happened in 2008. And the denouement of this story was generally quite predictable.
Already in the summer it became clear that customers were not able any longer to keep pace with the rapid growth in diamond prices, faced with a liquidity crisis: with every other month coming, you could purchase fewer and fewer rough diamonds using the available credits. It usually takes several months to get refund from retail. This was one of the reasons why polished diamonds grew in price slower than rough diamonds. At some moment rough diamonds got once again more expensive than polished stones made from them.
Then there came a “warning bell” from U.S. bonds, and the market froze - at first in anticipation, and then shocked. Possible repetition of the 2008-2009 situation became increasingly apparent. Rough prices first got frozen (especially since August was traditionally a no-business season) and then rolled down. In an effort to maintain demand and at the same time lock in profits market players began losing their nerve - for instance, BHP reduced prices by 15-20% at a time. By mid-autumn auctions were already being canceled one after another (there were just no bids if no discounts were made for opening prices), and even DTC made concessions to clients offering, for example, delays in payments.
For some time major manufacturers tried to contain the situation using the already tried out method - by limiting the supply of rough to the market to avoid price deflation. De Beers almost halved the volume of their sights and ALROSA completely ceased selling in the open market (about 30% of the company’s sales) and focused only on supplies under long-term contracts.
But even these measures did not help. At the December sight, De Beers reduced prices by 5-8% for some categories of rough. ALROSA, according to the company’s President Fyodor Andreev, lowered its prices by 4% on average since the beginning of the downturn. Rumors had it that the company’s Market Conjuncture Panel, which met in late December, discussed possible price reduction also in early 2012.
Vague prospects
Market players conclude that the lower diamond prices at sights are now more or less concordant with polished prices, so buyers from the diamond cutting community do not work at a loss. It remains true, however, that this does not mean they operate at a profit.
The situation with auctions is less clear. According to some market players, boxes sold in the secondary market are still traded at a discount, and according to others rough is rising in price again.
Currently, the market is temporarily hovering at a certain "balance" point. But it is extremely difficult to predict the direction in which the situation will move in the future. For this, there are several reasons.
Firstly, there is no clarity as to how much more time ALROSA will refrain from auctions and spot contracts. On the one hand, the company’s forecast for 2012 is to gain $5 billion in revenues, which speaks for its confidence in good prices and stable sales (in 2011 its forecast to reach a $5 billion level did not come true as it managed to get only about $ 4.5 billion). On the other hand, ALROSA is already negotiating with Gokhran to sell them rough in 2012, which was not done since the last crisis. Is it to say that the company has not so much confidence in its sales?
Secondly, the sales system of De Beers is now changing: a tangible part of trade is now moved to Botswana. And not all of those who wanted to get on the list of sightholders for the next 3 years were lucky to win that prize. This (as well as the fact that African countries increased their proportion of independent trade in diamonds) bears a promise of wider auction sales. Taking into account the current shortage of rough, auctions and spot sales may produce a good bonus.
On the other hand, there is an ever clearer prospect for increased global output of rough diamonds, which should reduce their scarcity. According to Bain & Company’s estimate aired late last year, the world’s diamond production in 2011 will remain at the level of 2010 (about 133 million carats), but from 2012 it will begin to grow, including due to new projects made operational. The diamond industry is still a long way to go to reach the pre-crisis output level of 150-160 million carats, but these targets can be achieved by 2017. Also, one should not discount "dark horses," the diamond mining countries which are not yet taking part in the world diamond trade due to controversial political and regulatory situations. This refers to Zimbabwe and the Democratic Republic of Congo. According to Bain, in the event that these countries will be able to stabilize their political situation, they will take a significant share of the global diamond market. According to some experts, Zimbabwe has great potential, and it can become the third largest diamond mining country in the world by 2020. 2020 is still very far, but if the differences between Zimbabwe and the Kimberley Process will be settled as early as 2012, it would mean additional influx of rough to the market.
Lack of confidence
The lack of confidence as to how the situation will evolve further affects not only the nerve cells of the diamond market players, but also the structure of the industry as a whole.
In November, we witnessed an event that can be considered a landmark: the Oppenheimer family sold its stake in De Beers to Anglo American. In the opinion of experts, the price of the deal – a bit over $5 billion - was significantly underestimated.
Of course, theories about the reasons for such a decision are abundant and completely different. Someone thinks it's because of Jonathan Oppenheimer who has not demonstrated adequate business skills and was unable to continue this business with efficiency. Someone says that the Oppenheimers did not want to sell their stake to Anglo American and sought a buyer at a higher price, but the agreement of De Beers with Botswana in case of a third party shareholder would be canceled, so the family had to agree to the terms offered by Anglo. Someone said that the threat of a second wave of the global crisis made the Oppenheimers take a decision to diversify their investments. Probably all of these theories have some validity. However, what is more important is that if the diamond business is being avandoned by its historic founders, it means they have lost confidence.
So, the decision of BHP Billiton to sell their diamond assets looks entirely unsurprising on the backdrop of this move by the Oppenheimers. So far, BHP is carful in formulating its intention saying they will "examine whether a continued presence in the diamonds industry is consistent with BHP Billiton’s strategy.” But in general, it is clear that BHP is ready to part with the Ekati Mine and all they have to do to wrap it up is to find a buyer. Ekati was sought to “marry” with Russia’s ALROSA, but it is much more likely that a future buyer may come from the second tier of diamond mining companies having small output to which even this old Canadian mine would be a good way to increase capitalization.
BHP says its intention to sell is due to that they see no possibility of a substantial increase in diamond production (it’s been a long time there was no new and large diamond deposits found across the world, while all the significant exploration projects have long been “snapped up”). But on the other hand, it is unlikely that it occurred to BHP’s management just now. So, their decision voiced late last year looks hurried: it would be more logical to put their mine on sale last summer, at the peak of prices, than now, when they are falling.
Most likely, BHP feels exactly the same lack of confidence in the future of the diamond industry. The rough coming from Ekati is sold at auctions, which proved clearly “abortive” starting from the fall of 2011. And it is not the fact that in future the situation will not worsen. Macroeconomics experts are unanimously promising another round of crisis in 2012 and a slowdown, even in the Asian region, which is now one of the main hopes of the diamond market. And in this case it is better to sell the mine now, and get at least some money than to have a loss.
Only ALROSA feels relatively comfortable in the current environment - due to the fact that it is almost completely owned by the state, which in case of difficulties will be ready to support the company. Therefore, even in such unstable conditions the company is preparing to enter the stock market in 2012. So far, the approximate scheme suggests that the government will make public some part of the stake it owns floating the released stock on the exchange. This will earn some money for the Russian state budget, while ALROSA will not just build up its capitalization, but will gain an important image factor having received the status of the largest listed diamond mining company. De Beers, which delisted many years ago, so far seems in no hurry to make it to the stock market, so ALROSA has a real chance to have time to do it first and win the lion's share of investors interested in diamonds.
There is an omen: you will live the new year the way you celebrate its advent. If you are apt to believe it, then we shall have quite an action-packed and nerve-racking year. But then everyone is free to decide for himself. Any crisis means not only difficulties but also opportunities to make fundamental improvements. And for those who do not feel confident, we can advise not to be superstitious.
Elena Levina for Rough&Polished
