The economics of our industry are sometimes mind-boggling. Rough diamond prices are rising again, but consumers have yet to return to the market. Bankers warn that they don’t see “new” money coming into the system yet. Most commercial activity is inter-trade going from one merchant to the other. The Hong Kong Jewellery & Gem Fair brings more hype than action.

As analysts, we are constantly monitoring the demand drivers in our industry. We always search for silver linings. Despite all the excitement about India, China, Turkey, etc., half of the worldwide diamond jewelry retail sales are still solidly finalized in the United States, which remains the key driver to diamond demand. Looking at commodity prices, there is the intriguing question as to the impact of the current price of gold on the level of diamond demand.

Recently, the price of gold passed the $1,000 per ounce mark. This beckons the question of whether there is a direct and quantitatively predictable relationship between the price of gold, the volume supply of gold and the jewelry-fabrication demand for gold on the one hand, and the demand and pricing of diamonds on the other hand. For instance, will a high gold price cause a jeweler to use less gold and more diamonds? Or does a high gold price cause a jeweler to use a larger amount of cheaper and smaller diamonds? The mass jewelry retail market is extremely price point conscious. In fact, with skyrocketing gold prices, jewelers are doing both – downsizing gold weight as well as diamond content.

Data released this week by the London-based, gold survey publishers, GFMS, reported that demand by the jewelry-fabrication sector for gold, measured in tons, fell by almost 25 percent in the first half of this year compared to the first half of 2008. Production fell from around 1000 tons in the first half of 2008 to 760 tons in the first half of 2009. The sharpest falls were seen in the Middle East and India, which together accounted for approximately 150 tons out of the worldwide 250-ton reduction. Actually, the decline for jewelry-fabrication gold demand was lowest in the United States, which registered a mere five-ton demand; only China proved to be the exception, where demand for jewelry-fabrication gold rose by seven percent.

What is most surprising is that new mining supply, unlike diamonds, was slightly up in the first half of 2009, though official central bank sales of gold contracted sharply. What is pushing the price of gold upwards is that the investment community, in the first half of 2009, bought five times (!) more gold than in the first half of 2008. Investment demand reached about 1,150 tons, compared to an estimated expected annual new mining production of 2,600 tons. There is no need to elaborate here on what triggers investors to run to gold. Most investors have ongoing fears about the global economy, particularly the inflationary consequences as a result of the trillions of dollars “printed” by governments doing their utmost to spend themselves out of the recession.

Looking at the Scrap Supplies

From our perspective, the more interesting gold activity is the scrap supply, which reached almost 900 tons in the first half of 2009. Scrap is gold that has previously been sold, mostly as jewelry, and then subsequently melted down so that it can be returned to the market. In the first half of the year, the worldwide scrap supply of gold was significantly higher than the worldwide gold-fabrication demand of the jewelry sector. As I said, scrap supply was 900 tons whereas jewelry offtake was merely 760 tons.

The high level of scrap supply could have triggered a collapse in gold prices if it weren’t for the extraordinary investment demand. What is the relevance of all of this for our diamond industry? One might think of a number of angles:

1)  Investments: The diamond mining companies and the diamond banks have come full circle. Specifically, companies like De Beers or banks such as ABN AMRO and the Antwerp Diamond Bank all now favor the development of diamonds-for-investment markets to enhance liquidity in the diamond pipeline. Except, maybe, for the short-lived investment diamond surge in the early to mid 1980s, the diamond market has never seen a meaningful supply to the market originating from investors’ disinvestments. The encouraging aspect about gold is that, except for two years, in the past decade there has been no net disinvestments. Thus, those who invested in gold during the last decade didn’t sell their investment back to the market; they are letting it sit pretty.

Will those who are now considering, or are actually buying diamonds for investments, demonstrate a similar behavior? Will they hold diamonds for the long term? And, more intriguingly, do we currently have the tools to analyze and effectively measure what diamonds “for investments” are, or what normal retail sales are? One tends to be extremely secretive about these types of deals.

2) Scrap Supply: The equivalent to scrap supply in the diamond market would be distressed owners of jewelry pawning their diamonds or selling their precious treasures for their own reasons. My Australian geologist friend, Bram Janse, once calculated that between 1870-2005, global diamond production totaled 4.5 billion carats  worth about $300 billion at mine-level selling prices. At polished wholesale prices this would come to $450 billion and, including the last few years of output, one might say the “stock” of worldwide diamond sales to the public, at retail prices, might well be about $1 trillion. As astounding as this may sound, the effect of the powerful promotions throughout the years, bestowing enormous sentimental and emotional values on diamonds, may well have discouraged the return of these goods to the market. Furthermore, diamonds have not proven to be a good investment.

Could that change in the future? If we look at the mining output of gold, which hovered annually around the figures of 2400-2600 tons a year for the last ten years, we see that so-called “old gold scrap” returning to the market ran consistently at the equivalent levels of 30-50 percent of newly mined gold. The current economic crisis triggered unprecedented scrap selling: in the first half of 2009 it rose steeply, to the equivalent of over 75 percent of new mining production. That’s an enormous supply.

Consequences for the Future

Looking at the jewelry-fabrication gold requirements, it seems that the fall in demand fairly runs in tandem with polished diamond demand at the jewelry wholesale levels. This is logical and almost self-explanatory. What we also see in gold is that those who invested in physical bullion stick to their investment over extended time periods. With a gold price of US$279/oz. in 2000, investors haven’t done badly at all given the current $1000/oz price.

The diamond market has never given such levels of returns. If anything, diamonds have proven a pretty lousy investment throughout the years. But with the changing supply and demand fundamentals, it is expected that diamonds will perform better in the future. With the right hype, especially for the larger goods, diamonds for investment may become a sexy, catchy phenomenon.

Assuming that, indeed, we shall be successful in creating investment demand for diamonds, is the industry prepared for the consequences? Gold analysts regularly report on supplies originating from new mining output, official gold sales by governments, scrap sales and disinvestments. In our diamond media, we monitor mine supplies (Sight sales) and inventory disposals (Gokhran). Will there come a day in which we also must report on a monthly basis of divestments or “scrap-equivalent” sales? How do we monitor this? Run surveys worldwide among pawnshops and investment funds?

None of this is going to happen tomorrow morning. It will take time. But somehow we have been lucky. Some of the $1 trillion worth of polished diamonds accumulated in the world’s households may trickle back into the market. If gold is the right example, then this will mostly happen when prices are at historically high levels or when recessions are extraordinarily steep. Is it happening today?

We wouldn’t know. What we do know is that “recycling” diamonds back into the market is a feature we never seriously faced in the past – but it will undoubtedly become a part of the business of the future. It is nice to predict an area with potential growth prospects in an otherwise contracting market.