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Will the diamond market face obstacles on the way toward new records?

17 january 2022

It appears from all the available indicators that the diamond market is entering the holiday season with insufficient inventories at all value chains due to the reduction in supply. The jewellery sales remain strong, and early data on the Americans' spending on the Thanksgiving Day holiday allow to feel upbeat about the Christmas period. An obstacle in this seemingly inevitable ‘race’ for records may be the factor of the low profitability of the cutting and polishing sector, which aggravated against the background of the rough diamond shortage and slowed down the polished diamond price growth. The market already stumbled over this problem several years ago, however, the picture was completed by the decline in jewellery sales at that time. But now, the already two-fold gap in the dynamics of the rough and polished diamond growth may be aggravated against the background of the new strain of COVID-19 spreading in South Africa that generates disruptions in the diamond supply and poses the risks of a larger deficit.

PRODUCTION AND THE MARKET BALANCE

The supply of rough diamonds remains limited, not only due to the reduction in the major suppliers’ production, the closure of small mining companies and the general depletion of diamond reserves, but also due to the deteriorated assortments offered by ALROSA and De Beers, VTB Capital writes in its review.

The rough diamond production has dropped by 15% by real value since 2018, and this year's growth in demand is attributed to the mining companies' reserves that seem to be depleted by now. In the medium term, there may be some recovery in the ALROSA’s and De Beers’ outputs, but the general depletion of the reserves and the absence of new large projects may limit the market in the near future.

“Since we do not see any significant sources of additional supply in the coming years, only a rise in prices can ensure the balance in the market, VTB Capital believes. According to the Bank, the situation with the diamond supplies next year will remain tough.

In volume terms, global production in 2021 is projected to edge up by 4%, as some mines such as Ekati and Renard in Canada and Grib in Russia have ramped up from their Covid-driven drop in 2020. That will somewhat compensate for the loss of Argyle,” writes Avi Kravitz of Rapaport. ALROSA plans to increase its production by 1 mn carats annually until 2026, launching the operation at its low-grade deposits and resuming the full production operation at its placer mines. At the same time, De Beers has lowered its production forecast down to 32 mn carats because of the ongoing operational difficulties due to the Covid-19 pandemic. The only major new rough diamond source in the near future is the Luaxe project in Angola that can produce about 5.7 mn carats of diamonds in 2023 (according to Diamantino Azevedo, the country's Minister of Mineral Resources), which is more than half of the country's production in 2020 year.

“Still, it appears the bar has been lowered in terms of the number of carats coming out of the ground, and these levels are expected to remain in the short to medium term,” Krawitz says.

The diamond supply is now 25% lower than before the pandemic, and 10% lower than in the early 2010s when the market was close to balance, but since then, the demand for jewellery has grown by 25-30%, according to the statement of Sergey Takhiev, head of the ALROSA's corporate finance department, made at the end of November.

SLOW SALES

The limited supply results in the slowdown in sales. In September-October, the rough diamond sales slowed down, they were 10% below the historical average for ALROSA and at the usual level for De Beers. Despite the strong demand from the midstream, the sales have been constrained by low inventory levels and deteriorating assortments over the past few years, VTB Capital believes.  

De Beers sold $430 mn worth of goods at its ninth sight this year held from November 8 to 23, which is 13% lower than at the previous sight ($492 mn) and 7% lower than a year ago. The demand was in line with the company’s expectations, but it was affected by the seasonal closures of the cutting and polishing factories in India during the Diwali festival, said De Beers CEO Bruce Cleaver.

The ALROSA's sales in October ($308 mn) were 7% below the historical average for this period, although they were slightly below the level of the previous year when the trade was recovering after the Covid-19 pandemic.

The reason for the decline in the company’s revenue was the lack of rough diamonds in the quantity required by the market, Takhiev explained. "We sold all of our inventories by the end of Q2. And since June, we have been selling the rough diamonds ‘just mined’. This shows that the market is very strong as our customers are ready to wait until we excavate the stones, wash and hand these stones over to them,” he said. Our customers were worried about the availability of rough diamonds and were eager to pay in advance for future purchases.

RISING PRICES

At the meantime, the prices are rising. The diamond price index has grown by 25% since the beginning of the year, including a 10% rise in price in Q3, reaching the level of 2018. In October, ALROSA raised its prices again, by an average of 1%.

De Beers raised the prices for its low-end small diamonds ahead of its November sight, Rapaport reported earlier this month. The cost in the cheapest categories rose by several percent. The demand for them is usually the last to recover, but such stones are in demand now amid the US jewellery retailers' concerns about the availability of polished diamonds for jewellery during the holiday season, according to the agency.

With the jewellery sales skyrocketing, the supply shrinking, and the inventories across the value chain remaining low, the rough diamond price index still has a 30% upside potential compared to the September levels, VTB Capital believes. An even larger increase is possible in the event of a price squeeze during the seasonal replenishment cycle in Q1 2022. Such cases were in 2012-2013.

ALROSA considers logical that in 2022, the average selling price of gem-quality rough diamonds would return to the levels of 2013-2015 when it was in the range of $170-175 per carat, Takhiev says. Now, the price is more than 25% lower than those values as it is close to $130 per carat, according to the results of 9 months of this year.

In 2013-2015, the rough diamond market was balanced, and the average price of the ALROSA’s rough diamonds was $170-175 per carat. Since there is an acute shortage in the market now, the price return would not be unexpected, according to Takhiev. Taking into account the inflation accumulated, "in real terms, the price should be under $200, at least $180 per carat," he said.

