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Rough prices "out of kilter" as diamond sector staggers

05 july 2012

According to RBC Capital Markets, current price weakness in the diamond sector is likely to continue, most likely into 2013, on the back of slowing growth and discrepancies between rough and polished prices, Geoff Candy writes in an article posted on on July 2.

Given the number of times the word ‘austerity' has appeared in headlines and speeches over the last few months, it is understandable that the diamond sector is facing a tough time of things.

The ultimate symbol of luxury and wealth, it is unsurprising that the sale of polished diamonds has been on the decline recently.

A little more surprising, however, than the decline in polished stones has been the price reaction from the major sellers of rough stones.

In a recent report on the sector, RBC Capital Markets points out that Diamantaires are facing pressure not only from slow sales of polished stones but, also rough prices that "seem out of kilter with polished."

The bank says it expects the low prices for polished to continue for some time, with the possibility of no material improvement until as late as next year, because of the current environment of low margins, lower sales exacerbated by the slowing economic outlook for China and the fact that diamond banks are reluctant to provide new credit lines at the moment.

However, it cautions, "even that depends on the way in which the leading diamond miners, Alrosa and De Beers, sell their production; restraint in what is offered and prices charged will help return the sector to health whereas pushing goods into an already clogged pipeline may well prolong the profit and liquidity drought unless customers push back on taking goods which they believe are not profitable."

According to RBC, although there is pressure at the moment for rough prices to come down, evidenced by the poor showing recently at the Diamond Trading Company's latest sight (the term given by De Beers to each of its 10 annual sales) where buyers decided to defer purchase on as much as $100m worth of diamonds over which they had previously expressed interest.

"Signs that the major producers will bend on price are not evident," the bank says, "with the DTC holding the line, according to sightholders, and Alrosa predicting in a conference call last week that H2 prices would be the same as H1. This is not congruent with polished prices which are ~8% down over the past year according to but rough is still higher with diamantaires suggesting some goods are as much as 25% too expensive in the DTC boxes with an average of perhaps 5%-10% too expensive."

The bank maintains that the likelihood of a major change in the direction of rough prices is slim at the moment. Arguing that while demand in China remain robust and the market in the US has continued to be fairly stable, the signs are that growth is slowing.

"In China much is dependent on a smooth transition in government and in the corruption investigations which have impacted on gift giving," RBC says, adding, "In addition, a weaker Indian rupee is having a strongly negative impact on the industry in India. The rupee has weakened 15% in the past quarter which not only makes diamond imports more expensive but also hurts those diamantaires who have US dollar debts. Consequently Indian diamantaires have been feeling increasing pressure and are not active in the market."

All in all, the bank is not particularly positive on the sector short term but, remains decidedly more bullish medium term as and when Chinese and Indian demand recovers.

"Rough supply (even with Zimbabwe) is likely to be tight when compared with burgeoning demand in markets such as China and India and a recovery in the US."

"As for the investment case, we continue to like the sector fundamentals medium term. The prices of diamond equities have been under pressure for some months and until rough starts improving that could continue. But companies such as Petra and Gem can fund growth either through cash flow or debt facilities as well as flexibility in project delivery. Such producers are in a strong position when the rough market recovers," the bank writes.