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Back to the Future
Oct 14, 1997 10:59 AM
By Martin Rapaport
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RAPAPORT...
Once upon a time America was the only real diamond market. The Far
East had not yet developed and U.S. diamond demand accounted for some
85% of overall diamond purchases. De Beers and everyone else had a
rather easy time forecasting demand and setting prices because the
market was relatively stable as it followed the huge U.S. economy. In
the 'good old days' volatile factors such as foreign currency rates or
shifting global consumer demand did not really matter.
Over the past few decades our industry has come and gone a long way.
New Far East markets vastly increased diamond demand. Prices rose as
new buyers with strong foreign currencies paid top dollar for select
qualities of diamonds. In fact over-time the Far East markets became
the price leaders for the diamond industry. They set the highest
prices paid for various qualities of diamonds. In many instances the
Far East markets outbid the U.S. market for desirable polished and
this forced the U.S. market to lower the quality and size of diamonds
sold to U.S. consumers. U.S. retailers in the 80's and early 90's were
forced to sell diamonds to U.S. consumers at Japanese prices. Many
could not and went out of business.
For quite a few years as the Far East markets boomed the U.S. economy
plodded through a recession. U.S. diamond demand was relatively stable
but many dealers in the major markets considered U.S. buyers second
class citizens. The Americans could not pay the 'new' prices and they
did not have the money. Global competition heated up the diamond
market and created new realities and opportunities for the diamond
trade. Lots of dealers ignored the 'old' U.S. market and concentrated
solely on 'new business.'
Now global economics is a rather tricky business. Forecasting diamond
demand from a large number of rapidly expanding countries is highly
complex. In general the greater the number of players the more complex
the forecast. One thing, however, is predictable.
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Economies move in cycles and nothing, good or bad lasts forever.
Diamond dealers have an old yiddish saying for this, "Kan boim vaxt
nisht biz der himmel", which translates to "no tree grows to the
heaven".
Decline of the Far East
Sure enough the diamond industry's great Far East tree stopped
growing. In fact, it is now shrinking rapidly. The huge Japanese
market started deteriorating in 1996 with polished imports falling 6%.
Things went from bad to worse, with a 30% decline through July 1997
and for the first time ever a drop in diamond engagement ring sales
this June. For a while many of the Pacific Rim countries provided
relief for diamond firms that specialized in sales to the Far East.
However, recent foreign currency devaluations and the accompanying
economic malaise have pushed these markets into a free fall.
These days even the strong Hong Kong market is experiencing a severe
liquidity crisis. The Pac Rim collapse developed so swiftly that few
firms could protect themselves from the large devaluations that
depreciated their currency. As a result many customers not only
stopped buying diamonds but they could not pay for diamonds already
purchased.
Although increasing demand from China and a stable Taiwan will help
ease Hong Kong's pain and Japan is expected to slowly emerge from
their prolonged recession within the next six to twelve months, the
overall outlook for the Far East is poor. In the short to medium term
the Far East will not be able to absorb the quantity of diamonds it
has in the past and those buyers still willing or able to buy diamonds
will be offering significantly lower prices.
Market Impact
The declining fortunes of the Far East markets are having a major
impact on the international diamond industry. Cutters that had relied
on strong Pacific Rim demand for a good share of their sales and
profits are unable to find new markets for their goods. The crisis is
compounded by the fact that the Pac Rim markets were price leaders and
accounted for a disproportionate share of trade profitability. Cutters
have not just lost customers, they have lost their best customers.
The shortfall in demand could not have come at a worse time for the
cutting centers. Trade profits have already been decimated by De Beers
monopolistic control of the rough markets (see last months "Crisis"
article). Furthermore, the world markets are choking on a severe
oversupply of polished diamonds from India. What had been a buyers
market is rapidly deteriorating into a no-buyer market.
The only bright side on the supply side is that De Beers has severely
restricted the availability of large better quality rough and this has
resulted in a sellers market for 3/4 and larger D-H, IF-SI polished.
While the market for these goods is especially strong and prices are
increasing, they only account for a small percentage of worldwide
diamond trading. In general, the overall level of demand is
insufficient to meet current supply. We have a market with too many
sellers chasing too few buyers.
It is worthwhile noting that this rather bleak outlook is shared by
the investment community who have sharply discounted De Beers share
prices. Quite a few analysts have taken De Beers off their buy
recommendation list citing concern over the rapid deterioration of the
Far East markets. The financial markets expect De Beers to sharply
reduce rough diamond sales in the months so as to maintain the
markets.
Another contributory factor is the difficulty De Beers is likely to
have maintaining the current level of rough prices. The lack of
profitability in the polished markets has finally worked its way back
up through the distribution system. Rough prices are now coming under
severe pressure as many small to medium size cutters no longer have
the financial resources to continue manufacturing activity. In spite
of a very small sight, almost all rough is trading at discounts to De
Beers price levels. Whereas once De Beers held back rough so as to
increase rough prices, they are now in a situation where they must
hold back rough sales to avoid a market collapse.
The American Market
The great thing about the American market is that it is the most
consistently reliable diamond market in the world. It is the bread and
butter of the diamond industry. These days only the U.S. is capable of
absorbing large quantities of diamonds from the cutting centers.
