October and November were notable for declining prices, to which De Beers and ALROSA, the world’s largest diamond producers had to succumb to restore earning power in the central link of the diamond pipeline – in manufacturing. Diamantaires remain to be major customers of De Beers and ALROSA, and their margins cannot be skipped by diamond giants. Especially when some of ALROSA’s customers failed to meet their obligations and one of De Beers’ sightholders initiated termination of its contract.
Having lowered prices, diamond miners may hope to revive demand driven by stable consumption of the most sought after goods. Clients are in no hurry to share such optimism: according to their statements, the fruits produced by lowered prices were short-term and their effect is almost played out. The value of facts – data on future major purchases and sales of rough by major market players - is only growing in this confusing picture across the world.
THE THREAT OF COMMUNISM
"Demand is sluggish. The principle of “mandatory purchasing” is in force,” Maxim Shkadov, CEO of Smolensk-based Kristall says. “The market is being affected by the lack of liquidity due to loans taken by the industry in the amount of its annual sales. The secondary market lives by the rule “It is better not to buy.”
"The situation for manufacturers remains complicated,” said Ruslan Sorokovoy, head of Gomel-based Kristall, a Belarusian state-owned company and long-term customer of ALROSA. “Buyers are becoming more demanding in quality and prone to pressure in the price field. Demand is there, but its price parameters are not satisfactory and taken with prices for rough the picture is quite disappointing," he adds.
So far, we do not see any recovery in demand despite the end of holidays in India and the upcoming Christmas sales, Valery Morozov, CEO of Ruiz Diamonds said. “The market is still weak. Demand from China declined. Hopefully, this is a seasonal thing, but the Chinese themselves are pessimistic," he said.
This year, the Communist Party of China adopted a policy aimed at limiting the consumption of luxury goods. This is a very dangerous trend for the market, as China is setting the pace in terms of pushing up demand for jewelry, and the growth of its middle class in recent years is one of the main drivers for the market. Even excluding the Communist Party line, cooler demand from China is inevitable. According to the research released by Bain & Company, retail jewelry sales in China went up only 2% in 2012 year-on-year (while growth in 2006-2012 reached 27%).
The cooling of Chinese demand is quite noticeable, Nikolai Afanasiev, Marketing and Sales Vice CEO of Smolensk-based Kristall agrees. "As for China, there is a lot of uncertainty there in general. The new policy is declared, but how will it be put into practice and what will be the result? The Chinese economy is a rather closed issue, and therefore it is hard to predict anything about it," he says. "It feels like in the near future demand will remain sluggish."
Seasonal events, such as Diwali and New Year, do not virtually have a decisive influence on the market situation, says Alexander Maximov, CEO of another Russian diamond manufacturer and a long-term customer of ALROSA, which is Yakut Diamond Company. "The market is in a stable condition. Among the factors bearing more often than not emotional connotations I can highlight the hope pinned on improving financial markets and a great desire to work and earn money," he said.
AUTUMN CORRECTION
Lower demand after a brief recovery in the first half of 2013 has naturally brought about a drop in prices. De Beers reduced prices by 2-5% at its November sight after sightholders left about 15-25% of goods on the table in September and October. According to Rapaport, many sightholders found that this reaction was late and price reduction was not enough as the disparity between the rough and polished markets was growing. The price decrease was also explained by the desire on the part of De Beers to preserve the loyalty of sightholders, which did not welcomed the company’s move from London to Gaborone.
The data released by the world diamond trade hubs also showed a decrease in prices in October. The average price of rough diamonds imported to India in October 2013 was $ 95.3 per carat, which is 10.5 % lower than in September of the same year, but almost at the level of a year ago, according to the GJEPC. The average price of rough imports to Belgium in October 2013 reached $ 138.5 per carat, which was slightly below the level of September, according to the data disclosed by the AWDC.
PRICES SET BY ALROSA
ALROSA started its markdown process in July, reducing prices by 1%. September saw prices go down 5.2% vs June, and the same situation was in October, said a source familiar with the pricing policy of ALROSA.
