In early 2009, ALROSA tied up long-term (mainly three-year) contracts for selling rough diamonds with 15 large Belgian and Israeli diamond dealers. The pattern for selecting clients to this pool included such pronounced criteria as a stable need in rough diamonds to an amount of $200 million a year; available own free funds; absence of problems with specialized banks; and a rather low leverage (up to 20%).
 
The content of these contracts is confidential, but reports mentioned that pricing within them was formulated as “the price-list of the Russian Ministry of Finance +17%” and that as a whole under these contracts ALROSA would deliver diamonds from its entire annual output range, their total amount in July 2009 being around $800 million. These contracts were viewed first of all as a facility to hedge ALROSA’s risks against violent fluctuations in prices for rough diamonds caused by crisis.
 
Certainly, it is impossible to assume that these long-term contracts impose any restrictions on how dealers will use the rough they buy. Any buyer is free to turn his rough into polished diamonds or make a diamond stock or re-sell it on the spot market: what will be done exactly depends on the rate of return. Therefore, if rough prices on the spot market will exceed the cost based on “the price-list of the Ministry of Finance +17%” formula at least by 10-15%, it is hardly any use to doubt that rough diamonds bought from ALROSA under long-term contracts will be released into speculative circulation instead of turning into polished goods.
 
Right now, many people voice their fears over a virtual misbalance between the rough and polished diamond markets: while the first enjoys a notable rise in prices the second is hibernated by stagnation. Such a threat is assumed to stem from the excessive liquidity leaked to the diamond market as a part of the liquidity injected into economies within national anti-recessionary programs. Once again easy credits along with the promulgated axiom about depleted diamond fields and a forthcoming slump in diamond output provoke investments into rough diamonds and rev up the speculative potential of this asset. Thus, “first-hand” contracts with a diamond-mining company based on fixed prices become a bonanza for their owners in case their profit from rough resale on the spot market turns out to be essentially higher than their margin from polished sales.
 
Moreover, since any significant price rise on the spot market is fairly gainful for holders of long-term contracts at fixed prices, it is impossible to exclude a chance of their purposeful actions to accelerate this growth. For instance, on the stock market coordinated actions of heavyweight players permit to manipulate asset prices within a rather wide range – these are well-known cases. Taking into account the criteria used to make a pool of ALROSA’s exclusive clients and their weight on the sufficiently narrow diamond market, such an opportunity is to be considered quite real. And this is not the case of some malicious intent – the point is that under these circumstances any dealings for a rise may seriously boost profits of such companies.
 
Of course, pacta sunt servanda (Latin for “pacts must be respected”) and ALROSA’s missed profit in case of further rapid growth in prices for rough diamonds is not the worst evil for the diamond market as a whole. However, an annual speculative injection of almost $800 million will obviously be not beneficial for the market’s highly fickle health. In early March, the experts of Leader Short-Term Bond Fund published their data on real unemployment in the United States (i.e. taking into account those people who stopped to receive their welfare payments but still did not find jobs) which will reach 16% in the middle of 2010. This estimate is close to the data released by The Marker Publishing House evaluating the real unemployment in the United States in February at 16.8%. This kind of background makes premature any talk of significant recovery on the largest diamond jewelry market, and even dramatic success of China and India can hardly sweeten this bitter pill.
 
At this conjuncture, hedging ALROSA’s risks by long-term contracts based on fixed prices brings about a new risk - the threat to make the amplitude of speculative tsunami much higher. It seems that the paradoxical situation when rough diamonds will cost more than polished diamonds is looming on the horizon again. Eighteen months ago all of us saw what it added up to.
 
Sergey Goryainov, Rough&Polished