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Diamond industry: virus test

13 april 2020

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Image credit: Gerd Altmann (Pixabay)


When diamond industry stakeholders described what was happening in the market last year as a “perfect storm,” they certainly couldn’t think of what was going to happen in 2020. At that time, it was a cyclical decline in demand due to excess stocks, problems with lending, geopolitical tensions, changes in consumer preferences and increased presence of lab grown diamonds. Now, the global diamond supply chain is essentially paralyzed, the “diamond pipeline” segmented and returned to the state of 2008-09.

In less than two months, the virus from a local Chinese outbreak has expanded to a global disaster. Restrictions on movement and national lockdowns hit the jewelry sector, because 90% of purchases are still carried out in shopping centers. Major diamond production centers have closed to stop the spread of the virus. Diamond miners were hit twice, almost completely losing the opportunity to sell their goods.

Having died, the virus will leave a powerful post-effect. According to the forecasts of economists and rating agencies, the damage incurred to the global economy will have a lasting effect at least during 2020, hampering the sale of jewelry. “The coronavirus “fear factor” is greater than past crises too, weakening financial markets. Its impact on the real economy—job losses, GDP declines and so on—is set to be extensive. Finally, luxury shopping by travelers will take longer to recover, as countries maintain restrictions on travel to prevent further waves of outbreak and some people remain nervous about flying or cruising,” Bain notes in a report on the impact of COVID-19 on the luxury sector. According to Bain, global luxury sales will suffer a year-over-year decline of 25% to 30% in the first quarter of 2020 and may slump by 25% for the year as a whole.

There is certainly hope for recovery. Economic activity in China is gradually resuming amid containment of the virus. Reduced production and sales of rough diamonds will save the system from overhang, normalizing the inventories of diamond manufacturers and improving their financial situation. The factor of pent-up demand is difficult to assess, but the experience of overcoming the recent economic crises and natural disasters showed that jewelry sales can very quickly return to the abandoned levels and even increase. The industry, like all other segments of the world economy, will survive this crisis and push off the bottom this year. It is important that this bounce is not a dead cat bounce, after which the load of accumulated problems and the degree of wear will force the industry to renew valley values.

FIRST SYMPTOMS: CHINA

After several months of turbulence, the diamond pipeline resumed normal operation at the end of 2019. The largest players, led by De Beers and ALROSA, reduced supplies (their annual sales in carats fell by 8% and 12% respectively) and restored the balance of supply and demand. The discipline of large diamond miners helped stabilize diamond prices in October, November and December and the midstream moved to a replenishment stage amid brisk Christmas sales, Petra Diamonds said in its report. In November, rough diamond imports to India grew by 32.4% in terms of value versus one year ago. “January saw steady demand for rough diamonds as cutters continued restocking on the back of positive Christmas jewellery retail sales,” ALROSA said following its January trading session, the result of which was 19% higher than the historical average for this month. Signet Jewelers, one of the largest jewelry retailers, increased its sales by 2% in North America during the festive season (nine weeks ending January 4) with online sales going up by 13.5%. Not only large US jewelry retailers showed strong results (accounting for 15-20% of the market), but they were also joined by small and medium-sized players, as it was noted in a review of VTB Capital.

China’s jewelry retail was the first to feel the impact of coronavirus across the country, whose population last year accounted for 90% of the growth experienced by the global luxury goods market. In mid-January, China had first to extend New Year holidays and then announce quarantine measures along with transport restrictions and the closure of shopping centers. Jewelry retailers temporarily ceased operations in mainland China and reduced opening hours for stores in Hong Kong and Macau. In this state, they met Valentine's Day. In the first two weeks of February, Hong Kong-based Chow Sang Sang closed 77% of its stores in mainland China. The company’s comparable sales for the first two months of 2020 in mainland China fell by 45% and by 44% in Hong Kong and Macau. In Hong Kong, According to the Census and Statistics Department of Hong Kong, sales of jewelry, watches and other luxury goods during the first two months of 2020 in Hong Kong fell by 58.6%. In February, jewelry sales fell by 78.5% compared to last year. Sales of China-based Chow Tai Fook in January-February in mainland China fell by 42%, in Hong Kong and Macau - by 60%. Online sales also fell by 36% compared to the same period last year.

