It looks like a diamond market has finally recovered after the market dive in 2014-15. The diamond producers report about high sales in Q1, but the rough prices finally show the growth after a full year of being flat (according to various estimates, it was from 0.9% to 3% for three months). Now, when everything is all right, the industry faces the most important and complicated task – to keep the existing balance. It is important because the market risks to enter a ‘tailspin’ again if the balance is not kept. It is complicated because over the last 5 years, the industry went through two such ‘tailspins’ which means that it could not cope with this task well enough.
I was led to write this by the latest diamond market review by Citi. Against the backdrop of the universal optimism, Citi still voices cautious concerns that the market can repeat the situation of 2015 soon. In my opinion, some arguments expressed by the analysts look reasonable and are noteworthy.
“The diamond industry is moving into a destocking cycle… (in midstream: R&P),” writes Citi. “The last was in 2015 when industry sales volumes fell 14% and prices declined by c. 25% …contributing to negative returns for the diamond miners. One of the key factors contributing to this was the significant inventories built up in the midstream (cutting/polishing segment)…. We think that 2018 is shaping up to be an extremely difficult year for the diamond industry. We expect industry sales to fall sharply in late 2017 and 2018 <…> [and] we expect rough prices to fall 6% in 2018.”
Past experience that can be useful in future
This view graph shows the history of ups and downs of the diamond industry.
Source: Bain Report, 2016.
Over the last decade, there were three significant market declines. Its drop in 2008-09 should be considered with reservations: that crisis was global and all the industries suffered, it also hit the wallets of all the consumers in the world. The downturns in 2011-12 and 2015 are purely the industry ones. However, when one looks more closely, they have something in common - the slump in prices for rough diamonds always follow the period when the rough prices grow faster than the polished ones. At some moment, their prices are dangerously approaching each other, so the polishers have no sufficient margin and they stop buying rough diamonds.
The strategy of the crisis recovery was similar in all three cases: producers cut the sales and, if possible, the mining output so that the market could ‘digest’ the existing stocks. As a rule, during a year, the diamantaires’ inventories gradually decrease and the market returns at first to its balance and then - to its steady growth.
As a matter of fact, this steady growth affected a diamond pipeline adversely. After the 2008-09 economic slowdown, the rough prices and its purchases grew too fast – several times faster than the consumer purchasing power. Then, there was a sudden rupee weakening that had a domino effect. As a result, the prices dropped by 20% in 2012, and it took the diamantaires who had huge inventories of expensive roughs to sell the rough diamonds on the market.
Next time, experienced through adversity, the market grew with more caution: the miners increased their prices by several percent a year only and the diamantaires were very cautious about inventories. But it did not help, either, as the sudden fall in demand in China due to the internal problems in the country that, in their turn, caused a slump in the Indian polishers’ sales. The cutting and polishing sector again was left having huge stocks of rough and cut diamonds. This time, the prices for roughs dropped by 15% and again it took two years for the market to recover.
Now, we are exactly at the point where the growth starts after stabilization. It is important to keep in mind the experience gained for several years to avoid repeating the history for the third time. And the ‘traps’ that can lead to this are at every turn.
The first possible trouble spot is the potential market overstocking, mainly, in the rough segment. According to various sources, the global rough production in 2016 was 127-144 mln carats. According to the miners plans, from 2017 on, this volume will increase. ALROSA expects to produce 39.2 mln carats in 2017 and about 40 mln carats in 2018. De Beers anticipates to produce 31-33 mln carats in 2017 compared to 27.3 mln carats last year. According to Citi, in 2017, the global production on the whole will grow by 8% compared to the last year, mainly due to launching new projects or reaching the project capacity by the existing new ones. And the growth in the global rough sales can be about 5%.
The issue is whether the market can digest these 8% of the output growth, given that in 2016, there was a balance supply and demand and now we do not see any explosive polished sales growth. According to the Citi prognosis, the demand in 2017 will increase just by 2%.
Most of the experts still expect a higher demand for diamond jewellery taking into account the anticipated GDP growth in the mature economies and developing ones. However, as we already mentioned in one of the past reviews, this correlation raises the question. As it was noted by Chaim Even-Zohar, since 1999, the global GDP rose by 240% and the diamond jewelry retail sales have risen by merely some 130%, and the diamond content in jewelry has risen to 150%.
Polished diamonds are not articles of daily necessity at all, that is why it is highly probable, that in case of even slight disposal growth the people would prefer to buy some living essentials or choose any other popular luxury item.
One should also bear in mind that today’s consumers are more cautious about their spending and lately they have preferred lower-end diamonds. In this niche, the natural diamonds have a growing competitor – synthetic diamonds – that are cheaper with their quality as good as that of natural ones, but at the same time, the synthetics have been promoted as eco-friendly and socially responsible goods. According to analysts, today synthetic diamonds account for about 2% of the market, but their share – and the quantity in carats – will rise in the years to come. Various estimates show that it can account for 5-16 per cent of the market by 2020.