Most clients of ALROSA felt this decline, but they diverge in its assessment. However, this can be explained by the difference in the range of rough diamonds purchased. For example, in Russia the best selling goods are relatively small stones (belonging to size/weight groups from +9 to 4-6 grainers inclusively), while those weighing from 8 grainers to 4 carats enjoy demand from the jewelry industry.
ALROSA corrected its prices by 5% and this mainly affected small stones, said Valery Morozov of Ruiz Diamonds.
It is true that ALROSA was reducing prices in the past two months, said Ruslan Sorokovoy of Gomel-based Kristall. He estimates the drop at 3-7%. But now there is an opposite trend - in any case, with regard to goods ranging from +9 to 4-6 grainers in size. Prices for most of these goods went up by an average of 2% during the last trading session. "In fact, about one-third of the autumn price reduction was won back in November. Polished prices also declined during that period," said the head of the Belarusian company. "Trying to balance the market by lower prices has so far been unsuccessful," he concluded.
Smolensk-based Kristall specializing in the larger product range has not even felt the impact of this decrease in prices offered by ALROSA, says Maxim Shkadov, Kristall’s CEO. Similar reaction came from Yakut Diamond Company, as witnessed by its CEO Maxim Alexandrov, who said, “ALROSA retained its previous prices, not increasing and not lowering them."
PURCHASING LIMIT
Another tool used by ALROSA in hard times for the market is the purchasing limit. ALROSA may adjust this purchasing limit on a monthly basis, reducing it to avoid overburdening its customers making them buy large amounts of goods in a bad market.
The purchasing limit set by ALROSA for its customers in October and November under their contracts remained unchanged - 80% (that is, buyers could reject 20% of goods). This level did not at all appear “crisis-prone”: for example, ALROSA permitted clients to skip 40% of the contracted amount of rough in August last year.
Currently, it is rather difficult to meet one's obligations and purchase 80% of the amount stipulated under your contract, says Ruslan Sorokovoy of Gomel-based Kristall. "This can be done in view of the additional items, which ALROSA may provide under the contract, and this means that we take 80% of goods due to these additions," he said.
POLISHED DIAMONDS GETTING CHEAP FASTER
Market players may disagree on the extent of price cuts on the part of ALROSA, but agree on one thing disappointing for all of them – polished diamonds are getting cheap much faster.
Over the year, prices for the most popular product range in the Russian market declined by 3-5%, according to Ruslan Sorokovoy. Diamonds got cheaper 5% to 10%.
"Manufacturing is marginal, there are some individual positions regarding gems weighing 5-10 carats, where you can squeeze out something," said Valery Morozov of Ruiz Diamonds.
For Russia, the situation is complicated by inadequate legislation that does not allow the sale of unprofitable amounts of rough promptly, as well as by the 18-percent VAT levied on purchasing.
According to CEO Maxim Alexandrov, Yakut Diamond Company is cost-effective only if it combines wholesale and retail markets. "This model works well and has fully justified itself. Owning diamond cutting and jewelry factories, we produce a sufficiently large number of goods and so far do not experience difficulties," he said.
PENALTIES OF SIZE
The comments on the market situation from Smolensk-based Kristall were not rosy, as usual. Even in March, when market players noted a 5-percent increase in polished prices, the management of Kristall stated that margins were close to zero.
This is partly explained by the fact that to sell larger-size and exclusive goods mainly produced by the Smolensk manufacturer is more difficult in the current situation.
Kristall is the largest customer of ALROSA in the domestic market, and the both sides renegotiated their long-term contract on the same terms last March. After just a few months it became clear that these terms were no longer satisfactory for Kristall, and the company asked to reduce the volume of purchases. A new contract was signed in November and the supply volume was reduced, according to a source familiar with the negotiations between Kristall and ALROSA.
Manufacturers “tailored” to produce large-size goods are right now hit hardest, as they are experiencing problems with sales, Ruslan Sorokovoy says. The Belarusian manufacturer mostly buys smaller size rough, which allows it to make the disparity between rough and polished prices not so conspicuous.
Despite the difficult situation, Kristall in Smolensk hopes to achieve the targets for annual revenue - $ 400 million, said Vice CEO Nikolai Afanasyev. This number is almost 4% below the level of 2012 (at the current USD rate).
