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There cannot be a 50-percent discount for polished diamonds a priori – Kristall’s General Manager

25 august 2009

As is known, polished diamonds are forever and they will always remain pricy. However, the financial crisis which hit the economy late last year demonstrated that speculating in “eternal values” may contest this rule: rough diamonds and polished diamonds started to turn cheaper in some period. Besides, in crisis time polished diamonds do not happen to be items of prime necessity and this reason made the demand for these gems go drastically down due to which all the companies involved in the industry found themselves facing severe problems.

Over six month later the industry is showing first signs of recovery. Maxim Shkadov, General Manager of Kristall, Russia’s biggest diamond manufacturer, described to Interfax the situation on the rough and polished diamond market and the role played on it by the state.

Late last year the rough and polished diamond market went through a real disaster – demand plummeted, rough prices dropped and cheap crediting dried out. What is the situation in the industry now, six months later?

Let us give a look into the recent past. Before 2000 the market always had a regulator – De Beers. From 2000 De Beers abandoned its regulating role. Conceptually, the market should have moved to self-regulation, but ran into interference of earlier unknown phenomena unexpected to all. All of a sudden rough diamonds turned to be the object of speculation.

It was specifically India which set the target to seize the market. The country’s central bank started to issue easily negotiable unsecured loans in U.S. dollars using would-be purchased diamonds as collaterals. Consequently, this generated a whole queue for rough diamonds including those being re-sold. Actually, one diamond could have been financed 3 and 5 times – nobody knows it now.

The peak came in 2008 and rough prices got untied from polished – all the manufacturers realized that diamonds were the object of speculation. We also had to re-sell them although we found the kind of rough suitable for production purposes. Production should bring profit but if the price of a rough diamond is $100 and that of a polished diamond made from it is $80…

This was a hair-raising pandemonium, but the financial crisis was tough to put everything in its proper place. Demand for rough diamonds has immediately petered out bringing down prices for some diamond categories two times as low and leaving other positions without any price whatsoever due to absent market. This was the picture facing all the manufacturers.

Today the rough market started to become more or less stable, if we can say so. What is happening right now? Demand does exist, in other worlds production is recovering. To support one’s own production everyone is trying to invest less money into rough diamonds at the same time striving to have as many rough diamonds as possible. Accordingly, this will keep their price low. Demand for expensive rough is very arbitrary.

What are the reasons behind the market recovery?

Fundamentally, so far there is no positive outside background. That is the market is not in the stage of growth or great revival. All this movement on the rough market is inter-industry shifts. In what way are they stipulated? Once again the reason is the state support in India. India has allocated around $4 billion in credits to give assistance to the country’s diamond cutters and this money is again used to buy rough. As a rule, July – August are the quietest months on our market. However, all the countries have launched their ant-crisis programs infusing money which are to be spent. This is why De Beers’ sales went up and growth was registered in those cheap categories of rough which appeared the most sought for. Generally speaking our market is very emotional and exposed to good news much more than other markets. This is why the news that ALROSA started selling again injected a certain portion of enthusiasm.

The market is stabilizing and what is happening to prices?

I would just like to stress it at once that diamonds are not oil. If oil has several brands, then diamonds have 126,000 varieties which are impossible to describe using one price or one line of information. This is not a commodity to be traded at an exchange, so it is difficult to say the spike is on the rise. Some diamond categories have always had a price and even an upward trend during the crisis.

What kind of rough diamonds are now most salable?

The most sought after are cheaper categories bought to engage production capacity. You get more carats paying less money. It is mainly melee below one carat – 0.75 ct and less, as well as bigger and at the same time cheap diamonds. In other words, this is rough averagely priced at $150-$200 per carat.

Was there any demand for such rough before the crisis?

Before the crisis there was demand for all kinds of rough. But large-size rough diamonds priced at $3,000-$6,000 per carat enjoyed a special speculative demand. However, if we speak of regular goods the demand for them is currently very weak. Formerly, stones of 5 to 10 carats drove people to mad buying, but now many categories of this rough remain entirely unclaimed.

However, speaking of general trends it may be said that the situation is getting stable and prices stopped their movement down. At least if we take De Beers’ figures diamond prices during the crisis slumped at an average of 30% by the end of last year and already reversed up by 7-8% in the course of this year.

And how about polished prices, that is prices for end products?

Polished prices also went down and in some categories quite a long way. There was a certain price correction, somewhere near 15-20%, going downwards during the crisis. However, now taking into account the correction in rough prices the trend looks more or less even. Since there are no growing prices for polished diamonds, there is no wonton growth in prices for rough and this is already a good thing.

