A Golden Message to the Rough Market

While discussing the impact that the bullish gold market is having on jewelry retail sales in China and India, a colleague argued that there is a cause and effect relationship between the two that works both ways, Avi Krawitz of Rapaport writes. It is true that higher gold prices are fueling stronger jewelry demand, as consumers expect additional increases, but the higher demand is also a factor in the high price of gold, she reasoned.

So while the demand for gold jewelry traditionally rises around China’s Golden Week holiday, which began October 1, and in the run-up to India’s Diwali festival (November 5), it is unlikely that jewelry demand trends in these markets, regardless of their magnitude and encouraging growth, were the catalyst for the bullish gold market. Instead, as one analyst noted, the current demand for gold is driven out of fear, rather than greed.

The implication is an important one for the diamond industry, as it marks the difference between an optimistic outlook and a more cautionary one. It is vital to recognize whether the recent safe-haven gold buying came in anticipation of a riskier market moving forward.

This appears to be the case. Certainly, given the near 10 percent unemployment rate in the U.S. and low consumer confidence, there is a cloud of gloom hovering over U.S. economic sentiment. At a retail level, it seems that in real terms, an improving market does not necessarily spell the end of the recession.

While some dismiss the possibility of a double-dip recession, many argue that we haven’t yet made our way out of the first dip. As analysts forecast that gold will move to levels as high as $1,400 and $1,600 an ounce, their question becomes: how much longer will we stay in that dip?

In theory, diamond industry professionals are aware of these issues, but the market appears to be sending some mixed signals.

While De Beers recorded a relatively low Diamond Trading Company (DTC) sight and kept prices stable, reports indicate strong demand for rough in the secondary market and that premiums on DTC boxes rose from September. In the context of the polished market, which remains stable, it is difficult to understand this recent rise in rough.

If the polished market is observing more prudence, and the rough market more aggression, which does one follow?

The rough and polished markets are increasingly operating as independent entities. By separating the two, however, one can recognize the underlying consistent message of caution from both markets.

It could be that while the rampant gold buying may be driven by fear, the rise in rough may well be motivated by greed. Rather than serve as a hedge against risk, rough buyers appear to be seeking to profit off anticipated increases, which in and of itself creates additional risk. As one manufacturer noted, “Strong rough creates caution,” especially when the demand from consumers does not synch up. And unlike for gold, diamonds are almost exclusively dependent on the consumer market.

That is not to say that the rough market is being driven by speculation at the moment, as there is a sustainable level of rough demand for polished consumption.

Instead, the rough market may well be offering the industry a timeline for its recovery expectations. Most appear to have become resigned to the fact that retail will demonstrate only modest, below-average growth over the Christmas season. There seems to be more of an upbeat view for 2011 at this point.

While 2010 was forecasted as a year in which the market will feel its way around, 2011 has been billed as the one that will bring a more sustainable recovery. The rough market appears to be betting on just that, with even De Beers expected to ramp up its production more aggressively next year to satisfy the anticipated level of demand.

But in struggling to correctly read the economic signs in order to shake off the recession, the diamond industry should perhaps take greater note of its golden counterpart’s activity. Based on the events of the last few weeks, the yellow metal is signaling a much longer recovery period. For now, the verdict is still out.