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Diamond firms take a kicking

11 august 2009

Mid-tier diamond producers are unstinting in their praise for the actions of De Beers and Alrosa for their actions in withholding diamonds from the market when demand collapsed, dragging prices down by half in less than a year, according to miningmx.com.

“It was wonderful the big players were so responsible in this market and cut their production,” says Johan Dippenaar, CEO of Petra Diamonds, arguably one of the most successful mid-tier producers. “It helped to bring stability and a belief from people in the industry that the market won’t be flooded and nobody will know what to do with the goods,” he says.

Asked why Petra didn’t follow suit and cut its output to stimulate prices, he says the company would reach production of 1 million carats in June this year in a market traditionally supplied with 160 million carats/year.

“It’s no fireworks yet. We aren’t going to make any great plans on what we’re seeing in the market now. We’re being patient. We’re saying it could take a bit longer for any price increases to be more permanent in nature,” Dippenaar says.

Gem Diamonds CEO Clifford Elphick was equally fulsome in his praise for the supply discipline practiced by the majors. “That’s been the single most important reason why a measure of confidence has returned to the manufacturers. Not enough credit can be paid to those companies for what they’ve done.”

Elphick says the stimulus packages and interventions in Western banks by a range of governments also played a key role in underpinning confidence in the financial sector – without which businesses could have been in far more dire straits.

“Are the shortages of product – which is clearly and quickly being felt – driving prices or is it confidence and manufacturers making profits? Time will tell,” Elphick says.

In early June De Beers MD Gareth Penny said rough diamond stocks were down by between a fifth and a third of the highs in mid-2008 and that it was time to again start cranking up output of diamonds.

De Beers, which contributes four out of every 10 rough diamonds to the market, cut its first quarter production by 91% year-on-year, suspending its giant mines in Botswana and elsewhere. During second quarter 2009 it started returning its mines to production and Penny says its Botswana mines were topping 80% of capacity by early June.

Of major concern to smaller players is the effect on rough diamond prices once De Beers and Alrosa return to the market and, in De Beers’ case, bring suspended mines back into production. “They’re skilful and seen the massive positive consequences of their behaviour for the value of their product/assets. They don’t want to undermine that and they’ll come back in a measured way,” Elphick says.

At the low point in the rough diamond market around year-end 2008 and into January, Gem saw prices drop by two-thirds for its products. Gem decided hold over a package of diamonds to January from December. “It was the holidays and on top of that we thought the world had gone mad,” says Elphick.

Gem has laid off two-thirds of its staff – 1,600 people – when it stopped its Cemphaka mine in Indonesia and suspended work on one of its two kimberlites in Australia. It’s put its Central African Republic and Democratic Republic of Congo alluvial assets up for sale.

Prices for rough diamonds from Letseng, which achieves the highest average price per carat of any diamond mine by far, fell to around $950/carat in January from $2 800 five months earlier.

Prices in May bounced back to around $1.600/carat as more people attended the tenders and the gap between the selling price and the nearest bids narrowed markedly.

“We conclude price discovery has taken place – what’s the right price in that environment, where all assets are priced differently and where credit is no longer freely available and where people understand what polished sell for and how much margin actually exists so they can buy rough with confidence,” Elphick says.

The other sizeable diamond producer to hit hard times is Trans Hex, which has suspended operations in Angola – long the most difficult and problematic of its operations. Trans Hex is the largest JSE-listed diamond producer. It’s joined on the Johannesburg bourse by a number of floundering juniors, the very type most likely to fall by the wayside in weak market conditions.

Trans Hex CEO Llewellyn Delport sounded a defiant note after its annual results, in which the group’s losses dropped to R797m from R18.4m and it passed on a dividend payment. The loss was exacerbated by a R569m impairment charge on assets.

At current rough diamond prices – and even if they dropped to this cycle’s lows again – Trans Hex will generate cash from its assets that remain in production, Delport says. “With our R205m of net cash in the bank and operating cash flows we’ll see this thing through.” If prices reach what for Trans Hex was the lowest point in February the group can sit out market conditions for another year, he says.

Its Angolan operations and some in South Africa will only be restarted once the market has “fully recovered,” says Delport, defining such an event as prices rising sustainably above levels that led to their suspension.

Petra stands apart from its peers in not suspending operations, one of the reasons possibly being it’s only recently taken over four operations from De Beers – three in South Africa and one in Tanzania – and it would be politically inexpedient to suddenly temporarily halt production. Dippenaar sees a strong future for Petra, which could grow production to more than 2m carats in five years from the asset suite it has now.

The market weakness that drove many juniors that hold exploration or very early stage development projects to the wall is ultimately good for diamond prices.

The volatility in prices will also provide a fillip to the market in the future, Dippenaar says. “That element of less predictability – or less price stability– means it’s extremely difficult for especially larger companies to get capital rights to spend a lot for exploration and expansions. You see the advent of loads of people called junior diamond miners – that have never mined, by the way. All those little properties and the bits of production from those: I don’t know if you’ll see them coming back too easily.”

That’s a view also held by Elphick. “Many people’s foundations have been so utterly shocked by what happened that boards are reluctant to commit to major capex until they’re certain the background information,” Elphick says.

Many smaller, largely exploration, companies – without production to generate cash or firms lacking sound margins – are really struggling and it could lead to a spate of mergers and acquisitions, he says.

It’s not a space Gem will find itself in for some time. “For Gem, I characterise this as a survival year and rebuilding year. It’s not a year of expansion at all.”

“You can approach a vendor, point out their assets aren’t economic and it’s over to us to keep it ticking. But many of those people have hopes and expectations that prices will recover and their project will be viable again.”

“To try and persuade them to hand over assets at the worst possible time – well, you don’t have a good chance of that happening and it’s unreasonable. I too believe that diamond prices are surely but steadily show a recovery,” says Elphick.