In a quite refreshing manner, Diamond Trading Company (DTC) Managing Director Varda Shine has given her assessment on the diamond market's performance during the first half of 2010 and presented her thoughts on what to expect during the second half of the year, www.diamondintelligence.com says. As Varda's views, whether right or wrong, will determine the DTC's rough distribution agenda, they deserve to be carefully noted.
"As we pass the mid year point, I thought it would be a good time to reflect on how we perceive the state of the diamond industry and offer a few thoughts about the second half of the year and beyond," says Varda. "In the first half of this year we have seen a period of re-stocking that led to significant increases in rough demand, added by concerns regarding scarcity of rough, healthy demand from retail and the exciting emergence of markets in India and China while the US slowly increased its demand for diamond jewelry."
We would editorialize that the term "concerns regarding scarcity of rough" is code for speculative buying; the "healthy demand" from retail is, in our view, driven by replenishment, and not consumer demand. But that may have less practical implications - the end result is the same: there is a retail demand for polished. How sustainable it is, in the absence of consumers flocking to the stores, is a different matter.
"To see all of these things happening in six short months is not something we may normally expect, but given the steepness and rapidity of the recent downturn, and given the propensity in any industry for optimism or pessimism to overshoot reality, it is a situation we probably should all have expected," says Varda.
The DTC chief than adds that "during the downturn most stages of the pipeline appeared to overreact to the severity of the situation and rush to decrease stock levels as everyone else was doing the same thing and no one wanted to be ‘left holding the baby'." Here, I would have phrased it differently. I would have said that during the downturn, which was triggered by an externally imposed liquidity crisis, the diamantaires were denied access to new credit; some of the financial traffic was paralyzed, while banker panic triggered exaggerated calls for additional collateral.
It has been shown that some $1 billion (if not more) of new equity was brought by the industry into the business. This wasn't done for fear of being left "holding the baby," but rather to avoid distress sales and exacerbate price instability. and exacerbate price instability.
Along the pipeline, we believe, we found the players acting in a rational and predictable manner. Retailers and jewelers reduced stocks in line with their turnovers. That's the way it should have been. Except for the banks - and maybe for the DTC itself, which went shopping for new rough clients among the oil-rich Middle Eastern investment markets - it is not fair to conclude that the pipeline "overreacted." The industry's behavior represented its better moments.
Feeling of Scarcity
Then Varda continues that "of course, the ironic thing is that a short while afterwards there was suddenly a strong demand for rough again and a feeling of real scarcity, as everyone had worked down inventories so heavily beforehand."
With all due respect, the feeling of scarcity was something that was stressed at all the De Beers Town Hall Meetings. At these meetings, De Beers Managing Director Gareth Penny clearly gave the triple messages that (1) the world will be running out of diamonds; (2) consumer demand for diamonds will exceed supply; and (3) rough prices historically rise after an economic crisis.
The market listened carefully to these messages and acted accordingly. There is nothing "ironic" about it - it points to the market's maturity and its propensity to listen carefully when De Beers or DTC spokesmen speak.
In her Mid-Term assessment, Varda observes that "retailers, especially in the US, have been going through a period of re-stocking so far this year [i.e.2010] and this has created some extra buoyancy." This is, of course, correct as the destocking behavior at some point meets a new equilibrium where stocks, sales and purchases are again in balance.
That new equilibrium isn't simultaneously reached everywhere geographically. In the United States, which has been harder impacted than most other markets, it was quite predictable that it would be the last market where the destocking would be completed. In many other markets that level was agreed already at the end of 2009.
"Consumer demand is reportedly on the increase and the situation with diamond jewelry is definitely improving (as can be seen from the financial results published by major jewelry retailers and even just the general tone of the media when talking about diamonds now, compared with how they were spoken of only a year ago); however, the industry has probably been ‘spoilt' a bit in the first half due to this period of re-stocking. Just as we suffered more than the reduction in consumer demand suggested we should during the downturn, so we have recently been benefiting more than consumer demand increases would imply," explains Varda in a quite fair and correct assessment.
She adds: "So, while the supply-demand fundamentals remain in good shape (in the short, medium and long term), we were always bound to see some correction due to the fact that the true levels of demand have been amplified recently by the re-stocking period and the natural euphoria created by an exit from a downturn leading to people being overly optimistic about the speed of the recovery." [Emphasis added.]
Here one might offer a different interpretation: I am not aware of any "overly optimistic" quarters in our industry. I am, however, acutely aware of those who strongly believe that purchasing rough today is always better than purchasing tomorrow, as the DTC has clearly stated and demonstrated (by doing so itself) that the price of rough will rise enormously in the aftermath of the crisis.
Speculators - in the long term - tend to become winners in our industry. One may not like this - but this is true. Especially, when some segments of the market again enjoy almost unlimited access to (cheap) credit, it would almost be madness if one weren't buying.
But this rough demand has nothing, absolute nothing, to do with optimism on the speed of recovery. Rather, it is a further spillover effect of the feeling of scarcity - and of producer statements that they prefer leaving the goods in the ground to lengthen the life of the mines and optimize revenues later.
DTC's Sober Assessment of Second Half 2010
"Although we may now be starting to see the early signs of a slowing of the acceleration in demand seen in the first half of this year, we still have many reasons to keep a level head and look to the future with measured optimism. Firstly, we must remember that at this time of the year activity is always quieter in the diamond industry. Our industry works in a cyclical manner and we are currently in a period which has traditionally been slower," explains Varda.
