Rough Times Ahead

“The underlying business is okay, it’s just that the mood in the business is so negative,” remarked an executive of one of the rough producers a few days ago. For one moment, I wondered whether he and I were looking at the same business at the same point in time. We’ve all been conditioned for decades to always sound positive and optimistic, because we want the market to perceive the industry as strong, optimistic and forward-looking. We want to convince our customers that they should buy now, because the goods will be more expensive a few months down the road. If, God forbid, there is feeling that prices may decline, this may lead to a postponement of purchases – and that is always a highly undesirable scenario.

            There is a thin line, however, between “being optimistic” and “being in denial.” There is a difference between presenting the business as being good, and deluding ourselves that this is, indeed, the case. Let’s face it: there are convincing indicators that give rise to the view that we may have had a few good years, but that we are now going downhill – and faster than any of us would like. Whether this is part of a normal business cycle, it is too early to say. For now, we can only identify some of the not-very-encouraging signals, which include: 

• In Surat, there is a holiday this month. Well over 100,000 workers will be informed not to return after the vacation. Production levels are down and will continue to decline even further.
• Ever since July/August of last year, the price of rough has fallen. The January rough price increase by the DTC only added to the acceleration of the overall downward trend.  It exacerbated the growing negative sentiments.
• DTC boxes are traded at list price or below.  This really means that Sightholders are selling boxes at a loss, since they had to pay the banks, the brokers, and the two-percent VAS charge. Moreover, they provide credit to the buyers.
• There is no liquidity in the market. There are too many confirmed instances in which people are selling rough or polished well below their own cost price. A diamantaire will only sell below cost if he doesn’t expect the price to go up shortly. It is a reflection of negative expectations; a desire too “cut one’s losses” now.
• A polished trader doing the rounds among clients in the United States said that “the only thing people were talking about there were higher oil prices. Consumers are worried about those issues and are not in the mood to buy an extra piece of diamond jewelry.”
• Diamond banks seem “concerned,” to say the least. They see the reduction in trading volume, but no corresponding reduction in debts. Some of the largest and best retail names in the business are delaying payments. It has happened before, but it is not helpful at this point in time.

             Is all the news negative? Not necessarily, depending upon your own interpretation. A major global player said to me that in the past three or four years, Sightholders certainly earned between seven and 10 percent on the sight boxes that were simply sold at considerable premiums.  Therefore, the argument goes that Sightholders as a group have earned between US$5-$700,000,000 a year over the past few years. It is irresponsible, immature and not fair to complain at the first signs of a slowing of the business activity.

            He may have a point.

            So where is that money? On this, opinions differ: 

• DTC Sightholders selling boxes used the earnings to overpay the other producers (Alrosa, Rio Tinto, BHP, etc.) and ended up with goods on which they hardly could make money.  We may have seen a massive transfer of profits generated by the secondary market trading of DTC sight boxes to the other producers. This is a cynical view, but there are quite a few observers who see it this way.
• The money has gone to downstream investments in partnerships, offices, branding, marketing, etc. It is a part of the increased marketing spent by DTC Sightholders that has become a source of pride in De Beers’s presentations to analysts.

            Any regular reader of this column is privy to my conviction that the diamond jewelry retail markets, by and large, have been stagnant over the last few years, and that in terms of prices, the consumer hasn’t really paid more for a diamond than he paid a few years ago. Retail margins have gone down significantly, and so have the margins of most other players in the pipeline. If the last few years were supposedly “good years,” then it seems that the industry at large has failed to prepare the “cushion” needed to face an adverse period. And if there is a “cushion” – it certainly isn’t visible.

            A major Sightholder looking at London added another element: “De Beers and the DTC are now being led and managed by young people who really haven’t experienced yet bad times. This worries me more than anything else.” 

            This gets us to some crucial questions. Are all these non-comforting indicators short term? Will the business pick up in the second half of this year as the optimists like to think? Or is it more serious then that? And, if so, should we get prepared for harder times ahead?

            We would suggest that the industry should embrace itself for what I would call, for lack of a better phrase, serious “cyclical challenges.”  

• Inflation expectations are well anchored in the world’s financial markets. The ever-increasing oil prices will accelerate those expectations. Sooner or later, short- and long-term interest rates could rise. The timing isn’t clear.
• Deterioration of rough prices has its own spill-over effect. As the industry has become more transparent, it will show up as a weakening of the corporate balance sheets, which then, in turn, leads to more difficult access to credit. This is already visible today.
• The diamantaire, at the end of the day, has to think about his own total global business interests, and he will apply his funds and resources wherever he gets the highest return. Whether one calls it diversification or a dispersion of risks, it all comes down to the same thing. We’ll see more money flowing into real estate or other businesses, which I believe to be more prone to inflation or, simply, more profitable.