Click image for the 2012 Diamond Pipeline poster

(IDEX Online News) – The best thing one can do about 2012 is simply forget that it ever happened! The market contraction and the drop in rough and polished prices that started in the last quarter of 2011 continued throughout 2012.

 

The plight of De Beers’ Diamond Trading Company (DTC) tells only part of the story. The DTC’s rough diamond sales dropped 15 percent, but that decline came on top of a further 12-percent plunge in selling prices.

 

The downstream diamond industry’s rough and polished inventories were hit by considerable value losses. Diamond financing institutions sent strong signals to De Beers that they would not finance rough boxes that could only be manufactured at a loss.

 

For the industry as a whole, 2012 was a year of losses – following 2011, which was also unprofitable for downstream players.

 

In the middle of the year, the resistance of DTC Sightholders to buying overpriced rough led to reluctance in taking their contractually committed allocations. The DTC reacted swiftly by institutionalizing so-called “deferred purchases.” Clients were allowed to postpone purchases, with the hope of picking up the goods at lower prices a few months later.

 

De Beers encountered mining challenges in Botswana, with the Jwaneng mine slope failure, and production declines in South Africa where it sold its Finsch mine, and reduced production by focusing on maintenance and waste shipping. De Beers’ production was reduced by some 3.4 million carats to 27.9 million carats; DTC sales declined to $5.5 billion.

 

The company’s mining troubles may have been a blessing in disguise for the diamond industry. They were also a blessing for Alrosa, which was able to increase its rough sales by 4.1 percent to $4.45 billion. Alrosa and De Beers together account for some 68 percent of the rough market. Their respective production, however, is not comparable since Alrosa produces a larger share of the smaller and cheaper Indian goods. It sold 33.2 million carats of rough last year.

 

Industry Suffers From Overcapacity 

Diamond manufacturers process carats, not dollars. Since the end of 2006, the volume of carats entering the diamond pipeline has been reduced by a hefty 33 percent. While De Beers and Anglo American continue to float forecasts that “the expected future supply shortages will trigger dramatic price increases,” we can only say that we are probably looking at an entirely different diamond industry. What the producer sees is not necessarily what the downstream gets.

 

De Beers makes demand assumptions we do not necessarily share. Things are changing. Diamond jewelry is losing its share of the consumer’s luxury product wallet. The huge decline in carat volume that we have faced in the last six years has triggered an overcapacity of manufacturing in India and is exacerbating price volatility. But the fact is that reduced supplies have not translated into higher prices.

 

On the eve of the 2008 financial crisis, India still had around a million workers, of which 200,000 have since been made redundant. What the industry has found out, however, is that when there is an upturn, those workers are not inclined to come back. Strictly speaking, an additional 120,000 workers ought to be laid off, but the manufacturers are holding onto them based on expectations of a renewed flow of Argyle goods and, of course, diamonds from Zimbabwe. In the meantime, they complete for rough to keep the workforce working – even though there may be no demand for the resultant polished.

 

Zimbabwe remains a “wild card.” The pipeline figure probably understates reality as there is anecdotal evidence that some 1-1.5 million carats are processed in Surat every month. Sanctions always lead to sanction busting.

 

 

The Losses of 2012 

The producers estimate that diamond jewelry retail sales grew by some 4.5-6 percent in 2012 – their figures are not yet final. Our figure for global diamond jewelry retail is $72.1 billion. However, what we have seen in the post-crisis recovery period is that the diamond content measured in polished wholesale prices (PWP) in the retail product is declining.

 

Jewelers are “downtrading” – selling “lesser diamonds” in their diamond jewelry products. Research by Tacy Ltd. and Mumbai-based Pharos Beam indicates that polished supplied to retailers increased by 2.2 percent in 2012. Since the comparable figure in 2011 was 10.3 percent, it is clear that the pace of growth in the diamond jewelry retail markets has stagnated. The prospects for 2013 look only slightly better.

 

This trend was even more profound in the sales from the cutting centers to the jewelry manufacturers. This figure was affected by the reverse ripple effect and industry destocking. After a year-over-year increase of 19.4 percent in 2011, these ex-cutting center sales declined by 8.4 percent to $20.7 billion in 2012.

 

The pipeline shows this contraction. Global polished sales dropped to $20.7 billion from $22.6 billion; rough declined to $15.5 billion from $18 billion. The declining sales clearly impacted the mood and trade confidence of the downstream players.

 

Influx of Undisclosed Synthetics

The discovery of huge sales of synthetic diamonds misrepresented as natural in New York and Belgium has been well documented. It is difficult to establish the size of the total synthetic market. What we did, however, was base our estimates on the supply side: the production of the Chemical Vapor Deposition (CVD) reactors that create the gem-quality synthetics.

