One of the first victims in any crisis situation is ‘hard information’ – potentially impacted people are reacting to rumors, to uncertainties, and too often panic becomes the driver of ‘rational’ decision making. Just ask any banker about runs on the bank. This week was a good week for the diamond industry – actually a very good week. The Antwerp Symposium, and the Workshops which preceded it, enabled the players to get assurances from the heads of the industry and enabled the crystallization of thoughts and facts. A massive amount of information was imparted. Participants went home with renewed confidence and trust in their product.

The industry’s major producers went on record that they will reduce rough supplies to the market. De Beers Managing Director summed it up: “Like any company in any industry today, we are fully prepared to reduce production to reflect the prevailing level of demand for new rough diamond supply from our clients.” Alrosa’s Sergey Vybornov gave similar assurances. He didn’t specify figures, but one Flemish newspaper reported that the company had received state authority to reduce sales by up to 40 percent of its output (and sell them to the state’s diamond and precious metals repository Gokhran.)

Though De Beers formally will determine the level of its reduced mining production only in February next year, insiders expect its output to be lower by some 20 percent. As much more is needed, its 2009 sales are likely to be considerably worse than that figure. If the DTC will have sold an estimated $6.4 billion this year ($500 million more than in 2007), the company should be happy if in 2009 it will sell $3.5-$4 billion.

Alrosa, so far, has been reluctant to reduce its rough selling price as it is facing huge cost increases, a negative currency trend, and, measured in rubles, reported a staggering profit decline in its last quarter. Alrosa’s largest domestic client, the Smolensk-based Kristall, refused the lion’s share of its recent rough allocations which it finds far too expensive. Alrosa claims that it sold rough to De Beers at 26.5 percent above the price Kristall was willing to pay to ‘justify’ its selling prices. Kristall considered the price 20 percent too high. Alrosa, in its arguments, conveniently ignores that some DTC boxes are traded at discounts of 10-20 percent to the market – some even more. Just because the DTC is willing to buy at a certain level doesn’t mean that the goods are worth the price. Kristall is joining a growing number of manufacturers who are ‘celebrating’ a newly found independence: they have reached the point of finally refusing to purchase rough that they don’t need and which are at prices they cannot afford.

The rough diamond workshop at the Symposium, which attracted some 500 people, was near unanimous in its position that ‘rough diamonds need to fall an additional 20 percent before they are at the level dictated by processing costs and the resultant polished price’. A lone DTC sightholder, a rough dealer, dissented and felt that the current rough price is adequate.

The expected decline in rough prices is closely related to the producers’ decision on output reductions – and it must be assumed that not all producers (especially the alluvial ones) will show equal measures of self-restraint. At the end of the day, the size of the price reduction will depend on the size of the cutback. The larger the cutback, the smaller the price decrease – but a synchronization between rough and polished prices is needed in any event.

Scenario Planning

While writing these words, I am in Mumbai where a brainstorm session with a few hundred diamond manufacturers concluded that it has a rough stock on hands of some $1.7-2 billion. This is the equivalent to some 9-10 weeks of rough imports so India’s industry’s decision to decree a one-month rough import stop seems justified by its stock levels. The industry’s banking debt is $4.5 billion and industry leaders believe that some $4 billion worth of account receivables are outstanding – mostly from the United States. The Indian industry may well be on its way to ‘paying the price’ for the quite insane periods of credit and memo it has granted its overseas clients. Chasing after accounts receivables may well become the industry’s primary activity in the weeks ahead.

While there is a consensus – shared by the producers – that rough sales levels into the industry will decline further, few attempts have been made to actually try to put a figure on it. At the Antwerp Symposium, I made a first attempt to quantify the industry’s future rough requirements – with the help of some very able Indian economists. The economic model used was based on the time-honored ‘ripple effect’. The ripple effect works both in a growing and in a falling market. It is premised on the fact that, under certain circumstances, increases of diamond retail sales of a few percentage points (for example 5 percent), may well trigger a correspondent rise of industry rough diamond off-take of some 15-20 percent. The reverse may also be true: a small decline in retail sales, in conjunction with negative trade sentiments, may cause a substantial fall in demand for rough and cutting center polished diamond sales. This occurrence is known as the ‘ripple effect’ and the ‘reverse ripple effect’.

If consumer purchases decline, as we expect will happen in 2008, the need for the retailer to replenish stocks falls accordingly. Depending upon trade sentiment, he will also be satisfied with a lower level of stock. Thus, a small reduction in retail sales will trigger a far greater decline in the level of replenishment. These dynamics will be repeated at every intermediate level of the diamond pipeline. This explains why a 2-5 percent decline in the diamond jewelry retail market, coupled with a negative trade sentiment, can cause a 20-30 percent reduction in polished demand – and thus rough requirements - within the trade.

