The dust has not even began to settle after one of the most dramatic monetary adjustment of the decade, but it appears clear that the jewellery and diamond sectors will be suffering serious consequences.
On Tuesday, 11 August, the People’s Bank of China took the unexpected decision of depreciating the Yuan by almost 2%. In the following days, further cuts to the reference rate occurred. This has caused a global turmoil that still reverberates in the global investment markets.
Beijing justified the move as a one-time attempt to “push forward with a market orientation”, but many analysts think that a weaker Yuan would be the best way for the country to increase export and kickstart a slowing economy.
Global luxury brands received the news with uncontrolled panic. Just two days after the announcement, LVMH Group stock quotes had gone down by more than 11%; Richemont by almost 17%; Tiffany contained losses at around 7%. In general, all major foreign jewellery brands who have seriously invested on expanding their retail channels in China register heavy losses.
The long honeymoon between foreign luxury products and China has been showing the first signs of a crisis since the beginning of the year, when failure to meet growth forecasts cast doubts over the ability of the Chinese market to absorb high-end products. LVMH, as an example, announced earlier this year that sales for its first trimester of 2015 had fallen by 6%, mostly due to poor performance in China.
The issue is crucial for the jewellery industry. All major companies have been looking at China as the most promising market in terms of growth. China already absorbs around 30% of global luxury products, and has up to now been showing a consistent growth rate of about 5% year. As analysts estimated that this China was still to show its full potential, they pushed luxury brands into investing in expensive retail and distribution channels, as well as costly advertising campaigns. But now it seems that Beijing’s insatiable appetite for jewellery might have come to an abrupt halt.
Apart from direct sales in China, an unfavourable exchange rate also has a negative impact on tourism that will undoubtedly further damage the European and US jewellery markets. Offshore sales are today a relevant source of revenues for big jewellery brands, which have invested on retail stores in major tourism destinations and airports. With a volume of over 110 million outbound tourists, and a projected yearly increase of 17% China was supposed to be the main driver of offshore sales in Western countries, but these estimates will also require some reviewing.
With global jewellery brands falling under Beijing’s new monetary policy, one would expect local jewellery firms to come out with big smiles. This is only partially true. Local manufacturers are ready to exploit the situation for increasing their relative power inside the Chinese market, but will not be able to exploit the competitive advantage on export given by a weaker currency. The reason for that is that Chinese luxury brands have not yet been able to establish strong export channels. This is not due much to the actual quality of jewel manufacturing, but rather to the fact that China has developed a reputation for inexpensive, mass produced goods which clashes with the idea of luxury.
Brands like Chow Tai Fook and Chow Sang Sang are deeply rooted in their domestic market, and therefore strongly tied to the state of Chinese economy. As long as the economy is cruising at reasonable pace, they will be fine, but when there are hiccups, local jewellery brands also suffer.
This comparative table showing the performance of some Western and Chinese jewellery and luxury brands in their stock markets since the announcement of Yuan’s depreciation gives a visual demonstration of the problem. As expected, Western brands suffered an immediate collapse due to the projected loss of competitiveness in the Chinese market. The more involved in China the brand is, the heavier the losses. With their main competitors’ titles plunging, the stock price of the two major Chinese jewellery brands initially rose well above the level of their reference index (Hong Kong’s Hang Seng). After a moment of general euphoria though, both titles were dragged down by the fall of Chinese stock markets and eventually dropped below the initial level.
The situation of the Chinese diamond manufacturing industry is somehow more complex. At a first look currency devaluation should provide a sensible competitive advantage. Chinese manufacturers should be able to decrease processing costs and offer polished diamonds at a lower price on the market. But in perspective those conditions might not have a serious impact. Among the competitors, Western diamond polishers have been increasingly specialising on high-end and large stones, which appeal to a different customer target and are definitely not Chinese’s strong point.
The Indian polishing centre of Surat is China’s direct competitor in the polishing business, and the one to look at for comparisons. The problem for Chinese manufacturers though, is that India has, in turn, also gone through a cycle of devaluation. Since last year, the Rupee has been quietly losing ground over other currencies (including the Yuan), which resulted in increased competitiveness. China’s move has therefore at best levelled the playing field.
There is a final aspect to consider when looking at the diamond polishing sector. Not dissimilarly from other markets for raw materials, the diamond market, is largely based on US dollars as exchange currency. Hence, a weaker Yuan implies that purchases of rough diamonds will be more expensive for Chinese companies.
In general, this is a good time to devalue a currency, as the price of several raw materials is exceptionally low. Crude oil, as an example, went down from 110$ to less than 50$ per barrel in just one year. Therefore the disadvantages of an unfavourable exchange rate are largely balanced by an overall price decline. Unfortunately, this does not apply to rough diamonds, the price of which has been kept artificially high by mining companies, even at cost of reducing sales volumes. Even now that the mining industry is discussing cost cuts for rough furnitures, nobody expects price trends to be realigned to that of other commodities.
In general terms, though, all considerations are linked on whether Beijing’s move will succeed in restoring confidence on long-term global growth. That will make the difference on whether these last days will be remembered as a bad dream or the beginning of a new crisis.
Matteo Butera, Rough&Polished