 

We discovered that the costs of acquiring a CVD growth reactor have come down to just some $50,000 per unit. In China, Malaysia, Singapore, Russia, the U.S. and other countries, there are now hundreds of workers operating scores, perhaps hundreds, of CVD reactors and High Pressure High Temperature (HPHT) crystal-growing units solely for the production of gem quality diamonds. Some of the familiar names in the business – Gemesis, Carnegie, SCIO (formerly Apollo) – are acquiring most of their equipment from the same supplier in Japan. The technology, however, is widely available from other suppliers as well – though skills are needed to operate the equipment successfully.

 

The diamond industry stubbornly clings to the belief that as long as there is a possibility of detecting synthetics, then there is no problem. This is wishful thinking. Some 98 percent of all natural polished stones entering the diamond market every year consist of diamonds smaller than 0.07 carats (7 points). No one really cares about these sizes – and most of these diamonds are set in jewelry at source.

 

If one looks at U.S. net polished diamond import statistics, this comes to hardly $3 billion, while domestic PWP consumption, in retail sales, totals about $7 billion. The difference comes from polished diamonds that enter the U.S. as diamond-set jewelry. Who can check these diamonds? And who would want to? Looking at all available data, analysis by Tacy Ltd. and Pharos Beam concludes that in 2012, some $500 million worth of polished synthetics were part of the diamond pipeline.

 

There is one other synthetics-related matter that makes 2012 a year we want to forget. After some of the undisclosed synthetics were discovered in Belgium, none of the diamond industry leaders felt it necessary to call in law enforcement officers. It was as if no fraud had taken place. The Antwerp police found out about it from the trade press. The lab returned the undisclosed synthetics to the Antwerp buyer of the goods who gave them to the local representative of the New York seller. Immediately, these goods were hand-carried back to New York. From there, the trail went dead. It is fair to assume that they have been sold in the New York market. Say no more.

 

Uncertainties Lying Ahead

Diamond people are by nature optimists. They must be. Every day they spend a lot of money on a product which, they hope, will give them a profit at some point. The industry is not homogenous, and there are also plenty of successful players, but in 2012 even the best and most efficient players faced challenges.

 

It has become a cliché to say that “the basic fundamentals of the industry look good,” that China and India will become our major growth markets and that we are only scratching the surface there. Nobody can disprove that. However, we need a much better understanding of what will drive future demand.

 

The lack of generic marketing will, at some point, exact its toll. Many of the 2012 uncertainties are swiftly becoming the uncertainties of 2013. The De Beers operations are now being integrated into Anglo American. What will it do? De Beers has become the lowest performing asset in the mining conglomerate’s portfolio even though it will contribute 20 percent to its income. Will Anglo sell off De Beers to the Chinese? The growth in the diamond market is largely driven by liquidity – especially bank borrowing. Diamond banks are facing complex regulatory compliance challenges that are leading some institutions to rethink their future in the business, while some others are increasing the cost of banking to the borrower. What will happen to the industry if in 2013 interest rates go up and liquidity is further restrained?

 

Pipeline Revenue of the Future

Much of the downstream sector’s future income will come from unconventional sources. In 2012, the impact of recycled diamonds back into the industry intensified. More and more companies make polished purchases from the public, from pawn shops, from estates, etc. their core business. Entrepreneurs are holding auctions of recycled diamonds. We believe that 5-7 percent of polished demand in 2012 was met by recycled diamonds rather than new diamonds, which is reflected in our pipeline.

 

For lack of a better word, we refer to this source as “The Household Mine.” Since ancient days, mines have produced some 5.69 billion carats of diamonds – which, at 2012 rough production values ($110 per carat), would amount to some $626 billion of rough. The historically adjusted polished output would be 1.3-1.8 billion carats. Traditionally, not more than 15-20 percent of output was considered suitable for cutting; that changed in the 1960s with the emergence of the near-gem quality stones.

 

The world probably has about $750 billion to $1 trillion of polished diamonds at current prices (or about 1-1.5 billion carats) in consumer hands. About 40-50 percent of these are held in America. At current consumption levels, existing diamonds can supply us for 40-50 years. Recycling will significantly affect demand for fresh polished and, consequently, demand for rough. It will also moderate the price growth of polished.

 

The combination of factors such as recycling, synthetics, the absence of generic promotions and the visible loss of market share (in favor of other luxury spending), makes one reluctant to unhesitatingly embrace predictions of a rosy future based on a growing supply gap between rough production and polished demand.

 

Our economic models indicate that in 2013, rough supplies will be broadly similar to 2012 at around $15.7 billion, with polished demand growing by some 10 percent to $22.8 billion. This should make this year considerably better than last – and it will help us to forget 2012 – as if it never happened…