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Bain & Company: Demand for rough diamonds should return and surpass the level of 2006 in the next 10 years

18 june 2012

Bain & Company, a leading global business consulting firm, offering solutions on issues of strategy and operations, works with over 2,700 major multinational corporations across every economic sector, including the diamond mining industry. Olya Linde, Principal of the company’s Moscow Office, gave this interview to Rough&Polished.

Speaking about the development of the diamond market, we often talk about the expected growth of diamond consumption in China and India. Can you give some recent figures to compare diamond consumption in these countries and in the United States?

According to IDEX, in 2010 the consumption of gem quality diamonds in China and India approached $2 billion for each of those countries compared to nearly $7 billion in the US, which accounted for 38% of the total wholesale diamond market. In terms of recent growth trends: in the years leading up to the most recent financial crisis between 2000 and 2007 China experienced a 17% annual growth, while India showed a healthy growth rate of 13%, compared to about 5% of annual diamond consumption growth in United States.

During the crisis, between 2007 and 2009, while diamond consumption was falling in the rest of the world, China had a 12% annual growth and continued to grow rapidly through 2010 at over 50%.

India’s results were a bit more moderate (although starting with a higher base before the crisis), slowing down during the crisis, but then showing a healthy recovery in 2010. In comparison, diamond consumption in the United States slowed down by -16% annually in 2007-2009 and recovered at about 8% in 2010.

Many in the diamond industry pin their sales hopes on China and India sometimes forgetting that the scale of diamond consumption in mature markets is maintained by an age-old tradition difficult to instill elsewhere in a matter of days. Do you think this can be achieved there or not?

It is true that the share of the diamond jewelry in the overall jewelry market consumption in India and China at 32% and 29% respectively is lower than that of United States and Japan (52% and 51%). However, there exists a relatively recent example of stimulating demand for diamonds through creative marketing and focused effort by the industry. The share of diamond engagement rings (among all engagement rings) in Japan was barely 6% in 1966 before the diamond industry decided to focus their efforts on that market. In short 10 years, that figure was up to nearly 60% and by 1990 it reached nearly 80%.

What we see today is that the marketing effort in China in particular is being undertaken not just by the traditional diamond players, but also by major jewelry manufacturers and retailers. Chinese couples are rapidly adopting modern Western traditions which also include white lace gown and tuxedo as wedding attire and diamond jewelry as gifts. By some estimates, already 30% of the brides in China buy a diamond engagement ring. We believe that consumption of diamonds in China and India will continue to grow driven by urbanization and growth of the middle class.

Some analysts say that the pace of economic growth in emerging ‎economies is expected to slow in 2012 and lately growth is being spurred by demand ‎in traditional markets while the emerging markets are relatively restrained, thus reversing ‎the trend of the past year. What is your take?

Traditional markets such as US, Europe and Japan are the largest consumers of diamonds and likely will remain such for the next 10 years driven by GDP growth. In addition to GDP, big factors driving the demand for diamonds in the emerging economies are urbanization and growth of middle class. With continued economic growth and demographic shift, we expect the growth rate for diamonds in India and China to continue outperforming that of the traditional economies in the next 10 years. According to the recent statement by major producers, they see a strong demand coming from Asian markets so far in 2012.

Judging by the new SoC contract pattern now in operation at De Beers, this diamond miner is going to feed customers from both hands using DTC sights and Diamdel auctions to select the best buyers. Do you think this will add more fuel to competition on the diamond market?

The access to rough diamond supply has always been a key competitive advantage in the diamond industry. With finite number of rough diamond producers and a rather large number of players down the value chain, such as polishers, jewelry manufacturers and retailers, this dynamic is very understandable. Innovations in how producers bring their rough to the market have been around for some time now. For example, BHP Billiton has been using an auction-based approach for selling their rough, while most majors have some sort of a mix of sights or long-term contracts and auctions. As more rough is being offered through auctions, more customers will have access to the rough supply. If the sales through Diamdel continue to increase, it will have some impact on the industry but the magnitude of the of the impact remains to be seen.

Do you think diamond demand can return to its peak level of 2006?

According to our projections, demand for diamonds will continue to grow due to the recovery from the economic crisis, expanding middle class in China and India and the increase in total private consumption levels in developed countries. Under the scenarios that Bain considered in its study, the demand for rough diamonds should return and surpass the level of 2006 in the next 10 years. Of course, there are several risk factors that can impact the level of demand. Potential change in macroeconomic environment, specifically prolonged recession in Europe, significant economic slowdown in United States or slower than expected growth in developing countries can have a negative effect on diamond demand.

