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Demand Driven Diamonds

02 october 2012

De Beers is talking up the market and downplaying its production, as one expects it ‎needs to do in the current economic environment. And it is not alone, as other miners ‎follow suit, Avi Krawitz says in an article posted on www.diamonds.net on September 28.‎

As a result, the company has stressed two distinct messages since it reduced prices at ‎the Diamond Trading Company’s (DTC) August sight. De Beers stated it will not make ‎any further price cuts and that supply will be low in the short term. Philippe Mellier, De ‎Beers chief executive officer (CEO), told a press briefing at the Hong Kong show this ‎past week that DTC will not meet sightholder applications for the remainder of the ‎intention to offer (ITO) period through March 2013. ‎

Limiting supply will help De Beers maintain its price levels and Mellier drove home the ‎company’s underlying message that despite the tough market, “the industry needs to be ‎optimistic to ensure that prices will increase.”   ‎

One expects higher prices to be a feature of the new De Beers shareholder structure as ‎Anglo American’s shareholders want the best value for their investment while Botswana, ‎which owns 15 percent in De Beers, needs to boost its budget. ‎

But what is good for De Beers may not be good for the industry, despite the company’s ‎proclaimed leadership position. As this column has noted before, mining companies are ‎unable to trade down in a declining market in the same way that diamond traders can and ‎should. Therefore with fixed costs to manage, their only option is to adjust supply to keep ‎their price points in order to maximize their profits.‎

However, the fact that De Beers is limiting supply as a result of lower production is ‎misleading. Rather, it has reduced production as a result of diminished demand. As one ‎sightholder responded to Rapaport News, “DTC is not meeting its ITO’s because ‎sightholders will [otherwise] continue to reject their goods.” Ultimately, the market is ‎demand – not supply – driven. ‎

Similarly, rough prices are inevitably a function of demand. Should sightholders lose ‎money on their rough purchases they will eventually reject the goods and force suppliers ‎to offer more affordable prices. ‎

Such has been the experience in the past few months. Sightholders rejected DTC goods ‎from the May sight until DTC adjusted prices in August. Since then, rough dealers have ‎experienced improved margins while manufacturers are seeing some light at the end of ‎the tunnel but report they are still losing money from cutting. It was clear at the Hong ‎Kong show that it is simply more profitable to buy polished than cut rough and ‎manufacturers are keeping their factories operating at lower capacities.‎

Mellier stressed that rough and polished prices are in equilibrium and next ‎week’s DTC sight, which begins on Tuesday, October 2 is expected to be relatively small ‎with little-to-no price adjustments.  ‎

Therefore, De Beers proclamation in Hong Kong to lower supply through the next six ‎months should be taken as a word of caution. Other miners have echoed that ‎pronouncement. ‎

ALROSA sales are down about 7 percent so far this year and its production is down by ‎approximately 15 percent. Harry Winston said it has held back $65 million worth of rough ‎to sell when the market improves, while Petra Diamonds noted that the market is ‎expected to remain under pressure in the short term due to prevailing economic ‎uncertainty.‎

Traders at the Hong Kong show expressed similar sentiment even as they left the event ‎in a fairly positive mood. It seems they have grown accustomed to the lower level of ‎demand that has been prevalent throughout 2012. The fair, which ran from September ‎‎19 to September 25, brought buyers who were selective – seeking mainly lower price ‎point VS2-SI goods – and price sensitive – doing a lot of price comparison before making ‎their purchase.‎

Traders estimate that consumer demand for diamonds will grow by low single-digit ‎percentages this year, but recognize that retailers are realigning their inventories to hedge ‎a prospective downturn. De Beers agreed with that assessment. Mellier said he expects ‎China’s growth will be driven by expansion to tier-3 and tier-4 cities, ‎while consumer ‎demand in the U.S. remains stable and may get a boost from the recent ‎decision by Ben ‎Bernanke, chairman of the Federal Reserve, to inject capital into the U.S. ‎market with ‎another round of quantitative easing. ‎The recent rise in consumer confidence may be ‎testiment to that but time, and possibly fourth-quarter sales, will tell if that is indeed the ‎case.‎

For now, there is business going on. But buyers are not building inventory and are testing ‎prices. Suppliers at the show were prepared to adjust prices down slightly in light of the ‎strong competition to obtain orders. During the week of September 20 to September 27, ‎encompassing the show, the RapNet Diamond Index (RAPI™) for 1 carat diamonds fell ‎by 0.6 percent (see graphs on page 1 of this report). ‎

As a result, polished dealers and manufacturers are caught in the middle of a tug-of-war ‎between mining companies intent on keeping their rough price points, and the lack of ‎urgency for goods among polished buyers who sense that the market hasn’t yet ‎bottomed out.‎

De Beers has put the onus on sightholders to hold their polished prices stable. But the ‎polished market is only as strong as its weakest link among the major players. Or, rather ‎it is the savvy polished dealer who is best working the downward market by selling ‎cheaper to initiate future profitable turnover that sets the tone of the industry. ‎

For as recent market trends have proven, culminating in this week’s De Beers ‎announcement, the diamond market is demand driven and its outlook is therefore ‎cautious. Reduced polished demand will ultimately translate to softer prices and result in ‎lower supply throughout the pipeline.