Diamonds Update

Diamond Industry Copes with Crisis

 

The past 12 months have been witnessed many forms of economic crisis and the diamond industry was no exception.  In past decades when demand for diamonds dropped, De Beers simply stockpiled diamonds to keep supplies and therefore prices stable.  However, in recent years the European Union has forbidden monopolistic activities (like stockpiling) and De Beers now only controls 40% of the diamond market compared to over 80% a few years ago so no longer has full control over diamond production.  As a result, the diamond industry had to implement new strategies to cope with the economic crisis.

The industry’s main tool was stopping production of diamonds.  De Beer’s mines in Botswana, Canada, and Namibia were mostly shut down with only about 10% production in the first quarter of 2009 compared to the same time in 2008.  While production is slowly being brought back online, some companies like Harry Winston Diamond Corporation has decided to cancel winter production at their Diavik Diamond Mine in Canada after a summer shutdown and production returning in the fall.

Rio Tinto shut down its Argyle diamond mine in Australia during the first quarter of this year resulting in a production drop for the country of almost 90%.

Alrosa, the Russian diamond producer, continued to produce diamonds but protected prices by having the Russian government purchase and stockpile the diamonds.

Even with the cuts in production, the dramatic drop in demand results in global polished diamond prices dropping 15.7% from August 2008 to August 2009.  Most of that drop occurred in the November to February period with prices being stable since May.

The past year produced the largest drop in diamond demand in more than 50 years with the most visible fall out being the weekly reports of bankruptcies in the retail and manufacturing sectors of the diamond industry.  Retailers in particular simply could not cut enough costs to compensate for the lack of sales.  Retailers and wholesalers who had made money by leveraging purchases of diamonds as the prices were going up suddenly saw their credit lines cut and interest rates rise at the same time their inventories lost 15% or more in value.

What can the diamond industry expect in the months ahead?  With the US economy slowly coming out of the recession and demand continuing to grow in China and India, demand should become more stable and head back up.  At the same time, many of the large diamond mines are moving from open pit to underground production, which will lower production levels.  The economic crisis has also delayed opening of any new mines so global production of diamonds will soon be outpaced by supply again, which means diamond prices will soon return to their historic 3 to 4 percent annual inflation trends.  However, the that price inflation will likely see considerably short term fluctuations as the industry continues to react to the more chaotic global financial times.

Global Economic Slowdown Impacts Diamond Industry

Diamond prices, like most commodity and luxury items had been climbing for years.  Large diamond prices in particular have been sky rocketing the past five years due to the imbalance of supply and demand.  This year alone, diamond prices were up about 16 percent.  However, the global forecasts and now the reality of economic slowdown, are taking their toll on the demand for diamonds.

After seeing the prices of large diamonds begin to fall, the world’s largest producers of diamonds (De Beers and Russia’s ZAO ALROSA) have announced they will cut supplies of rough gems to support prices.

The sight-holders who purchase diamonds from De Beers have requested the supply of diamonds be reduced at the final two “sights” scheduled in November and December.  ALROSA has said they will reduce rough diamond supplies as much as 30 percent.

The reduction of rough diamond supply is an effort to keep the price of diamonds steady and thus encourage continued exploration and mining efforts.  A sudden, short-term drop in diamond prices would play havoc with the capital-intensive diamond mining industry, causing some business to stop exploration and mining efforts.  Then when the economy recovers and the demand for diamonds gets back on its fast track, the supply side would lag the demand side of the industry and cause sharp price increases.  De Beers and ALROSA are acting as a moderating agent for diamond prices.

The plummeting stock market and severe credit crisis have caused the confidence of luxury buyers in the United States to drop to its lowest level in four years.  Stock prices of luxury retailers like Tiffany & Co have dropped as much as 40 percent this year in anticipation of reduced diamond sales.

Consumers will continue to purchase diamonds as engagements, anniversaries and special occasions continue in good and bad economic times.  However, even the wealthy shoppers are being more discriminate about their purchases and shopping for values.

July Rough Diamond Prices up 5%

De Beers Diamond Trading Company (DTC) has increased the average prices of rough diamonds more than 5% at its sixth sight distribution July 7-11.  While the average was over 5%, the price of higher quality rough diamonds over one carat increased as much as 15 percent.

The next sightholder rough diamond distribution, scheduled for the week of August 18, will likely have further price increases.

The prices of polished diamonds tend to track closely with the rough diamonds because the cutters and wholesaler have to pass on the increased cost of new diamonds.  It is only a matter of days or weeks before the retail market reflects these increased diamond prices in polished diamonds and diamond jewelry.

Expected Diamond Price Increases

De Beers has scheduled sightholder meetings in July and August, which is where they sell the rough diamonds to cutters.  Industry expectations are that there will be significant price increases for rough diamonds and that the expected increases will probably take place in August rather than July.  Traditionally De Beers announces in advance what the range of increases will be but that information has not been released, resulting in anticipation of double digit increases in for some groups of diamonds.