Do you expect synthetic and recycled diamonds to increase their market shares?

We believe the potential for significant market penetration by synthetic diamonds remains low in the near term because of several limiting factors. On the demand side, we do not yet see the evidence of consumers willing to buy synthetic diamonds, especially for engagement rings. An aggressive marketing campaign by producers of synthetic stones could affect the situation, but we do not see a substantial marketing activity for synthetic diamonds at this time. On the supply side, heavy capital investments are required for mass production of gem-quality synthetic diamonds and currently there are no players on the market making those kinds of investments. In fact, largest producers of synthetic diamonds are focusing their efforts on high end industrial uses that offer attractive returns.

Recycled diamonds present a different challenge. In our view, there is a limited supply of recycled diamonds for the reason that a person that buys a diamond at a retail price will very rarely be willing to sell it back at wholesale polished price, which is significantly lower due to the retail markup. As a data point, consider that the value of all diamonds sold wholesale by polished-diamond dealers in 2010 was around $18 billion, while the value of those diamonds in retail was over $60 billion. It is that price differential that prevents most people from selling diamonds that they own, thus limiting the overall supply of recycled diamonds.

Is there any possibility the diamond industry may face another crisis?

Diamond industry has lived through a number of crises throughout the history. Just in the past 30 years, we have seen the rough diamond prices taking a drop due to a major new discovery coming online (Argyle) in mid-1980s, de-stocking of a major government stock of Gokhran in mid-1990s and, of course, the financial crises of 2000 and 2009. However, the prices have always recovered and continued to grow, so that we can see a healthy 3% annual growth in real prices between 1982 and 2010.

While it is possible that the industry will experience a crisis from time to time, our forecast of global rough-diamond supply-demand balance for the next 10 years finds a likely global deficit of rough diamond supply given the lack of new major discoveries. In our base scenario, demand is projected to grow at 6.6 percent per year in value terms between 2011 and 2020, while supply is expected to grow at 3 percent per year. Historically, such supply-demand imbalances have provided the foundation for firm prices in the industry.

In your opinion, does the diamond market need a greater degree of transparency?

Diamond industry has traditionally been considered complex and difficult to understand, with the companies in the middle of the value chain financed primarily by a few ‘diamond’ banks who have a deep knowledge of how the industry operates. Greater degree of transparency could make it easier for financial institutions to value diamond businesses and thus enable diamond capital-intensive companies an access to new financing channels. One of the major reasons for Bain and AWDC to undertake the study of the global diamond industry was to try to bring a greater degree of transparency to the multi billion-dollar industry which spans the globe and involves a wide spectrum of players, from mining to retail.

How do you assess the investment attractiveness of diamonds?

With gold prices growing to record highs in recent years, many investors have been looking at diamonds as potential investment alternative. But unlike gold there has not yet emerged a strong market in investment demand for diamonds. Part of the reason is that diamonds are unique products to value by their very nature: not a standardized product (like other precious metals) and no spot market for rough or polished diamonds.

Many attempts have been made to create diamond investment vehicles but no one has been notably successful so far. Keys to creating investment demand include: creating an exchange for polished diamonds, defining the criteria for investment grade diamonds e.g., carat sizes) and reducing the number of price points, now numbering in the 12,000 to 16,000 range based on cut, clarity, color and carats. Until these challenges are overcome, difficult to see diamond investment demand taking off.

How do you evaluate prospects for the diamond market after it was abandoned by the Oppenheimer family and also in the light of Rio Tinto’s and BHP’s intention to sell their diamond assets?

As mentioned before, the forecasted supply-demand gap in the next 10 years indicates healthy fundamentals of the diamond industry. Rio Tinto and BHP-Billiton are looking for new owners of their diamond assets because the scale of their diamond business does not fit into the overall portfolio of assets that they have (revenues from diamond operations comprise around 1-2% of the overall revenue for each of the companies). Anglo-American on the other hand is pursuing a different strategy as they took over the Oppenheimer family’s stake in De Beers.

ALROSA and De Beers will continue to maintain their leadership by focusing on high-quality assets, operating efficiencies and a disciplined approach to optimizing their portfolio. The diamond business is especially lucrative to rough producers who enjoy operating margins of 22 to 26%.

Alex Shishlo, Editor in Chief of the European Bureau, Rough&Polished