Due to declining demand, polished inventories replenished before the Chinese New Year are likely to remain high in the short term, Chow Tai Fook pointed out in its reporting. Wholesale buyers are not so willing to buy polished goods because due to the coronavirus, their transportation and sale in the Chinese market is becoming a problem, Rapaport reported in late January. Antwerp diamond exports fell by almost 94% in February due to the closure of Asian markets and the cancellation of key industry events for the first half of the year, Hong Kong International Diamond, Gem & Pearl Show 2020 and Hong Kong International Jewellery Show 2020. Diamond exports from India halved in February - this rate of decline was last observed in 2015.

RELATED FACTOR: EXCESS SUPPLY

We should not consider the virus as the only cause of problems in the diamond industry. Perhaps the signs of stabilization in December-January were too shaky to ensure full growth. Despite the fact that jewelry retailers showed good results during the holidays, the trend is not strong enough to support the dynamics of re-stocking by polishing enterprises for a long time, VTB Capital noted in a review published in late January following a meeting with market participants in Antwerp. “Most stakeholders in the polishing business with whom we spoke pointed to a fragile balance between supply and demand in the market, which could easily be violated in the event of price and / or supply fluctuations. ... Restoration of demand and prices for diamonds were not felt by all market participants, from which it follows that the tendency to re-stocking may be limited to the next 2-3 months, including January," the VTB Capital survey said.

In response to reduced inventories and increased demand, diamond miners boosted sales and midstream hurried to increase purchases, Edan Golan believes. De Beers and ALROSA achieved maximum sales in January for the past 12 months. During the first two months of 2020, rough imports in Antwerp increased by 30% in carat terms.

According to Golan, the supply of rough diamonds in the market was already excessive in January. “The more than $1 billion worth of goods was more than the diamond midstream could digest, fueling concerns among manufacturers. ... This raised concern that this could be the start of another vicious cycle of available money, followed by exaggerated rough diamond demand, then rising rough diamond prices, and oversupply of polished diamonds, leading to the inevitable polished diamond price fall,” writes Golan. As a result, wholesale prices for diamonds in February fell by an average of 2.9%, following an increase of 1.4% in the previous month, undermining confidence in the short term, which was exacerbated by the spread of COVID-19. After strong demand for rough diamonds, the system may accumulate an excessive amount of polished diamonds, as travel restrictions will affect global trade, Rapaport wrote in late January.

Diamond producers were guided by the interests of their own business, because they had their own plans for 2020, which was supposed to recoup the losses and sacrifices of last year. In 2019, diamond miners did not significantly adjust production, increasing inventories and hoping to reduce them in 2020, said Moody’s Vice President Denis Perevezentsev: in 2019, global diamond sales in USD terms decreased by 20%, production - by 4%. This complicates the situation, and there is a likelihood of continued growth of rough stocks.

ESCALATION: SUPPLY CHAIN BROUGHT TO A HALT

Diamond miners, who projected strong January results into the first and second quarters, felt the immediate effect closer to mid-February. The coronavirus rather seriously affected the demand for rough diamonds, which slowed down in February after successful January sales, the head of ALROSA Sergey Ivanov admitted, speaking in Ramat Gan during the International Diamond Week. Market stakeholders are redefining their strategies in the Asian market in light of stopped jewelry sales in China and surrounding regions, he explained. A little later, another Russian manufacturer, AGD DIAMONDS, which held an electronic auction for special-sized diamonds in Antwerp, said that a significant part of the lots put on the block remained unclaimed as “the market generally remained influenced by negative news from China due to the coronavirus.”

