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19 july 2012

The diamond market, which started its timid recovery in the first quarter of 2012, relapsed into a slowdown spiral in its second quarter. Most experts are now not as optimistic as before and currently expect rehabilitation by the following year. Leonid Tolpezhnikov, Head of Analysis at ALROSA, told Interfax how the company evaluates the situation in the market at the moment; if it sees a reason for reducing its annual price forecast; and what it expects from the second half of the year.

SLOWDOWN, BUT NOT CRISIS

"Right now, we really see some slowdown in the diamond market and even a price collapse in some of its segments,” Leonid Tolpezhnikov states. “But it is premature to talk about large-scale crisis phenomena."

The difficulties in the market in recent months have been noted by experts and its immediate participants. Igor Kulichik, Financial Director of ALROSA, earlier reported that during the first quarter rough prices went up on average by 5%, whereas in the second quarter remained stable. Industry media quoting their sources say that ALROSA slashed prices by 10% on a number of diamond categories. Similarly, BHP is reported to have dropped prices by 6% at their last auction.

Diamond Trading Company, the marketing arm of De Beers, announced that sightholders may defer purchasing half of rough goods they were offered at the July sight for the period up to March 2013 without any sanctions (historically, the obligations imposed on DTC clients were quite stringent and failure to buy could result in the loss of sightholder status). As it was explained by the company, this measure was taken due to sightholders’ claims that the volume of orders for goods greatly exceeds their current needs. At the June sight DTC customers postponed purchases due to reduced demand and the fact that DTC prices remained high.

Market experts say that the world’s diamond centers are now facing a liquidity crisis and the pressure caused by low profit margins.

However, according to Leonid Tolpezhnikov, the major markets, which today shape final demand for diamond jewelry - the U.S. and China - are functioning normally. Demand for jewelry remains stable, although some market participants noted changes in consumer preferences: as prices for polished diamonds rise buyers are not ready to spend more money, so they purchase stones of lower color and quality grades. But this phenomenon is not yet widespread.

"This is why so far there is no reason to say that there are long term and radical crisis phenomena,” Leonid Tolpezhnikov says. “We remain optimistic about 2012 and believe that performance in the second half of the year will be better than in the first. The company’s price forecast remains the same: we believe that world prices for rough will increase by 3-4% in 2012 compared with its average price in 2011."

INDIA, ONCE AGAIN ...

One of the main reasons for the correction of rough prices in the second half of 2011 was a surplus in the amount of rough, resulting from the sale of diamond collaterals by Indian banks. In 2012, the roots of cooled-down demand are once again traced back to India, which is the world's largest diamond cutting center and buyer of rough diamonds.

"The reasons for cooling in the diamond market lie in the sharp devaluation of the rupee,” Leonid Tolpezhnikov believes. “Today, this is the key factor determining price movements. India is the largest end user of rough and the world’s largest importer of rough diamonds producing the greatest amount of polished diamonds, which makes problems arising in the Indian market visible to the entire industry."

According to the Kimberley Process, India imported 132.4 million carats of rough diamonds in 2011. The sharp depreciation of the rupee made diamond trading expensive because trade transactions are in U.S. dollars.

The Indian rupee is falling against the dollar since early 2012. Currently, the exchange rate is about 55.4 rupees / $1, whereas in June it fell to a record low of 57.32 rupees / $1. During the last year the Indian currency has lost about 25% of its value.

To support its national currency, the Reserve Bank of India ordered exporters to convert 50% of their income on dollar-denominated accounts into rupees. This measure is effective from mid-May.

"In India, exporters are required to convert their proceeds into rupees, and on the backdrop of a rapidly decreasing exchange rate such a behavior of the rupee affects the country’s imports. If, for instance, a diamantaire exports a parcel of polished diamonds and converts the obtained income into rupees, some time will pass from this moment until a decision is taken to buy a new parcel of rough diamonds for manufacturing purposes,” Leonid Tolpezhnikov explains. “If the rupee continues to fall, the diamantaire will already need more rupees to buy dollars and pay for rough diamonds. It is obvious that this is an additional burden."

Besides, according to Leonid Tolopezhnikov, many Indian diamantaires attracted dollar loans to purchase rough and now, with a falling rupee, they should spend more money on paying interest rates than initially expected.

"It’s noteworthy that this lack of liquidity in the industry is not related to insufficient credit,” the Head of ALROSA Analysis says. “The largest diamond banks say that the overall debt carried by the industry is now at the 2008 levels, while the volume of world trade in diamonds is above 2008 (diamonds turned more expensive). Diamond traders working in Belgium, for example, are currently not using their credit lines to their full extent. That is to say, once again, that the existing problems are related solely to the Indian market."

By September, when the Reserve Bank of India will start implementing measures to support exports, the overall picture of the situation in the market will become clearer, Leonid Tolpezhnikov believes. But the result of these measures will not be visible immediately. "If these measures will prove effective, the diamond market will start to recover given the expected strengthening of the rupee," Leonid Tolpezhnikov says.

EXPERTS

Industry experts also believe that the current difficulties in the market are short term and the situation is to normalize at the end of 2012 and in 2013.

“The short-term forecast is bleak, with demand in key markets like China and India cooling and a fully stocked pipeline of rough diamonds,” RBC Capital Markets analyst Des Kilalea believes. “Though rough diamond prices are expected to show signs of recovery next year.”