Price increase announcements for rough diamonds are usually scheduled ahead of the three major industry trade shows (Basel in March, JCK Las Vegas in June, Hong Kong in September).  Price increases tend to be the greatest for larger diamonds since those are the items with the biggest differential between supply and demand.  The last major price increase was in May with average prices increasing about 8% but some four-carat and above diamonds increasing over 20% in one day.  Production of small diamonds tends to be more in line with demand so they have seen relatively small price increases.

The price increases for polished diamonds tend to follow close behind the rough diamond price increases so the likely timeframe is August or September.  If you are planning a large diamond purchase in the next few months, I would suggest taking action sooner rather than later.  We do not know when the retail price increases will occur, for what types of diamonds, or how much the price increases will be, but all the signs are that they will go up near the end of summer.  It would be a shame for a consumer to pay 5-10% more just because they waited a few weeks too long to make their purchase, especially if they have been made aware of the impending price increase.

Round Diamond Prices Up 8.5% Already This Year

Even though there is a softening of the Unite States diamond retail market, prices of diamond are continuing up due to increases in rough diamond prices.  Prices for rough diamonds this year through the May De Beers sight distribution are up 8.5% overall and over 25% over the past 12 months.  However, most of the price increases were for high clarity and larger carat weights (those that will be finished to 2-carat weight).

One of the reasons that diamond prices is continuing to go higher is that the worldwide demand for diamond jewelry is still growing, thanks in part to an exploding Chinese jewelry market.

While the price increases for rough diamonds mean higher prices for consumers, it is the middle of the diamond distribution pipeline that are getting hurt the most.  The diamond cutters and wholesalers are often not able to pass on all of their cost increases and become susceptible to cash flow shortages.  For many of these diamond cutters, survival will depend on whether they can pass these cost increases to retailers and what financing support they can get from banks.

Energy Outages Putting Pressure on Diamond Prices

For several years now, the demand for diamonds has exceeded the supply and that trend is going to be continuing for the next several years until new supplies can offset the declining production in older mines.  Recently, the supply situation has been hampered by an energy crisis in the southern regions of Africa.

South Africa’s energy problems result from a booming economy and an incompetent government that has strained the energy infrastructure.  In Zimbabwe, the problem stems from a dictator’s management crisis.  As a result, some diamond mines are experiencing a 40% drop in production compared to last year at a time with demand and prices are soaring.

The slowdown in the U.S. economy has slowed the demand for diamonds in the market that historically purchases 50% of the diamonds sold annually.  However, the economies of India, China, and the Middle East are on fast growth paths for their economies and diamond production so that worldwide demand for diamonds continues to grow.  As the growing demand hits the declining production, diamond prices are on the way up.  Diamond speculators are fueling the demand already and it is hard to image what the diamond industry will be faced with in the next 5 to 10 years of this continuing imbalance of diamond supply and demand.

Round Diamond Price Increases

Diamond price changes vary greatly by carat weight, color and clarity.  This is especially true for the price increases we have seen in recent years.

The chart below (click chart for larger view) shows the total percentage increase from the start of 2005 to the start of 2008 for round diamonds with various color, clarity and carat weight combinations.  I have focused on colorless (D, E and F) diamonds but similar trends are true for G, H and I color diamonds.

The following observations reflect the information in the chart.

1) Four and five carat diamonds have significantly increased in price more than lower carat weights. The one and two carat weight diamonds have increased relatively little over the three-year period and in some cases have exhibited no price increase.

2) The VVS2 clarity grade has experienced the highest price increase across almost every carat weight and color grade combination. 

3) Diamonds with SI1 and SI2 clarity have shown considerably lower price increases, especially for the three, four and five-carat weight diamonds.

4) Diamonds with Internally Flawless clarity have lower price increases than diamonds with VVS and VS clarity grades.

5) Diamonds with F color have experienced higher price increases than E color, which are higher than D color.

For consumers who have purchased colorless diamonds with VS2 or higher clarity in the past, the price increases indicated that the value of their diamonds has increased significantly.  As a result, they should consider getting their insurance appraisals updated to reflect the current values of their diamonds.

For consumers ready to purchase and wondering about the “investment value” of their purchase, the colorless, diamonds with VVS and VS2 clarity would appear to have the greatest opportunity for future appreciation, assuming that recent history is indicative of future performance.

As the number of affluent diamond buyers worldwide increases and the production of large diamonds (3 carats and above) decreases, the price of larger cart weight, high clarity diamonds is projected to explode.  This trend is especially true in the case where the diamond is unique in the marketplace and consumers are bidding up prices.  When cutters and wholesalers have waiting lists for particular types of diamonds, they can ask and get almost any price they want for the diamond when it comes on the market.

Diamond Prices Going Up

There are sure signs in the diamond industry that diamond prices at the consumer level will be raising for the next several years.  When the price of rough diamonds goes up, the price for finished (cut and polished) diamonds at the consumer level are not far behind in increasing.

Average prices of rough diamonds are up ten percent from this time last year.  There is about a 12 to 18 month time from when rough diamonds are purchased until they are cut and available on the retail market but price increases are often passed on even faster because wholesalers and retailers know the cost of new inventory will be higher than what they are selling today.  The demand for diamonds over one carat is growing faster than the demand for average diamonds.