As far as I understand speaking of the correction in prices for polished diamonds we mean wholesale prices. Has the individual consumer felt such a significant price drop at the retail level?

The point is that the budget of individual consumers has changed – if earlier they were eager to spend $300 to buy a diamond jewelry piece, now they are ready to spend less than $200, whereas at the retail level there are naturally no discounts. Polished diamonds cannot go cheaper in retail. And if someone offers great discounts it means something is shifty there. One should understand how the system works: stones offered by retailers are not owned by them or by their stores, these stones are just goods given on a consignment basis. If they will not be sold they will be returned back and their owner will wait until the price will shoot up. No one will give any discounts on polished diamonds. Only if worst comes to worst the seller may consent to losses.

This is an important clarification since many people reading such reviews think that prices should go down in jewelry stores as well…

Prices inside the industry reflect the situation inside the industry. Cars have not become cheaper because metals dropped down in price. Or did gasoline in this country turn cheaper when oil prices plummeted? In polished retail it is the same thing. The value of polished diamonds remains. Now sometimes you may see posters reading “Anti-crisis offer: 50-percent discount for diamonds.” There cannot be a 50-percent discount for polished diamonds a priori – just imagine what kind of diamonds are there then…

What countries enjoy demand for diamonds now?

Mainly in the South-East. Actually diamond demand exists everywhere. It just got deflated in volume. In some places it went altogether flat curtailed by 70-80 percent and in other places it bottomed out to 50% of the pre-crisis level. Life goes on, events continue to happen and people still give gifts to each other – although maybe based on a different budget. In America, for instance, we did not stop our sales despite the market which crumbled there most of all.

What is your evaluation of the market?

There is a notion called “the market of diamond jewelry.” It is valued differently, but the maximum peak figure was around $76 billion – before the crisis, of course – of which about $40 billion belonged to America. America has now dropped most of all, it may be said it went down as much as four times, while other markets fell two times as much. Now there are a few figures of this kind and they have limited publication since all are very cautious about these figures. People tend not to release negative information to the market.

Kristall has most certainly closed the books on the first six months of this year. Can you disclose the results?

We have summed up the results for the first six months of the year with losses amounting to about 200 million roubles. But there is a very good trend. The end of the past year and the first quarter of this year were just horrible for all of us – we were mostly engaged in solving social problems trying not to close production and preserve everything. This is why we went in the red, but during the second quarter we set off almost all the loss. I believe that in the third quarter we shall close up the loss entirely.

Probably, the rouble devaluation played its role in your performance?

From the production point of view we would never have had such a loss. We got it exclusively because of banks since banks changed their crediting terms. Devaluation was of course the second reason. Any changes in currency rates mean permanent revaluation of these credits for us, and we have credits issued in hard currency. Suppose we take 1 billion roubles worth of credit which turns into 1.2 billion roubles by the end of the first quarter – and here you get a loss of 200 million roubles out of thin air. We have also to deal with revaluation of rough diamonds since we buy them at prices tied to the dollar rate, in other words the price list is fixed in dollars.

Incidentally, speaking of rough diamonds – you have finally resumed cooperation with ALROSA and are again buying diamonds from this company. Could you disclose who made the first move? In other words, was it that ALROSA had to sell or was it your company that had to buy urgently?

It was both. Certainly, ALROSA’s initiative was underway. They had a new president and his first decision was to resume sales from July 15, which actually kicked off the work. We are working with ALROSA quite closely; they have qualified people in the United Selling Organization so neither we, nor they had to spend much time to start working together.

In August we made the first contract and now they will follow one after another. All in all we shall buy from ALROSA around $100 million worth of diamonds till the year end.

And what is you total purchasing schedule for this year?

I believe that during this year we shall spend for purchasing around $200-$220 million. However, we have already spent about $100 million for these purposes in the beginning of this year. In other words, if cooperation with ALROSA will knit together we shall have no special need in anyone else around. Of course we collaborate with De Beers and bought some stuff from Rio Tinto but the amount they offer is not what we need. The Russian cut should be based on Russian rough – you cannot reach the famous “Russian cut” level working on African rough.

In other words, everything is clear as far as purchasing is concerned. And how about sales?

Our sales are going on in the first six months of this year and of course Gokhran helped us in this respect. Speaking of market sales, we have already brought them up to 50% of the pre-crisis level – and this is a sufficiently good indicator. If earlier it was approximately 10%, now it runs about 50%. This is close to $10-12 million a month, sometime reaching even $15 million. This means there is a trend towards growth. Naturally, we have corrected our product range to suit the market, also correcting rough prices and polished prices. Although today there is no hope for higher prices: any price rise, even by a half percent, results in an abandoned contract.