Clifford Elphick, CEO of Gem Diamonds, also believes that the current price volatility due to the debt crisis in Europe and a weakening rupee is likely to last until the end of 2012. "In the very short-term, between now and October-November, we may well be in for choppy rides as confidence disappears," Elphick said. He is backed by Bob Gannicott, CEO of Harry Winston, who told the mass media that the company expects "a pretty chaotic” market till the end of this year.

According to BMO Capital Markets’ forecast, rough prices are to stay at their current level and may regain 3% next year.

Companies like Petra and Gem Diamonds can adjust their capital expansion plans by postponing spending, Mr Kilalea said.

According to Rapaport, polished diamond prices declined 3.6% in the first half of 2012 (the RAPI is calculated for one-carat diamonds), showing the steepest fall in January-June. "The second half of 2012 is expected to be challenging for the diamond industry as Far ‎East demand is projected to remain conservative in the near-term while India’s industry ‎crisis may be more prolonged," Rapaport says.

Besides the negative events in the Indian market due to the devaluation of the rupee, demand in the diamond market started to weaken from April because of the macro-economic problems in Europe, the slowdown in the Chinese economy and the accumulation of diamond stocks by major traders, Sergei Phylchenkov, an analyst of Metropol, says. "Improvement may get momentum in September, since we are expecting further action from the Chinese authorities to stimulate the economy, as well as due to seasonal demand growing in the U.S. on the eve of Christmas," he said.

In his opinion, the weakening of the global diamond market will not affect ALROSA’s financial performance significantly: "We continue to expect that the company will register an annual average sales price of $140 per carat in 2012 maintaining its output at 34.9 million carats (as in 2011)." The ability to sell diamond goods to Gokhran, Russia’s State Repository, will also serve as a "safety cushion" for ALROSA in the event of a significant deterioration in the market environment, says the analyst of Metropol.

PRODUCTION AND DEMAND

According to Leonid Tolpezhnikov, in the current situation the diamond market is not under the threat of another price collapse which was observed in the crisis. "Then, the price collapse was triggered by a surplus of rough in the market,” he says. “Banks are now much more cautious towards taking rough diamonds as collateral, the same being true for polished diamonds as well. This is quite problematic for banks because evaluation of stones is very subjective. Different appraisers will give you different prices for the same stone, whereas banks would like to have a clear idea about the value of collateral. Besides, banking regulation is getting tougher the world over. This is a general trend - the requirements for the quality of assets held by banks are increasing, so banks are respectively increasing their requirements to customers.”

In his opinion, diamond supplies coming from Zimbabwe, which were restrained by the Kimberley Process until the end of 2011 do not threaten the market. A number of experts earlier this year expressed concern over the "Zimbabwe factor," believing that large diamond supplies from this country could bring down rough prices. "I continue to express skepticism about the fact that Zimbabwean diamonds could undermine the global diamond market,” said Leonid Tolpezhnikov. “Zimbabwe's annual output is about 10 million carats. A number of companies in this country now say they will not be able to fulfill the previously announced production plans because miners are now striking horizons with a lower than expected diamond grade," he said.

According to ALROSA’s Head of Analysis, totally the world’s diamond output in 2012 will exceed that of 2011, but only slightly. "In spite of force majeure instances, there is a gradual recovery of diamond production after the crisis of 2008-2009. In terms of global production, we still believe that the results of the second quarter will be approximately equal to the results of the second quarter of the last year. In the first half of the last year, production slipped somewhat due to heavy rainfalls in South Africa and Australia. Now there are no such extraneous circumstances, so all the major manufacturers will apparently reach their planned levels."

At the same time Leonid Tolpezhnikov notes that currently it should not be expected to see significant and prolonged hikes in global diamond production: “Pre-crisis levels are unlikely to be achieved also because many miners are beginning to seriously mull over whether they should accelerate the extraction of diamonds from the earth, speeding up their depletion. So I think that after some time our industry will re-assess its values and companies will have to define whether to chase production growth in carats or find the right ratio governing the yield and growth quality."

ALROSA: POSSIBLE AND IMPOSSIBLE WAYS TO INFLUENCE MARKET

Speaking about ALROSA’s lower output in the first quarter of 2012 (by 19% to 8.09 million carats), Leonid Tolpezhnikov said that any decisions regarding output are medium-term in diamond mining and that it is impossible to radically manipulate it in the short term. "I saw the opinions saying that ALROSA decreased its output in the first quarter to propel market prices. But to lower performance so sharply and then dramatically increase it in diamond mining in the short term, simply following the demand, is impossible from a purely technological point of view,” Leonid Tolpezhnikov said. “If output is lowered it is the result of complex mining and geological conditions arising in the course of developing diamond deposits."

Large-scale companies may influence the market condition by limiting sales of rough. Thus, late last year, ALROSA suspended trading in the spot market and restricted sales only to long-term contracts, while during the crisis the company supplied $1 billion worth of diamonds to Gokhran.

ALROSA is negotiating supplies to Gokhran this year as well, but on a much more modest scale - $110 million. In the previous year, the company did not resort to this possibility, since most of the year market conditions were favorable. "Deliveries to the state fund to some extent can balance the situation on the market,” Leonid Tolpezhnikov said. “In theory, any subsequent sales from the state fund may have an impact on the performance of the world market. But this year, Gokhran is not planning large-scale sales."