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The future for synthetics lies in that it has become possible to grow a stone you want and make what you want out of it

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Market report: Between a bird in the hand and two in the bush

02 july 2012

Last Thursday, three people at once mailed me one and the same link with a comment, "Have you ever seen this? It’s unprecedented!" As one may easily guess, the link was to the news that De Beers let its sightholders defer one half of the goods at the July sight and reschedule that amount to some other time. The company calls this a step towards the customers, because the current size of the sight exceeds their needs.

Judging by the previous reports, DTC encountered some problems at the June sight despite the fact that De Beers has been trying to maintain flexible prices for the second consecutive month - raising or lowering them for different types of stones depending on demand. Still, several sources in the market reported that currently bidders had not enough funds, so trading activity was weak both at the sight and in the secondary market, where DTC boxes were sold either at their original price or even at a discount. And one of the sightholders, wishing to stay anonimous, voiced the "open secret": "At the moment, the market has no interest in rough, these goods are now simply unprofitable."

Industry experts say there is a liquidity crisis present on the market, pointing to the lack of credits and falling demand. De Beers’ actions demonstrate that right now rough producers have to adapt to the financial situation their customers are in. But in fact, it is the producers that create this situation.

People may repeat as much as they want that market participants are extremely concerned about the uncertainty in financial markets, including the expectation of a large-scale crisis in Europe. However, by and large, this anxiety drags on for more than six months, but so far Europe appears afloat. This uncertainty, of course, brings about a good portion of tension, but it would be wrong to put all the blame for reduced demand on it.

The talk about the liquidity crisis has also two sides. On the one hand, banks are now really tightening the requirements for borrowers to get a loan so it becomes more difficult. But it wouldn’t be superfluous to recall that these measures are, inter alia, a response to the events of 2008 and introduction of banking regulation measures, Basel 2 and Basel 3. It seems that before the crisis, to get a credit under a rough diamond collateral was easier than to get a consumer loan to buy a mobile phone - there were a lot of banks eager to credit diamantaires. As a result, speculation in rough reached an unprecedented scale and then suddenly it turned out that credited companies were involved not only in cutting diamonds. It is true that now banks are more demanding towards borrowers and more willing to extend credits to those who are involved in diamond cutting and invest in the development of this business. But this measure is designed to protect the banks and the market itself. And if market participants point to difficulties in obtaining credits, it is rather a problem of compliance of some of them with the reliability criteria, and not a problem of the system.

Again, it is worth to remember that higher requirements for borrowers is a kind of response to the growing requirements for the banks themselves. If you recall the 2008 crisis, it becomes clear that we really need reliable banks.

Currently, several sources in the banking environment have pointed out that their credit limits for the diamond industry are not decreased compared with 2008 and that diamond cutters’ debt to banks is at about the pre-crisis level. Moreover, according to them, the ratio between the finished diamonds value and the manufacturers’ debt is now even better than before the crisis. Sources say that the majority of traders from Antrwerp this year are not using their credit lines to their full extent. Problems are facing mainly companies from India, which have been hit hard by the fall of the rupee against the U.S. dollar and imposed tax on imports.

If the volume of lending has not changed, then the reason for the liquidity crisis should be sought elsewhere.

Rough is expensive, but has no consumer value until it turns into polished diamonds. And after the crisis, there is emerging a new trend on the consumer diamond and jewelry market, which is extremely worrying for the industry: people do not stop buying luxury items, but they buy things that fit their income. The buyer comes to the store with a specific amount of monery and is not ready to spend more. So, watching the rising prices for jewelry, customers still make their purchases, but opting for lower quality goods - for example, instead of top color grade diamonds they select diamonds of the third or fourth color grades. Or they go in for smaller stones or piqué rocks. The difference in a fraction of a carat, as well as the difference in colors may be visually imperceptible to most consumers, and therefore insignificant. But the difference in terms of money earned by merchants is essential.

Therefore, numerous analytical consultancies, of course, report about stable demand for luxury goods and even about an increase in prices for polished diamonds. But, in fact, sales growth is achieved due higher sales of low-cost products.

This trend is already well felt by manufacturers. Sources say that, for instance, Swiss watch makers are turning out new collections with fewer diamonds. It may be assumed that this will keep their cost lower, and later vendors will again report an increase in demand. The same goes true for jewelers.

But if you look at this situation from the diamond manufacturer’s point of view, you get a different picture. Rough diamond producers are raising prices for their goods. They are prompted by the simplest laws of the market: the higher the price the greater the profit. All major producers of rough diamonds today are market-oriented companies which have their shareholders, and the ultimate goal of any company is to make a profit for shareholders.

Forecasts for the luxury market clearly say that it will go through a rapid and long-term growth. India and China have just entered their "era of consumption," and the middle class (due to the total number of population) in these countries is comparable with the number of consumers in the traditional jewelry markets. Accordingly, there is no reason for diamonds to become cheaper.

Global production forecasts clearly suggest that there are no new dismond fields and hopes for new discoveries are delusory, whereas the old diamond mines  will soon be depleted. The market is facing a shortage of rough, which means that in the long term prices will rise, and there is no reason for diamonds to turn any cheaper.

However, diamond cutters (and we are still speaking about them) live for the day and, as a rule, they do not have an adequate reserve of financial strength to pin their hope exclusively on the long term. In the face of daily rising prices, they can afford to buy fewer and fewer rough diamonds with the initially available amount of money, and this "eats away" their margins at the stage of purchasing rough. On the other hand, end buyers shifted to cheaper goods, and this is what just equally "eats away" diamond cutters’ margins  at the stage of payback from retail. They may even borrow more money from banks, but what will they get from this besides turning able to purchase a larger amount of rough? The above mentioned bank sources say that diamond manufacturers’ margin fell below 6%, which actually means that the industry is operating at a loss, because there is no one to cancel production costs and these, alas, are growing accross the globe.

Indeed, there are no fundamental reasons for the decline in diamond prices. But that does not mean that there are reasons for their growth right now. The market is at the point where some pricing decisions should be made not only in terms of economic benefits, but also in terms of strategic development of the industry. The main idea of the diamond business is that polished diamonds are not getting cheaper with time and, respectively, prices for rough diamonds should also rise. But in the current liquidity crisis, it may be advisable to proceed not from the price of rough diamonds, but from the amount of money that would eventually reach the participants of  the diamond pipeline.

For rough diamond producers it would be an economically beneficial situation if prices would continue to grow at the current level of supply. But their growth in this case can be achieved not only by higher demand, but also due to reduced supply, which is currently, unfortunately, almost impossible.

Some part of diamond dealers squeezed in funding, of course, would like to have significantly lower prices. But ultimately, lower prices will lead to devaluation of collaterals and stocks of rough diamonds, which may affect rough producers, diamond dealers and banks, as well as the cutting sector.

In case the current level of demand will be maintained, a compromise solution would be to adjust prices, which allows to increase rough sales in terms of carats. In this case, miners will have comparable total sales due to a higher sales volume and buyers will have an opportunity to operate having a greater margin.

The current slowdown in the market is, of course, worrying diamond miners, but this price adjustment allows the market to regain strength. The Central Bank of India has already announced the launch of a series of measures aimed at restoring the rupee. The diamond market will start its partial recovery along with the recovery of the rupee.

Elena Levina for Rough&Polished