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Losing Sightholders

24 july 2012

It may have taken a downturn to prove it, but Diamond Trading Company (DTC) sightholders ‎are sensing that the game has changed, Avi Krawitz writes in an analysis dated July 20 on As a result, there was an underlying anger emanating ‎from this week’s DTC sight as prices softened a mere 3 percent and De Beers supply remained ‎unprofitable. ‎

The resentment seemed directed at De Beers rather than DTC as some have started to ‎differentiate between the two. As Anglo American last week received final approval to buy ‎out the Oppenheimers’ 40 percent stake in De Beers, sightholder concerns have grown about ‎the true implication of the takeover.‎

Having lost an industry advocate in Nicky Oppenheimer, sightholders are wondering to what ‎extent their profits will continue to be sacrificed for the sake of the De Beers bottom line. ‎Certainly, they’re taking current DTC prices, their lack of profitability, and DTC’s price ‎inflexibility as a signal for the worse: a more corporate, Anglo-led De Beers that will be more ‎rigid in maintaining steady prices in a market downturn and driving higher prices in an uptrend.  ‎

Currently, while the RapNet Diamond Index (RAPI) for 1 carat certified polished prices has ‎dropped 7.4 percent so far in 2012, and rough prices from other mining companies and on ‎the secondary market have declined by 8 percent to 15 percent in the second quarter, DTC has ‎held its prices relatively steady. Dealer sightholders can only sell their DTC goods at double-‎digit discounts while manufacturers are similarly losing money on their resulting polished. ‎Demand for DTC rough has therefore slumped and trading of DTC goods on the secondary ‎market is minimal.‎

The July sight closed this week with an estimated value of $420 million, before accounting for ‎rejections which were expected to become more apparent after press time. DTC gave some ‎leeway for deferments at this sight. The company notified sightholders that they could ‎postpone up to 50 percent of their allotments as long as they take the goods in the current ‎intention to offer (ITO) period, up to and including the March 2013 sight.‎

It is unclear what the consequence will be for sightholders who do not take those deferred ‎allotments at a later date — a concern that was clearly on sightholder minds this week. Will ‎they be punished with a smaller ITO next year or even lose the sight all together in the next ‎contract period in 2015?  While Diamdel goods are a more profitable alternative, and its clients ‎therefore better able to buy, will DTC favor Diamdel clients in its so-called “dynamic ‎distribution approach” — recently introduced to allow strong Diamdel customers to apply for a ‎sight in the middle of the contract period — over sightholders who consistently reject their ‎goods in the current sights?  ‎

Sightholders appear less reserved than before about voicing their dissatisfaction. A number of ‎companies have noted that they would prefer to see DTC cut its supply rather than postpone ‎it, as it did in 2008. While the market is not at 2008 crisis levels, and given market sensitivities to ‎De Beers holding stockpiles, the company is unlikely to hold back output. Furthermore, scaling ‎back production is a costly exercise. ‎

Rather, sightholders should be lobbying for prices that better reflect the market. The only way ‎to do that is to continue to reject DTC goods at these prices. As this column stressed in the ‎past, sightholders will leave goods on the table even beyond the July deferment window if ‎DTC prices do not reflect the market (see editorial Supply Versus Profit published on June 28, ‎‎2012). ‎

De Beers is not expected to budge unless significant volumes of goods are left on the table ‎over a sustained period. Rather, the company is betting that market conditions will improve ‎soon enough that it can avoid such continued rejections. Meanwhile, sightholders question ‎whether the market will upturn significantly enough to boost their liquidity in the next six ‎months. They contend that it will remain difficult to buy out the remainder of their ITO, ‎including the goods rejected to date, especially given their current profit margins – or lack ‎thereof. ‎

They further fear that should the market weakness persist, De Beers threshold to hold its ‎prices steady will increase as its ownership structure evolves. ‎

In fairness, it’s entitled to do so. Like any company, De Beers is primarily accountable to its ‎shareholders and not the market, especially given that its principle shareholder is now a public ‎company. Furthermore, sightholder complaints that Nicky Oppenheimer is no longer there to ‎advocate on their behalf may be a necessary maturing process.  ‎

But by maintaining high prices that do not allow for sightholders to profit, De Beers is ‎diminishing the value of its DTC supply contracts in the long run. While De Beers famously ‎presents its favorable long-term, supply-demand outlook for diamonds to demonstrate the ‎value of the product to shareholders and others, that widening gap means little if there’s no ‎profit in the trade.  ‎

This column continues to advocate that price volatility is to be expected in the diamond market ‎and accepted as a normal part of doing business. While traders can profit in a downward ‎moving market by selling cheap and buying cheaper, mining companies don’t have that luxury. ‎Dropping prices has a direct impact on their bottom line as miners are blessed, and sometimes ‎burdened, with fixed operating costs. It is little wonder then that De Beers is reluctant to do ‎so.‎

Sightholders are therefore left to ensure that market forces take effect. The longer they are ‎forced to lose money on their DTC supply, the more disgruntled they will be, especially as ‎economic prospects remain uncertain for 2012. While diamond dealers and manufacturers ‎struggle to ensure their own profitability, they will reject goods regardless of the ‎consequences to their supply relationships. Not only are sightholders questioning the value of ‎their DTC supply, but the long-term contracts that govern them. ‎