The spread of the virus outside of China, especially in Italy, where strict quarantine was introduced on March 9, exacerbated the situation. Nevertheless, the illusion remained for some time that the impact of COVID-19 would be localized and there would be no quarantines similar to the Italian scenario. Exports of polished diamonds outside China continued; supplies from Antwerp to Israel grew; US sales, which account for 40% of the jewelry market, remained stable. In early March, quarantine in China was relaxed and retailers began to open their stores. And even the closure of Antwerp diamond bourses due to quarantine in Belgium did not become an insurmountable obstacle to the sale of rough diamonds, the bulk of which is sold under long-term contracts during the trading sessions of De Beers in Gaborone and ALROSA in Moscow.

If the majors are insured against collapse by long-term contracts until a certain point, second-tier companies such as Gem Diamonds and Petra Diamonds were the first to feel dramatic deterioration in market conditions at their tenders. It is this trading mechanism, with all its vulnerability, that clearly reflects the current state of the diamond market. Petra was forced to interrupt ahead of time its tender, which was held in Antwerp and South Africa at the end of March, due to a sharp deterioration in the trade environment caused by restrictions on flights and the closure of diamond cutting factories and jewelry stores. Earlier, during this auction, the company was faced with “depressive and opportunistic pricing” for its diamonds, especially for a large and high-quality assortment belonging to the high-end category. The company decided to sell only 50% of the goods put up, while the rest will be offered when the market situation permits. The rough that was sold went at 24% below the level of February. Petra plans to hold the next auctions in May and June, but at the moment, as the company notes, their prospects are very uncertain and will depend on restrictions at that time, as well as on activity in key diamond centers in India, Israel, China and the United States. Gem Diamonds, which develops diamond fields in Lesotho and Botswana, has canceled a regular tender scheduled for March 25 and will limit its trading to spot sales of largest top-quality diamonds to its customers.

The apocalyptic scenario for the industry was fully realized with the restriction of flights to the United States (since March 13) and the closure of most retail stores in North America, including Signet and Tiffany, by the end of the month. After the closure of the main jewelry market, the game was quit by the largest diamond manufacture – India introduced a 21-day lockdown on March 25. The closure of factories in India led to a drop in demand and wholesale customers were less able to cut or resell rough diamonds. It makes no sense to keep rough to process it after a month, one of the De Beers sightholders conveyed market sentiment to Rapaport.

Finally, with the restriction of international flights in Russia (from March 23) and the closure of Botswana for quarantine (March 27), ALROSA and De Beers found themselves in a situation where even contractual obligations do not guarantee customers' ability to buy. Both companies have consistently reduced requirements for sightholders. De Beers ultimately canceled its third sales cycle this year, which was scheduled for March 30 to April 3, due to restrictions on travel and transportation in Botswana, South Africa, and India. At the same time, in accordance with the company’s schedule, there was no sight in March. De Beers allowed its customers to postpone the purchase of the entire amount of rough intended for the third sight.

ALROSA limited itself to reducing the limit of mandatory purchase under contracts to 50%, some of which (up to 10%) were required to be purchased until the end of May. The miner’s March trading session yielded about $ 153 million, or 56% lower than February and 59% lower than a year ago. “With several companies we had to terminate such contracts and switch to spot sales,” said Evgeny Agureev, Deputy CEO of ALROSA. This alarm signal means that customers can no longer buy diamonds for the future, even at the risk of losing a contract. However, according to BCS, so far no more than 3% of the total amount of ALROSA's long-term contracts has been affected and the outflow included only relatively small buyers who will return when the crisis is over. ALROSA’s strong competitive position will make it possible for the company to recover when the crisis-related restrictions begin to weaken, as expected, starting in June, BCS believes.