This year you have already sold 2 billion roubles worth of rough diamonds to Gokhran. Do you plan to sell more?

It does not depend on us. If it did, we could sell to Gokhran on a monthly basis. However, this is decided by the government issuing special decrees. I believe that there will be another purchasing round this year. The point is that the problem is not solved for Kristall only but for the whole industry. If they decide to purchase from ALROSA, and this is what is most probable, then of course we shall go along being tied to rough.

So, it means that decisions are taken involving your companies simultaneously?

Naturally. Selling our finished products we get our money and use it to buy rough – in the same place, in ALROSA – and then put this rough into circulation. In this way we sustain mining, manufacturing and processing based on the stock accumulated in Gokhran. And these are very good investments on the part of the state since the state exchanges paper money – which is inflated and get devalued – for a product which is currently maybe not so valuable, but which will regain its value by all means in time. Diamonds like gold have never turned cheaper in time, their only trend is to grow in value. They are eternal values.

As it turns out, the market does currently have a regulator and this is the state?

Undoubtedly, the state is the major regulator now. From a detached point of view, this is the main large-scale investor which has money. This is why it is regulating the market, of course. However, the regulation does not follow market tunes but has more social overtones. The state cares more about people working in this field. ALROSA has 40,000 workers plus all its infrastructure. Our figures are more modest, I think that about 5,000 people may be considered industry-dependent, but for the City of Smolensk this is also a no-nonsense figure.

Besides Gokhran purchases, does the state give any other kind of assistance? By way of tax exemptions or credit subsidies?

We have applied for all these programs since we are a backbone enterprise, strategic enterprise. But in our case some gear does not work quite properly. Subsidies are given only for rouble credits whereas the major part of our credits is in dollars since all our products go for export. And the state does not subsidize interest rates on hard currency credits.

Maybe, there are some other means of assistance?

Our company’s management is currently asking the state to increase our factory’s capitalization. Initially, transformation into a joint-stock company occurred on the basis of what there existed at the time – in other worlds, our authorized capital included buildings, machine-tools, and equipment. Of course we have accumulated some floating capital but it is not enough to fund production. Since we have increased out turnover four times after becoming a joint-stock company we need financing. We are now getting gravely dependent on bank credits. This dependence became critical during the crisis because of the way banks started to behave. They immediately raised their interest rates and the burden of servicing our credits turned unbearable. Some banks just unilaterally refused to credit us.

If the money which the state gives to banks for crediting purposes will be put into our authorized capital, then just receiving dividends – which we shall guarantee if we shall not pay maddening interest to banks – the state will get the same amount of profit. This is a very good investment.

To what extent are you going to increase your capital?

Some time ago our turnover reached 14 billion roubles. Right now, during the crisis, it is difficult to speak about it, but if the market will recover we can regain this figure eventually. But we need appropriate financing. Evidently, it is difficult to maintain such a turnover having 1.5 billion roubles in capital of which 80% are non-financial assets. Our proposal is currently under consideration in the Ministry of Finance. When they will issue some decision it will be possible to give figures. However, we believe that for the state this is an absolutely normal and reasonable investment.

Are there any other requests which you address to the Ministry of Finance?

We have another serious problem on the market related to the VAT which we have been trying to solve for some years already. The problem is that our VAT has a transit status. Buying rough diamonds our enterprise pays VAT and the money is debited. The average term of VAT reimbursement is 9-10 months. But we buy rough every month and it means that in six months all the floating capital is transferred to VAT and the company has no ready cash at its disposal.

There is an optimal way to apply a zero VAT to avoid its transit because this kind of VAT is not credited to any budget, just wandering to and fro. Actually it means that companies are crediting the national budget. Indeed, this is a complicated process and we proved it at all levels and the Ministry of Finance is aware of the problem. Currently, this matter is being reviewed by the State Duma and I think that some decision will be finally taken.

When do you expect this decision?

It is hard to predict. In point of fact, this problem is just feared to deal with because its essence is not clear to everyone, so people say: we are busy with bread and pharmaceuticals and you are trying to impose your rough and polished diamonds. But no one is going to withdraw any money from the national budget; we are just asking to eliminate this transit, this traffic jam, which interferes with our work. Of course diamonds, both rough and polished, are not social goods, but it is a real sector of the economy involving production facilities which employ thousands of people and these people are the core of the state and giving them support is the main priority of this country.