At some diamond mines like Gem Diamonds’ Letseng mine, the average price of diamonds is 35 percent greater than a year ago.  This mine is known for producing larger sized diamonds, which indicates larger carat weight stones will be increasing much faster than smaller stones.  If the average price of all diamonds goes up 10% a year, the price of larger diamonds (over a carat) will increase even greater than the average and finished diamonds over 4 carats in weight could 30% or higher annual increases.

As I have mentioned in many previous blog articles, the reason for the price increases is simple supply and demand.  Global demand for diamonds is growing well in excess of five percent a year due in part by increasing consumer wealth in Russia, China, and India.  At the same time, supply of diamonds is starting to decrease as older mines are coming to the end of their lives and not enough new mines opening to replace that production.  There have been no major diamond kimberlites discovered in 15 years, since the deposits in numerous areas in Canada (Saskatchewan, the Northwest Territories, and Quebec).  Exploration continues in Canada and new Canadian mines are scheduled to come on line for the next ten years but there are no new kimberlites ready for opening mines 10-20 years out to take up the slack in decreased production from the older mines.

Diamond exploration companies are spending hundreds of millions of dollars in search for the next new kimberlite discoveries but any new finds have lacked the world-class size necessary to meet the growing demand for diamonds.  The bottom line is that diamond prices, especially for larger sizes, will be growing significantly for the next 5 to 7 years.  Consumers will find prices higher than they were a year ago but should expect even greater increases in the next several years, especially for diamonds over one carat in weight.

Supply and Demand Update

Supply and demand for polished diamonds are constantly changing with the differences reflected by the prices.  Diamond prices in 2006 through July were greater than the same months in 2005.  The price differences were constantly decreasing until each month with August through November actually down slightly from the same months in 2005. November appears to be turning point with the price differences seeming to stabilize.

The apparent stabilization in polished diamond prices indicates that the supply and demand for diamonds are near balance.  For several years, demand has grown quicker than supply with prices increasing.  The recent economic impact of higher interest rates and prospects of a global economic slowdown have slowed demand and reduced retail inventories and production by some suppliers.  This gave the diamond market a chance to catch its breath.

Diamond prices peaked in the fall of 2005 declined slightly during 2006 and now seem to be stable.  The long-term forecast is for demand to increase and the worldwide supply of diamonds to decrease as production at old mines dwindle more than new mines can gain in production.  The expected result is increased diamond prices for the next several years.

What is a little misleading about the diamond price trends it that they are averages for all sizes of diamonds.  In reality, the larger diamonds (over 3 carats) are getting harder for cutters to find and the prices are growing dramatically.  For example, while diamonds in up to 2.0 carats are close to even or slightly lower than this time last year, prices for diamonds in the 4 and 5 carat ranges are up over 10% on average and even more for higher color and clarity.  There is every reason to believe that that increase in prices for larger size diamonds will be even more dramatic during the next several years.

Diamond Demand and Prices to Increase

For the first seven months of this year, polished diamond prices continued to increase compared to the same months last year but August through October have seen prices fall compared to last year.  Polished diamond prices peaked in the fall of 2005 and the worldwide market has softened since that time.  The lower prices are the result of a slowing global economy (expected to continue to 2007) and high interest rates, which limit retail inventories and reduce consumer purchasing power.  Even though the 2006 retail holiday demand for diamonds is expected to be strong, the high interest rates have kept jewelers’ inventories lean.  The result could be weak sales despite the strong demand.

While polished diamond prices have declined in recent months, prices for rough diamonds have held steady.  This has created intense pressure on diamond cutters and polishers who were already feeling the financial burden of rising interest rates. 

At the recent World Diamond Conference held in Perth, diamond production projections for 2010 are $11.3 billion compared to $12.67 billion estimated for 2005.  In other words, production of diamonds will be down more than 10% from today’s levels.  At the same time, demand projections are growth increases by as much as $5 billion.  The supply shortfall could be as much as $3 billion by 2008 and $6 billion by 2010.  This is the first time in 25 years that world diamond production is on the decline.

With these large supply shortfall projections, prices for rough diamonds are expected to rise significantly by 2008 if not sooner.

With prices expected to be on the rise, what is the diamond industry doing to increase supply? The key to the supply question lies with exploration.  There has been no major diamond deposit discovery for 15 years.  The last big discovery was in 1991 at Point Lake in Canada’s Northwest Territories, which led to the large mines in the area like Ekati.  However, resources at the Ekati mine are expected to be depleted by about 2015 and there are no major finds to replace them.  Diamond mines are very capital intensive and take years to put into operation once the diamond deposits are verified. Unless diamond exploration is accelerated soon, the shortfall projection will become reality.

My advice to diamond shoppers is to enjoy the relatively stable prices we have now.  In the future, we will be talking about 2006 as the good old days of low diamond prices.  Diamond prices in future years will be soaring, especially for larger diamonds.