"But taking into account the existing shortage, there is every chance to achieve higher prices," said the ALROSA’s representative. In his opinion, the change in the assortment is not very important in this sense because "the market should be assessed based on how much a consumer is willing to spend on a piece of jewellery."

Since September 2020, 180 mn carats of rough diamonds have been sold, with the production of 110 mn carats, according to Takhiev. The rough diamond shortage has become a new reality, and the market is balanced mainly by prices. At the same time, the market does not respond to the decrease in supply as quickly as in the case of gas and oil, he notes.

The spread of the new Covid-19 (Omicron) strain in late November in South Africa and Botswana where the De Beers' main mines are located has given a new impetus to the rough diamond price growth. According to the Indian Economic Times, the rough diamond prices rose by 5-10% in a few days in response to the news of the new Covid-19 strain and the supply problems it caused.

The rising rough diamond prices coupled with the possible supply constraints have raised concerns among the cutters from Surat and Mumbai who are receiving the orders from the United States, China and the Middle East for polished diamonds. The Indian cutters began to hold on to their inventories to avoid buying rough diamonds at a higher price.

MIDSTREAM

According to some estimates, the polished prices will grow by about 12% this year, which is quite a big rise, bearing in mind the last year's decline, but it seems insufficient compared with a 25% rise in the rough diamond price index in just 9 months. This situation threatens the profitability obtained by the cutters and polishers.

According to Rapaport, some cutting and polishing companies in India had to extend their Diwali vacations to three weeks due to the high value and limited availability of rough diamonds. A polished diamond manufacturer CEO said to Rapaport that the industry had a good year after three years of turbulence, but everyone expected the next year to be very turbulent if the rough prices remained at these levels. He thought it would take some time before the polished diamond prices would start rising.

At the same time, the midstream, which has undergone a massive reduction in the inventories over the past few years, still has a great potential for their replenishment, VTB Capital believes. A minor restocking in the midstream began in September prior to the Diwali festival, when the rough imports rose by 40% by 2020, although the polished exports were largely unchanged.

The midstream did not make any significant restocking after the rough diamonds were sold out in 2018-19 during the liquidity crisis in this market, when the banks withdrew the credit lines from many cutters and polishers and needed to strengthen the balance sheets, which was achieved by disposing the surplus. This year, the jewellery retail has the lowest turnover in the last 7 years, which is partly due to the transition to the e-commerce requiring no large inventories. A further decline in the inventories in this segment is also unlikely, VTB Capital believes.

The midstream, as a rule, features a fast capital turnover, striving to sell the goods to retailers and purchase rough diamonds from the suppliers as soon as possible, therefore, it does not hold more or less large inventories, according to Takhiev.

In October, the rough diamond imports to India, according to the GJEPC, increased by just 2% compared to the last year's imports amounting to $1.38 bn, which may indicate a shortage of the rough diamonds after strong purchases in the previous months. The India's diamond exports in October rose to $2.56 bn (up 45% year-on-year), a record high since September 2017, reflecting the surge in activity prior to Diwali in India and a strong retail demand ahead of the US holidays.

JEWELLERY RETAIL

The global jewellery market continues to amaze with its growth driven by the accommodating monetary policy and travel restrictions. ALROSA expects a record demand for the diamond jewellery in the United States and China ahead of the Christmas, New Year holidays (including Chinese ones), and the Valentine's Day. The total demand may exceed $90 bn, up 18% over the previous year.

In 2021, the global jewellery sales, according to VTB Capital, will grow by more than 30%, with the growth over 50% in the United States. While some slowdown is possible in 2022 due to the fact that the figure in 2021 was affected by the pent-up demand during the pandemic, the level of sales will be 10% higher than in 2019.

In September, the US jewellery sales rose by 32% YoY, up 58% compared to 2019. The jewellery sales in China also show its strong dynamics, with an increase of 22% YoY and 47% compared to September 2019, although this is mainly due to the gold jewellery sales, according to retailers.

One indicator of the jewellery sales during the holiday season might be the US spending over the Thanksgiving weekend. According to the Mastercard SpendingPulse’s data, they are up 14% this year driven by the increased sales of jewellery and apparel. In particular, the jewellery sales rose by 78% during this period. The in-store spending jumped by 17% compared to 2020, while the online sales rose by 5%. Both categories also surpassed the 2019 performance.

EFFICIENT DISTRIBUTION

Unable to quickly saturate the market with the required rough diamonds, the miners decided to pay even closer attention to the efficiency along the entire value chain.

The exact details of the new model are unknown, but according to ALROSA, its logic is “to adapt the specifications as accurately as possible to the needs of the buyers, taking into account not only the purchase history, but also the specifics of the business of each category of the customers, including the diamond cutting and polishing companies, traders and jewellery retailers”. This approach to the long-term contracts that will come into force in January next year will help maintain a balance in the industry, reducing the volatility and dependence on external conditions, the Company believes. “Thanks to this, we can now formulate the specifications taking into account the needs of each client as individually as possible and ensuring an effective buyout,” commented Yevgeny Agureev, Deputy CEO of ALROSA.

The new approach used by the major suppliers will lead to a tougher supply chain and the competition for available goods, which will further highlight the scarcity of natural diamonds, Krawitz says.

Igor Leikin, Rough&Polished