The cyclical nature has always been mostly manifest in DTC sales. A back-of-the envelope exercise, taking all DTC rough diamond sales for the 1991-2008 period (18 years), shows that, on average, 55 percent of annual sales took place in the first half of the year, with 45 percent left for the second half.
If the DTC Managing Director believes that much of the H1 2010 excitement was not really warranted, maybe the industry is being prepared for much lower sales in the second half. There is a lot of speculation about this.
"Alongside this," continues Varda, "we should recognize the fact that the downturn gave the industry a good chance to get its affairs in order. In 2008, De Beers' rough production was at a much higher level in light of typical strong demand, leaving us more vulnerable to any profound reduction in demand. We managed our production in line with significantly reduced client demand throughout 2009 and, we continue to take a long term approach to profitable production."
That's an interesting phrase: "long term approach to profitable production" refers to the desire to leave the goods in the ground, as they will be worth more tomorrow. Speculative mining?
Upbeat about the Future
After mentioning the "long term approach on production," Varda shifts to consumers. "In any case, consumer demand is looking really quite healthy at the moment. We all know about the growth in India and China as important consumer markets, but perhaps the most encouraging thing is the US is taking the first steps towards a quiet and measured recovery. This remains easily the largest diamond jewelry market and it is very reassuring to see that the retailers there continue to build inventories, in anticipation of this year's holiday season," she notes.
"The gradual uptick in demand in the US was borne out by the positive feeling following the JCK Las Vegas Show this year and we are currently seeing another show take place in Hong Kong. The results from the current Hong Kong show seem to have been fairly mixed, with some participants reporting very good business, while others seem to see things as being a bit slower. It is to be expected though, that this show would not see very high levels of business as this period is traditionally quiet in the Far East. What is positive though is firstly that stocks of polished goods are still quite low in some areas; and secondly there remains good demand for polished with business being done," says the DTC chief.
Polished Price Resistance and Bank Support
According to Varda, "there are reports of resistance from buyers to higher polished prices, but this is to be expected as the business is still trying to find its equilibrium. Polished prices have reportedly been steadily rising over the last few months and so a period of resistance to ongoing growth would always have happened some time around now. The important thing for us is to keep focusing on increasing consumer demand," she says, without taking the opportunity to remind us all how to do that. It is easier said than done - and with limited availability of rough, it remains a question as to whether one can meaningfully increase demand.
"The prospects for this upwards price movement are also reasonably good as we look beyond the immediate horizon," she notes. It is puzzling why these prospects are good, after noting the resistance to higher prices in the previous paragraph.
"One key problem as we entered the downturn related to liquidity as the global financial markets struggled so obviously to access capital. We are now, however, in a very different place. More equity has come into the business as investors have realized that returns on diamonds were superior to those achieved in many other investment classes," she declares.
We would really take issue with that statement - and we would hope that in the near future, the DTC will share with all of us these calculations. When measured in real terms, price performance of rough diamonds has been abysmal.
Varda adds: "In addition, the banks have been, and continue to be, supportive of the industry as it has proven to be resilient and to have strong prospects for future success." Except for the Indian banks and maybe one or, at best, two others, banks have proven to be part of the problem rather then the solution.
In certain countries, such as Israel and Belgium, banks are rather reluctant to reopen the money-tap. To go out of the way to compliment the banks may be good public relations, but it doesn't necessarily reflect reality. Rubbing it in, Varda says that this banking support is "really the most exciting thing, as we do have a very positive outlook for the Diamond Decade. Consumer demand continues to increase," she says, at a time the industry and consumer demand is still some 20 percent below the 2007 level, "and will grow so even more rapidly as the economic recovery continues over the medium term."
Continues Varda: "When this is allied to the more moderate levels of rough availability forecast for the period, all is set fair for the industry to remain in good balance. We will of course see some fluctuations along the way, as is the case with every industry around the world, but those that hold their nerve and look to position themselves to take advantage of the many opportunities likely to come along will be best placed in the long run."
Concludes Varda: "Overall, my view is that we should all be pretty satisfied with the way the first half of this year has gone, and while the pace of demand growth is likely to slow a little in the second half, we should not be worried by this as it is what we have always expected. Consumers in the US still love diamonds and more people in other parts of the world are also waking up to their allure. Expectations in US retail are for the holiday season to show growth and the further we look into the future, the better the picture becomes for diamonds," she inspiringly says.
Amicable Solution for Zimbabwe?
As everyone needs to say something about Zimbabwe, Varda also adds her views about the situation. "To ensure that the picture remains positive, however, the industry needs an amicable solution to the present situation in Zimbabwe. There has been a lot of noise about this in the press and we must hope that a workable agreement can be found in the next Kimberley Process meeting in St Petersburg, as consumers' confidence in diamonds as symbols of the best of human emotions is fundamental to success. If the diamond business can overcome this hurdle then we should see some good times ahead."
Looking into my dictionary, none of the synonyms for "amicable" would apply to the various solutions which are currently on the table. Let's hope Varda knows something we don't.
In conclusion: "So, while 2010 may end up being a ‘year of two halves', with the second six months being the ‘responsible half', it is encouraging that the fundamentals of the industry mean that both H1 and H2 should be positive. As the old fable of the tortoise and the hare teaches us, slow progress is better than no progress and by the end of the year we should still be comfortably ahead. Then, as the decade progresses, we should be able to stretch our lead even further," says Varda, signing off with wishing her clients "good luck to you all for a happy, healthy and prosperous second half to the year."
