Maxim Shkadov: Growth of Rough Diamond Prices Has Made Both Cutting and Speculation Unprofitable

Smolensk-based “Kristall” enterprise is the largest polished diamond producer in Russia, also one of the major clients of ALROSA and a DTC sightholder. The company’s position right in the centre of the diamond pipeline, as well as its close ties with the major market players, force Kristall to analyze and take into account the global trends in diamond sector as much as, or even more than the prospects for development of its own business. Chief Executive Officer of Kristall Maxim Shkadov gave an interview to Interfax, speaking on the measures which might be taken by market players amid weakening of diamond market environment, the dangers of dominating position of Indian diamantaires and explaining why speculative growth of rough prices is as harmful as sharp decline of the latter.

- How would you evaluate the current market environment?

- The market environment is rather weak and stagnant. To a large extent it’s associated with the approaching of the peak of speculation which used to flourish for some period recently. Rough diamond prices reached the point where neither cutting nor mere speculation is viable. When rough diamond prices outstrip polished prices this will inevitably result in price correction. As there is actually nothing to produce from rough diamonds but polished diamonds.
Nowadays loan portfolio of Indian banks which used to provide generous credits to Indian diamantaires, has reduced while operating environment deteriorates which resulted in exposure of problems. That is why the market sees adjustment of prices and soon we are going to see how rough the correction will be. Should the companies responsible for supplies of rough stock to the market fail to undertake necessary steps we might face the situation similar to recession in 2008. While it can be even worse, as depreciation of stocks accumulated by both dealers and cutters may cause a corkscrew of the market.

- What can the major players – dealers and mining companies – do in this situation? How long this instability can extend?

- It is difficult to make predictions on how long uncertainty will retain as it depends on the actions of rough suppliers. The main measure they must proceed with is reduction of supplies to the market and gentle price adjustment. These actions were taken in 2008-2009 and proved to be successful in turning the market to normal.

- Have rough diamond prices become fair following the market correction, or are they still exaggerated? Could you speak on dynamics of prices of the largest global diamond producer and Kristall’s supplier – ALROSA?

- Rough diamond prices are excessive at the global market, and they are overstated by 15-20% depending on categories. Speaking about ALROSA’s prices – corrections have been very modest. And there were no prerequisites to growth.

- Does Kristall suffer lack of financing for procurement of the rough diamonds in sufficient volumes?

- No, we don’t. The issue is rough supply rather than financing. Subject to the situation at the market we tend to purchase rough diamonds of categories which can ensure profitability of polished production. And we do not procure rough diamonds for stocks. Therefore we control the situation based on final production sales results.

- You mentioned that diamond cutting turned to be unprofitable in the current market environment. How long has this situation retained? Does Kristall partially offset the negative effect by means of reselling some parts of rough stocks?

- We have faced difficulties in securing profitability of cutting activities for the recent eight months. Diamond cutting is not effected just for the sake of it, and if rough diamonds are more expensive than polished ones – the cutting is obviously not viable. In order to evaluate profitability of our business we need to take into account availability of financing which a company might use to cover losses resulting from cutting activities. A company can make money from selling rough stocks during speculating activities at the market. Yes, I suppose this is not normal, but this is the market. That is why a lot depends on managers’ skills to cope with stocks, procurement and sales.

- Following the weakening of the market, has the amount of rough subject to reselling been reduced or raised?

- We do not purchase rough diamonds for further sale. But we do resell parts of rough diamonds which are unprofitable to cut and polish. The percentage of such stones is approximately the same and we are able to control it.

- Has the company changed its preferences in purchasing rough diamonds from ALROSA?

- We have agreement with ALROSA which stipulates fixed assortment of goods, therefore no changes could take place.

- Did the company reduce procurement of rough from ALROSA in the first half of 2012 against the volumes agreed in the contracts? Do you negotiate the issue of reduction of contracted volumes and/or prices of diamonds with ALROSA?