When calculating the size of the expected downturn, we took into account that although half of the global diamond jewelry retail sales take place in the United States, that market’s actual share of the relevant diamond content is only 43 percent of the some $20 billion worth annual global diamond sales (at polished wholesale prices). Though diamond jewelry retail sales will probably fall by some 15 percent in the United States, in other markets the decline is expected to be less pronounced. This gets us to the following prediction: 

 Maybe we are a little bit too much on the optimistic side, but we presently expect that global diamond jewelry retail sales in the next 12 months will be down by close to 10 percent. The actual demand for polished will decline more and amount to 20 percent. This is because of the substantial reduction in levels of inventory to be held by the pipeline players.

Remembering the Ripple

Maybe it needs some more illustration. A typical retailer whose stock turns around once a year may have, in the first year, a hypothetical opening stock of diamonds of $100,000. His sales also totaled $100,000. In the next year, he sells $120,000, i.e. a 20 percent increase on the preceding year. Being optimistic about the future, he wants to have a stock of $120,000 at the year-end. Consequently, his diamond purchases went up in the second year by 40 percent, from $100,000 to $140,000. Now let’s look at a different scenario in which the market falls.

In the third year, the same retailer’s sales declined by 10 percent to $108,000. Because of his now pessimistic view of the economy, he feels that his stock level should be adjusted in line with his sales volume. In such a year, the retailer’s diamond purchases from his wholesale supplier would plummet by a figure much greater than 10 percent (in this hypothetical view by 31 percent).

In the concrete 2008/2009 scenario in our table above we have calculated that the actual decline of rough off-take in the cutting centers will be about 35 percent in 2009. In 2008, the total rough supplies from all producers to the market will total about $14.5 billion. Given the 35 percent needed drop, it will be sufficient for the producers to sell $9.4 billion in 2009.

As not all producers are expected to display a comparable sense of self-restraint, the producers will probably optimize their so-called ‘rough placing power’ and sell more than is needed. A smaller reduction in sales will almost automatically trigger a greater price decline – something which wouldn’t be in the best self-interest of the producers.

More about that in the weeks ahead. Let’s first listen to the new music coming from Mumbai and the leadership that is provided by the Gem and Jewellery Export Promotion Council.

India’s Import Stop on Rough

At the moment, the very last thing the Indian industry needs is more rough. The workers are still on Diwali vacation, and it seems that most manufacturers will extend that vacation by a few more weeks – some even by a month or more. Unlike any other cutting center in the world, in the production of some one billion plus small stones of one-pointers or two-pointers the labor cost per stone will usually exceed the material cost per stone. Thus, a reduction in manufacturing activity will substantially relieve the financial burden on the industry.

The step taken by the Indians make a lot of sense. My instinct says that it would have been preferable not to announce an industry-wide rough purchasing stop, and depend on each and every manufacturer to reach the very same conclusion by himself. But the Indians are pragmatic – they realize that the fear of the producers is still so prevalent among the various Sightholders, that this kind of collective action is needed to enable them to withstand the producer pressures. They probably make a valid point. Most Sightholders will comply with the self-imposed purchase ban; some others will take their allocations in Antwerp.

It is easier for the Indian industry to walk an independent course than any other cutting center. They have a virtual monopoly in the processing of the smallest goods. The producers cannot divert their sales of these goods to any other center. So the Indians have leverage. They also use that leverage effectively to get access to better goods. That ‘bargaining power’ is expected to increase in the years ahead.

De Beers is making huge investments in developing the most sophisticated technology to reprocess the mountains of ‘waste’ (also called ‘tailings’) from forty years or so of mining in Botswana. In the years ahead Botswana will produce an additional 10-15 million carats annually of miniscule diamonds. These will all end up in India.

If one starts thinking about it – the producers (especially De Beers and Rio Tinto) have a great interest in the financial strength, the stability and the endurance of the Indian cutting center. Though we don’t expect the producers to be overjoyed with what the Indian industry is doing, they ought to be quietly happy about it. It is also in their best interest. The fact that no other cutting center has dared, as of yet, to do likewise, shows that the Indian manufacturers have reached an important junction in their professional lives. They are turning the rough market into a truly demand driven one – well ahead of any other cutting center. The temporary rough import stoppage is not aimed against anyone – it aims at strengthening the Indian link in the worldwide diamond value chain. That is a good thing – and deserves to be supported by all, including the producers themselves. Even though at the Antwerp Symposium the banks reassured clients that they weren’t about to pull the rug and are willing to finance some more inventory, it is doubtful that they’ll agree to finance goods which are clearly overpriced.

The Indian industry will not buy rough now – and what they don’t buy now will most probably be bought next year at a lower price. In a rough market characterized by unprecedented price volatility the rules of the game are changing – and rewritten in Mumbai.

Have a nice weekend.