BRISK DEMAND
If sales of large and exclusive gems are running into problems, demand for medium quality goods is not abating. Therefore, despite the pessimism - perhaps opportunistic and somewhat exaggerated – expressed by its customers ALROSA may have reasons to believe that measures to stimulate demand take effect.
"Now we can cautiously start talking about gradual market recovery. And the fact that rough prices were lowered in autumn, of course, played its role," said a source familiar with the pricing policy of ALROSA.
So far, this recovery is not in rising prices, but in stable demand emerging for rough diamonds - though not yet for the entire product mix, but for some of its categories.
"For instance, currently there is very good demand for rough diamonds 4-6 grainers in size, as well as for all gem quality goods required by the U.S. market, that is for stones having average characteristics, containing pique inclusions, which are used to produce not very expensive polished diamonds," the source said. Goods attributed to size categories -5+3 and used to manufacture melee are also selling well.
"A major role in this recovery is played by the fact that diamond sales are going on and doing well," the source said. Inventories held by jewelry stores are being significantly reduced, and therefore, they will have to be replenished.
MAGIC POWER OF FACTS
It is natural, that visions of the situation by the upstream and downstream may reflect diametrically opposed business interests. Only facts may be revealing in this case. A priceless example of facts was given by the web service launched in November to disclose state procurement in Russia.
According to this resource, Gokhran, Russia’s state repository is ready to buy diamonds worth RUB 3.52 billion this December. This agency is replenishing the State Fund, using the best time in terms of market conjuncture and maneuvering funds within the budget limit (simultaneously, Gokhran sells diamonds - the agency raked in $ 25.4 million from two auctions for the sale of rough held in 2013). Gokhran actually lent a helping hand to ALROSA having bought RUB 8 billion worth of diamonds at the miner’s request in 2012 (6% of ALROSA’s consolidated revenue for the year). This year, state procurement purchases are yet to come, but ALROSA pointed to such an option in the second half in its memorandum to the IPO.
ALROSA does not comment on the upcoming purchases by Gokhran. But it is obvious that no one in Russia, except ALROSA, is capable to deliver rough diamonds valued at more than $ 100 million to Gokhran.
Another important notice for the market came from Smolensk-based Kristall. Judging by a recent announcement on the state procurement website (Kristall is a 100% state-owned company), the manufacturer intends to buy 7,000 carats of rough worth RUB 106 million. The swing is not as wide as that of Gokhran, and this amount will be purchased within two months prior to 19th January 2014 - unlike Gokhran, which buys the whole amount in one go this year.
Kristall also does not comment on the purchase, saying that the information to be disclosed by law is just a kind of statement of intent, not a liability. But if the numbers in the bidding documents were not spun out of thin air, then the parameters of the future purchase may indicate that Kristall has not changed its priorities. The average price per carat of rough eyed by Kristall is hovering somewhere at $ 454, and this is the standard price of gem-quality diamonds, according to an industry expert. Which, incidentally, may indicate that one time market rumors about Kristall allegedly getting softer on its assortment and almost switching over to “Indian goods” were groundless.
Note that the both purchases are made from "a single supplier", which excludes the possibility of small and medium players taking part in these transactions, meaning, for instance, a few customers of ALROSA from Yakutia, which for various reasons could accumulate stocks of rough bought earlier from the miner and now willing to sell it to Gokhran or Kristall. So, it is highly probable that there are only three contractors, which are Gokhran, Kristall and ALROSA.
The only question is the configuration - for example, Kristall may purchase diamonds not only from ALROSA, but from Gokhran, as the industry expert believes. “Perhaps Gokhran has accumulated a certain amount of rough, which is needed by Kristall. And the tender announced by Gokhran for the purchase worth RUB 3.5 billion does not contradict this, because Gokhran may simultaneously buy and sell, that is to carry on business for profit,” he said.
If both purchases are implemented in the planned volume, then two legitimate questions may arise. Is the situation in diamond manufacturing that pitch-dark, as it is eagerly being painted by various players engaged in this industry? And is the picture of demand that positive if ALROSA will have again to exploit Gokhran to fulfill this year’s sales target?
Boris Ashkenazi for Rough&Polished
