It may have taken a downturn to prove it, but Diamond Trading Company (DTC) sightholders are sensing that the game has changed, Avi Krawitz writes in an analysis dated July 20 on www.diamonds.net. As a result, there was an underlying anger emanating from this week’s DTC sight as prices softened a mere 3 percent and De Beers supply remained unprofitable.
The resentment seemed directed at De Beers rather than DTC as some have started to differentiate between the two. As Anglo American last week received final approval to buy out the Oppenheimers’ 40 percent stake in De Beers, sightholder concerns have grown about the true implication of the takeover.
Having lost an industry advocate in Nicky Oppenheimer, sightholders are wondering to what extent their profits will continue to be sacrificed for the sake of the De Beers bottom line. Certainly, they’re taking current DTC prices, their lack of profitability, and DTC’s price inflexibility as a signal for the worse: a more corporate, Anglo-led De Beers that will be more rigid in maintaining steady prices in a market downturn and driving higher prices in an uptrend.
Currently, while the RapNet Diamond Index (RAPI) for 1 carat certified polished prices has dropped 7.4 percent so far in 2012, and rough prices from other mining companies and on the secondary market have declined by 8 percent to 15 percent in the second quarter, DTC has held its prices relatively steady. Dealer sightholders can only sell their DTC goods at double-digit discounts while manufacturers are similarly losing money on their resulting polished. Demand for DTC rough has therefore slumped and trading of DTC goods on the secondary market is minimal.
The July sight closed this week with an estimated value of $420 million, before accounting for rejections which were expected to become more apparent after press time. DTC gave some leeway for deferments at this sight. The company notified sightholders that they could postpone up to 50 percent of their allotments as long as they take the goods in the current intention to offer (ITO) period, up to and including the March 2013 sight.
It is unclear what the consequence will be for sightholders who do not take those deferred allotments at a later date — a concern that was clearly on sightholder minds this week. Will they be punished with a smaller ITO next year or even lose the sight all together in the next contract period in 2015? While Diamdel goods are a more profitable alternative, and its clients therefore better able to buy, will DTC favor Diamdel clients in its so-called “dynamic distribution approach” — recently introduced to allow strong Diamdel customers to apply for a sight in the middle of the contract period — over sightholders who consistently reject their goods in the current sights?
Sightholders appear less reserved than before about voicing their dissatisfaction. A number of companies have noted that they would prefer to see DTC cut its supply rather than postpone it, as it did in 2008. While the market is not at 2008 crisis levels, and given market sensitivities to De Beers holding stockpiles, the company is unlikely to hold back output. Furthermore, scaling back production is a costly exercise.
Rather, sightholders should be lobbying for prices that better reflect the market. The only way to do that is to continue to reject DTC goods at these prices. As this column stressed in the past, sightholders will leave goods on the table even beyond the July deferment window if DTC prices do not reflect the market (see editorial Supply Versus Profit published on June 28, 2012).
De Beers is not expected to budge unless significant volumes of goods are left on the table over a sustained period. Rather, the company is betting that market conditions will improve soon enough that it can avoid such continued rejections. Meanwhile, sightholders question whether the market will upturn significantly enough to boost their liquidity in the next six months. They contend that it will remain difficult to buy out the remainder of their ITO, including the goods rejected to date, especially given their current profit margins – or lack thereof.
They further fear that should the market weakness persist, De Beers threshold to hold its prices steady will increase as its ownership structure evolves.
In fairness, it’s entitled to do so. Like any company, De Beers is primarily accountable to its shareholders and not the market, especially given that its principle shareholder is now a public company. Furthermore, sightholder complaints that Nicky Oppenheimer is no longer there to advocate on their behalf may be a necessary maturing process.
But by maintaining high prices that do not allow for sightholders to profit, De Beers is diminishing the value of its DTC supply contracts in the long run. While De Beers famously presents its favorable long-term, supply-demand outlook for diamonds to demonstrate the value of the product to shareholders and others, that widening gap means little if there’s no profit in the trade.
This column continues to advocate that price volatility is to be expected in the diamond market and accepted as a normal part of doing business. While traders can profit in a downward moving market by selling cheap and buying cheaper, mining companies don’t have that luxury. Dropping prices has a direct impact on their bottom line as miners are blessed, and sometimes burdened, with fixed operating costs. It is little wonder then that De Beers is reluctant to do so.
Sightholders are therefore left to ensure that market forces take effect. The longer they are forced to lose money on their DTC supply, the more disgruntled they will be, especially as economic prospects remain uncertain for 2012. While diamond dealers and manufacturers struggle to ensure their own profitability, they will reject goods regardless of the consequences to their supply relationships. Not only are sightholders questioning the value of their DTC supply, but the long-term contracts that govern them.