VACCINE: DIAMOND AS A SYMBOL OF OVERCOMING TROUBLE

The duration of isolation remains a major issue and risk factor. India’s diamond manufacturing looks to be the most vulnerable, according to Sergey Goryainov of Rough&Polished. If the quarantine lasts longer than mid-April, a halt in production could cause a credit bubble explosion, since the Indians will not be able to cope with debt servicing, and financing is now extremely difficult to attract. With the bankruptcy of the Indians, ALROSA may lose a significant share of sales. Igor Kulichik, Deputy Chairman of the Board of Directors of AGD DIAMONDS believes that Indian diamond manufacturers can receive state support and continue their operations. “The Indians know how to support their people. One or two months of downtime is bad, but not horrible,” Igor Kulichik says. “It seems to me that in May, very many companies will begin to resume their operations, as China is doing now, and there will be a wave of pent-up demand. This does not mean that everything will recover, but the fall will stop for sure,” he hopes.

Another argument for recovery is the normalization of midstream inventories. The industry entered 2020 being more stable and more prepared for shocks than on the eve of the demand crisis a year ago, ALROSA said. “The polished stocks in the middle segment of the pipeline are much lower than they were a year ago and the sales policy of diamond miners is already adapted to market volatility,” said ALROSA deputy CEO Evgeny Agureev after meeting with long-term clients on the eve of the March trading session. “The industry is better positioned to handle stocking today than it was in recent years as a painful mid-stream inventory deleveraging cycle already took place through most of 2018 and 2019,” agrees Paul Zimnisky.

In addition, national lockdowns influenced not only demand, but also supply and its reduction contributes to the restoration of demand. It is true, however, that this reduction is not so significant. According to VTB Capital estimates, disruptions in the supply of rough caused by the spread of coronavirus will affect 2.5% of the global diamond supply. So far, about 16 million carats have been affected by lockdowns lasting from 21 days to 4 months, which could lead to a loss of 3-4 million carats (2.5% of the global diamond market in 2020). Currently, production at Ekati (Canada, Dominion Diamond), Finsch, Cullinan and Koffiefontein (South Africa, Petra Diamonds), Letseng (Lesotho, Gem Diamonds), Liqhobong (Lesotho, Firestone Diamonds), Mothae (Lesotho, Lucapa Diamond), Williamson (Tanzania, Petra Diamonds) is partially or completely limited. De Beers operations in Botswana have not yet been affected, but De Beers has reduced staff by 75% at the Venetia mine in South Africa. In some cases, for example at Williamson, a lockdown was not even required: the closure is explained by the inability to sell goods in the current situation, which is why the mine’s work is economically unjustified.

Liberum analyst Ben Davis estimates that global diamond supplies will diminish by about 12%, but that, in his opinion, is not enough to help the market move into a state of insufficient supply. Additional reductions are possible if some part of ALROSA’s rough diamonds is purchased by Gokhran, but there is no clarity about this decision. Although interruptions in the supply of diamonds are growing and may intensify if ALROSA's rough will go to Gokhran, a sharp drop in demand in the United States and Europe may more than compensate for this in the coming months, VTB Capital believes.

Edahn Golan in his article gives several examples of how diamond jewelry sales leaped out of the abyss of disaster. This happened after September 11, 2001, when the next year, retail sales of diamond jewelry in the United States grew by 20%, while global sales grew by only 5%. This happened in 2009, when the world was just coming out of the economic crisis, which destroyed entire industries and deprived a huge number of people of their livelihoods. In the festive season of 2009, jewelry sales jumped by 5.4%, while diamond jewelry sales went up by 3%, despite the fact that in many other areas there was a decline; and 2010 was one of the most successful for the diamond industry. This happened in Japan in 2011, when diamond jewelry sales were one of the few segments that grew at the height of the disaster caused by the earthquake that destroyed the Fukushima nuclear power plants.

Golan explains the reason for this paradox: “The tendency to spend on diamond jewelry is a response to large-scale deaths, disasters, and economic meltdowns. … When coming back from a bad situation where we felt our lives were threatened, we experience a need to celebrate, outwardly express our love, and signify our triumph. Buying something of value, symbolic, and everlasting is a common response.”

Igor Leikin for Rough&Polished