Moreover, as we saw over and over again during the last decade, various unpredictable events could impact the consumer demand. An unexpected global financial crisis; the unforeseeable Indian currency crash that seemed to be not directly connected to an American couple purchasing a ring; the sudden launch of the anti-corruption campaign in China that cut off the demand for luxury goods in the country. At times, it seems that the diamond market players, in principle, should plan their operations based on zero or even negative growth in demand to avoid facing the negative unexpected situations.
The only possibility to increase the demand is to revive the consumer interest in the polished diamonds. The DPA specially set up for this purpose has already started its activity but there is doubt whether it can have the same success as de beers achieved making its marketing campaigns for decades. I think, in fact, the market will see the DPA activity effect in some years only, and in the meantime, there is no point to expect any marked increase in demand.
Uneven growth trap
If the rough diamond prices grow faster than the demand and diamond jewellery prices, the polishing sector will be in a cleft stick again.
According to the Rapaport Index, the polished diamond prices dropped in all categories as compared to March last year. In Q1, the prices rose for the smallest and the largest diamonds, the mass-market segment prices continued their drop.
Below you see the correlation of the rough and polished prices over a longer period of time:
Source: Citi Report.
Over the last 4-5 years, the polished diamond prices follow a downward trend, and the rough diamond prices remain practically flat, with several ups and downs. The last view graph again shows the situation we discussed at the very beginning: as soon as the rough price growth outperforms the polished price growth, the slowdown starts in the industry. And now, since January 2017, the rough diamond prices start their growth exactly when the polished diamond prices continue their decline.
In 2015, the diamantaires decreased their rough diamond purchases and started to supply the surplus of goods and the stocks they built up to the market. In 2016, they resumed to replenish their inventories, which increased the sales by the diamond miners. The estimates made by Chaim Even-Zohar show that last year, total midstream inventory levels rose from $10.6 billion to $12.3 billion. In his opinion, the stocks have not reached the level usual for the industry, which means that they will probably continue to grow in the first six months of the year, and judging by the market activity, that is what is happening.
However, taking into consideration the rough prices and sales growth, soon the building up of stocks will come to an end. The declining polished diamond prices and lower demand for the stones threaten again to decrease the diamantaires’ margins down to zero level from today’s 3-4% and again slow down the whole chain.
It should be emphasized that the market has changed greatly for the last decade. Earlier, it was a closed business within the framework of which its owner (often a sole owner) could take any decision, but today a diamond mining sector is mainly represented by public companies. The free-floating shares of ALROSA, Dominion, Petra and Gem Diamonds are publicly traded, and De Beers and rio tinto Diamonds are also operating within public mining conglomerates. Many retail representatives came to public status. The diamantaires and cutters and polishers are still private firms but the requirements the banks impose on them have become so stringent that they do not differ much from the exchange level.
“The main purpose of any company is to obtain profit for their shareholders.” This common knowledge about the business is given at the first university lecture on micro-economics or management. Certainly, such a wording might sound blunt to some people having very idealist perception of life, that is why the companies - when describing their mission in their advertising booklets – normally write something about the development of economies and improvement of the standard of living of people. In reality, there are a few of those who start their business having philanthropic purposes in mind. And it makes sense: I do not think that you, my readers, would agree to work without being paid for your work.
In addition, it is advisable that the profit could grow and the company would have a clear development programme so that the investors were able to bank on higher dividends and share value growth, and the banks could give new loans, preferably, at lower interest rates. To increase the profit, it is necessary either to sell more goods or to raise prices for the goods available. The option ‘more goods at higher prices’ is the most preferable one but, unfortunately, it is a pipe-dream – it works only in cases when the demand for the goods rises irrespective of their prices. Otherwise, the laws of economic balance force down the prices or demand sooner or later.
Almost all the diamond pipeline companies take part in the profit race. Few of them are sufficiently financially stable to be able to work with low sales for two years waiting for the full market stabilization. And the profit race inevitably comes to the never-ending problem of choice between high output and high price.
Without panic, but with caution
The purpose of this review is not to throw a scare into the readers in face of the future crash. On the contrary, now the market looks quite robust and improving. Our goal is to remind that even the run of good luck is not a reason to lose one’s head and forget the lessons the past has taught. The market players being connected by the common diamond pipeline chain should now have the most responsible approach to their business. The diamond miners should be cautious about their supplies, the diamantaires should attentively follow their inventories, the jewelers and retailers should take an unbiased look at the potential of the consumers’ demand. And all of them should – when possible – exchange the information about the movements in the market with each other, doing it either publicly or in their correspondence or in the framework of the industry organizations. The industry has repeatedly shown its ability to solve many problems thanks to mutual efforts and it is really able to cope with the challenge this time as well.
Elena Levina for Rough&Polished