- In the first half of the year we fulfilled the terms of the contract and did not reduce purchases, neither ALROSA reduced supplies. But now ALROSA has accommodated its clients, and we are free to defer purchasing of some amounts of rough diamonds offered. But we do not negotiate reduction of rough supplies volumes. As far as the prices are concerned, we do not support sharp reduction of prices while we would appreciate graduate and accurate correction. Reaction of the market will depend on this accuracy in price adjustment.

- Did you purchase rough diamonds from Gokhran in the first half of the year? How did the volume of purchases change compared to the same period of 2011?

- We have not purchased yet. I suppose we will buy rough diamonds within the same volume as we did last year.

- Do you plan to apply to Gokhran with an offer to buy part of your final production?

- This issue requires comprehensive examination and review, in the context of support to the diamond industry in general. Should such decision be brought and if ALROSA initiates and sounds this idea – then we would like a part of our production to be acquired by Gokhran. Similar to the way it was done in 2009 – at that time the initiative benefited the government and Gokhran made good profit selling diamond production purchased in crisis times. But we shall bear in mind that this initiative might be realized only due to a crisis at the market.

- At the beginning of the year your company did forecast 20% year-on-year growth of revenue in 2012 compared to 2011. To what extent were these plans justified?

- Now I can say that we were right to predict slump of sales figures at the end of 2011. Now we see sales figures similar to the corresponding figures of the previous year, and I do not expect any positive developments in the third and fourth quarters, as this is going to be challenging times.

- ALROSA effected rough diamond shipment worth about RUR 3.5 billion to Gokhan in the second quarter. Meanwhile the aggregate share of domestic market in the company’s total sales decreased to 27.3% at the end of 1H2012 from 30.4% in the same period of 2011. Has ALROSA reduced rough supplies to its clients engaged in diamond cutting and polishing?

- No, it hasn’t. The reduction you are speaking about is caused by some changes in the terms of distribution policy. A number of foreign companies which had to form JV or procured rough diamonds from ALROSA subject to some arrangements through the Russian entities, have shifted to direct sales contracts signed with ALROSA thus falling under category of foreign buyers.
Unfortunately there are very few real buyers of rough diamonds based in Russia capable of diamond cutting, while ALROSA, in this context, is interested in these consumers rather than resellers involved in speculative transactions. Russia lacks proper environment and not open for development of diamond processing industry, there are a lot of restrictions which hamper turnover of rough and polished diamonds.

- Kristall is a sightholder of De Beers. At July sight of its distribution arm – DTC – the clients were entitled to defer up to 50% of the total sales volume for following trading sessions, till March, 2013. Has Kristall exercised this right and embraced the offer?

- DTC actually permitted deferring of up to 50% of rough goods. It’s comforting that such large suppliers understand the necessity of reduction of rough sales to the market. Yes, we have exercised this right. DTC expects the market to recover till March 2013, and the rest of good to be sold out. However should the environment not improve by March 2013, purchases of these volumes of rough will be deferred again.

- At the end of last year you applied to the Indian Gem & Jewellery Export Promotion Council (GJEPC) expressing your protest against their request to open rough supplies from Gokhran. What response have you received? Is the issue still pressing and how has situation developed?

- Indeed, we treated their request concerning the opportunity to initiate rough supplies from Gokhran to India as inappropriate. It’s the same as justling. Gokhran is like a treasury of Russia, rough diamond supplies from Gokhran are conducted subject to terms and parameters specified in the Russian budget. Rough diamond from Gokhran are sold only to Russian companies which have the right to secure certain amount of rough goods from Gokhran annually. If Indian buyers are added to this distribution system we will face a scenario similar to the situation of the 1990s when half of Gokhran’s stocks was sold out at opaque prices.
We did not receive any response. Certainly, Gokhran is not going to sell any goods to India.
In general I prefer exercising vigilance and retain caution in dealing with Indian companies – their aggressive policy is producing a negative impact on the global market. Due to their policy speculation is promoted and market prices for rough goods do not comply with the prices for finished goods. Diamond cutting business in the United States has turned to be loss-making due to the dumping policy of Indian players. Should Indian companies push out all their competitors and amass around the sources of rough diamonds they will be able to administer prices for rough of any quality and assortment. We have seen a similar situation in the category of low-priced small diamonds – the so called “Indian goods.”

/Finmarket/