Lucy in the Sky with (Rough) Diamonds

February, usually a cold month in the northern hemisphere, was anything but cold for the diamond industry. Polished diamond prices raced upwards and rough diamond prices, ever the lively creature, went wild. Is this the Promised Land of insatiable consumer driven demand that takes whatever the industry can supply and then wants more? Or are we about to trip over ourselves and land face first in a cold pool of mud?

The figures are straight forward. Polished prices increased 1.5 percent compared to January and 8.5 percent year-over-year, according to the IDEX Online Polished Diamond Price Index. Prices are rising since late 2009 and in the past year the pace has picked up. Adding to the year long revival, February's price increases brought the average price to just 4 percent short of their record level in August 2008, when everything started to tumble.

Rough diamond prices increased some 35 percent during 2010 (DTC's average price moved up 27 percent), growing nearly 40 percent between August 2010 and February 2011, according to our calculations. By all accounts, rough diamond prices passed their August 2008 level without slowing down.

It's important to put this in context. Rough diamonds are not just a raw material used for manufacturing a consumer product. It's a commodity. It's treated like one and therefore behaves like one. It's bought to be traded as is, it's used to guarantee bank loans and credit, it's bought and sold as a futures commodity and it backs a whole basket of other investments. This is to say – don't mistake the zeal for rough diamonds to indicate how well polished is doing.

Polished should be judged by one parameter: consumer demand. Demand is very good now, mostly in Asia, led by China and India, followed by Japan and trailed by other Asian countries such as Singapore. The European and U.S. markets are doing well too. Not back to pre-crisis, but definitely on an upward path. Traders in the global markets are awash with optimism, which buoys polished diamonds. We see it in the weeks before a major show, when trading among wholesalers is at an elevated level and prices are on the rise.

If the Hong Kong show goes well, the higher polished prices will be maintained. If, however, the show will not meet expectations, we can expect a softening in prices. After that, it's a long road to Vegas.

As for rough prices, it seems like the sky is the limit. The South African Sights are about to be slashed by 55-60 percent, manufacturing capacity is increasing, new Sights are about to be awarded, Alrosa wants to go public, and the growing use of auctions and tenders are sure to encourage further high prices. Remember, if manufacturing is not the most economic use of rough, there is always something else that can be done with it. Long live the ingenuity of the diamond traders!