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Hope over experience

04 may 2012

A few weeks ago there was a piece in the Wall Street Daily entitled ‘Proof that Diamonds aren’t an investors best friend,’ Charles Wyndham writes on www.polishedprices.com.

The trigger for the article was the news that IndexIQ were starting preliminary filings for a diamond ETF.

At the time I thought about scribbling a bit about this article as its conclusion, based I am pleased to be able to say to a large extent on a graph produced by us and used by Bloomberg, comparing the historical performance of diamonds to gold and silver.

For whatever reason I decided not to, probably simple boredom at the thought of replying to what is, in my opinion, such a painfully simplistic conclusion.

What has turned my mind back to the article has been the news that Rio has decided to put its diamond business up for sale.

Following on from BHP doing the same, this would not on the face of things appear particularly positive for diamonds in general.

Taking the last points first, namely Rio and BHP.

I consider that news as rather muddying the waters rather than providing any particular insight into the future for diamonds.

BHP has always been pretty much a seller of its Ekati mine. They tried to sell it to De Beers before it went into production but a difference in opinion as to price scotched the plan.

Oh how De Beers must rue that call, especially when it led them to throw all that money away on Snap Lake, but that it another issue.

BHP fell into diamonds almost by chance and diamonds were and remain inconsequential to the company, and in the days of the financial gurus shouting focus all the time it is hardly surprising that they have continued from time to time to try and sell.

Ekati has proved to be a very high quality asset, like any mining asset time counts against it, but it still makes a great deal of money.

Pro rata BHP handling of its diamond asset has been remarkably more successful than that achieved by De Beers, but however successful it is, it is still small, very small, in the scheme of things at BHP.

It will be interesting to see if BHP do in fact sell at the end of the day.

Rio’s position is somewhat different.

If I have not gone completely soft in the head, I think that Tom Albanese, CEO of Rio, was saying not that long ago that the company wanted to expand its diamonds interests.

So again, on the face of it there appears to have been a remarkable volte face.

However, any company that has had to take an impairment charge of around $350 million on one asset that produced $10 million net profit, namely Argyle mine, would probably have second thoughts.

Again, diamonds in relation to the total Rio business is insignificant, that is apart from the impairment charge.

Maybe the timing by Rio is to put its 60% in Diavik up for sale before the BHP sale of Ekati goes through.

The most obvious purchaser for both Ekati and the Rio 60% in Diavik is Harry Winston, given that it already owns 40% of Diavik and has come out publicly saying that it is interested in expanding its mining interests and especially in Canada.

It would be unlikely that Winston would want to chew off Ekati and Rio’s share of Diavik at the same time, so maybe Rio, once it decided that it might step back from diamonds, presumably did not want to give an open field to BHP?

Who knows, I don’t. But what is clear is that there are sound reasons why BHP and Rio should both want to extract themselves from diamonds on the basis of willing sellers and not forced sellers.

There are others apart from Winston who are reported to be interested in either BHP and or Rio’s interests so price will presumably be the key issue, and as already mentioned it is not a done deal that either major will sell if the price is too far below its expectations.

Whilst BHP and Rio have given notice of their desire to get out of the industry, Anglo has gone and spent $5 billion buying out the Oppenheimer’s 40% share of De Beers.

I do not think that the decision to spend $5 billion was solely on the basis of creating an effective poisoned pill, so there must be some optimism about the diamond industry.

It is also worth noting that while BHP and Rio are selling their interests it is unlikely that the total value for the two sets of assets to be sold, that is if they are sold, will be for more than around $2.5 billion; so this puts even more weight behind the $5 billion being invested by Anglo.

In short, I think it is coincidental that two major’s are putting their diamond assets up for sale, there are sound individual reasons for them doing so which are totally outside any bearish view about diamonds; therefore as such I do think it says much about the future prospects of the diamond industry.

Turning back to the article I mentioned at the beginning of this burble, the conclusion I would draw is exactly the opposite to that taken by the author Louis Basenese.

There is no denying that diamonds as a commodity have performed woefully in comparison to gold and silver, to mention but two.

But you have to ask the question why.

The industry’s total inability, in fact the industry’s wilful obstruction, to make it more transparent has put the thickest of glass ceilings on its potential growth however benign the overall future supply demand scenario undoubtedly remains.

The creation of properly constituted ETF, very strong emphasis on the word ‘properly’, and the opening up of the commodity to outside investment will I believe unlock the untapped potential which has been kept under wraps through a combination of the dead weight of a monopoly and the luddite approach by most of the major players within the industry that have benefited personally from the archaic way of doing business within the diamond world.

The lack of performance by diamonds is I believe the strongest argument for its investment potential, based on the assumption that presumably it cannot continue forever to work in what it believes is a flat world.

I have been very surprised just how long the status quo has survived and I may be surprised again, but at some point reality is going to have to catch up with the antediluvian world of diamonds.

The scope for the industry to grow the cake is huge, but not necessarily will those that have the biggest slice at the moment continue to do so, which is probably why things are taking so long.

The threats to the industry are its arcane business practices and the industry’s ability to live in cloud cuckoo land.

Diamonds could be an investors best friend but the industry is going to have to change substantially to take advantage of this potential.