America is not only the best market for the diamond industry, it is
the only market.
While U.S. demand is not booming it has been holding up very well.
Retail sales are slightly higher than last year and most jewelers are
expecting a very strong holiday season. While some hot spots exist as
a result of strong selective buying by large retail chain stores,
polished up to 3/4 is generally available in all qualities. There is
a severe oversupply of Indian polished and some of the pointer
(1/5-2/4) imperfect goods and this is depressing their prices.
The market for larger better quality stones is completely different
from the regular goods. The trend towards cert goods and fine cuts is
gaining strength. Demand for 3/4 and larger H+ VS+ goods far exceeds
supply. Severe shortages of these sizes and qualities are hurting the
market. While prices are firming rapidly retailers are upset because
they are unable to locate the stones they need when they need them.
The supply situation for larger better quality stones is expected to
get much worse before the strong November/December buying season. This
is a major problem because the trend in the U.S. is for buyers to put
off their holiday purchases until very late in the season.
Furthermore, most jewelers rely on memo calls to fill these orders.
There will not be enough better quality large stones in the market
this year and unfortunately, retailers are going to lose sales if they
don't reach out and buy some inventory.
Direct Marketing
Unfortunately, in recent years the U.S. market has been neglected by
the diamond industry. When times were good in the Far East few cared
about maintaining the U.S. market. Now that the Far East markets have
dropped off, all of a sudden everyone is discovering America. In fact,
too many people might be discovering America.
Diminishing profitability caused by high rough prices and declining
demand from the Far East markets are forcing the cutting centers to
find new, more direct ways to sell their diamonds. Cutters are no
longer content selling their goods to dealers in the major cutting
centers. Instead, they are venturing out into the U.S. market and
doing everything they can to bypass middlemen and sell direct to
retailers. It is not that cutters are greedy. They are struggling to
survive.
The trend to direct sales has created a cycle whereby the diamond
distribution system is not just tightening it is restructuring. As
more cutters penetrate the consumer markets fewer buyers have the need
to visit the cutting centers and buy for cash. As less buyers visit
the cutting centers trading falls off and more cutters are then forced
to go to the consumer centers to sell their goods. The net result is
cutters are being forced to sell more goods directly to retailers on
credit terms. The focus of diamond trading is moving away from the
cutting centers and into the consumer markets.
The problem with direct marketing by cutters is not merely the havoc
it causes in the distribution system of the consumer countries. The
real danger is that cutters are moving away from cash marketing their
products. They are getting suckered into the memo, credit and program
trading game. In a desperate attempt to make sales cutters are trying
to be dealers and wholesalers in the consumer markets. But most
cutters are not built that way, they can't play that game. They don't
have the cash, the risk experience or the local market expertise to
maintain direct marketing programs. It's only a matter of time before
the cutting industry runs out of cash.
Many of the new firms entering the U.S. market don't know how to sell
America. They do not know how to effectively evaluate the risk
associated with the credit and memo requirements of the American
jeweler. They don't understand the diamond programs used by the large
firms and the service requirements of the small firms. All too many
think that price is everything and that they can penetrate the market
by cutting out intermediate levels of dealers and wholesalers.
In fact, price is not everything. More often than not dealers and
wholesalers provide real added value services to retailers that
justify their middleman profits. Sure everybody wants to buy at a low
price, but they also want to make sure that they can get stones on
memo when they need them. That they can develop long term
relationships with a limited number of suppliers they can trust. Many
of the cutters crowding into the U.S. market think it is a cash market
where diamonds can easily be sold and paid for. They do not realize
that the U.S. is not a cash market it is a service market.
Back to the Future
It appears that the diamond industry has come around full cycle. We
started out selling America and we end up selling America. Ah, but
what a difference.
In the old days, the industry had structure. Everybody had a role to
play. Cutters recognized that dealers provided critical liquidity and
marketing expertise. Dealers bought parcels not select stones because
they recognized their responsibility to the cutter. Retailers bought
inventory and did not just flip diamonds on memo, they sold what
needed to be sold, Everybody made money because they not only added
value to the diamond product, they also added value to each other.
Sure there was competition, but the goal of our industry in those days
was not for us to kill each other in the marketplace but rather to
support each other in the marketplace.
Perhaps more importantly, people were people in those days. A customer
was a customer. You didn't drop a customer just because someone new
from Japan came along. You took care of your customers. You made sure
they came out OK. The focus was not on goods, it was on people.
Finally, there was the concept of the good hand. A 'good hand' did not
just mean you sold with a good hand and insured your customer a
profit. A 'good hand' also meant that you bought from a good hand and
refused to deal with firms that overcharged, be they De Beers or the
dealer across the street. People protected each other and the market.
They said no to 'no profitability' by simply refusing to buy the goods
and bid the prices up to unprofitable levels.
Now I'm not saying we can or should recreate the 'good old days.'
However, shouldn't we try and learn something from our past. Perhaps
the lesson of our industries 'Back to America' cycle is that in order
for our industry to have a future we must have a past. We have to
evolve beyond Adam Smith's 'animal instincts of the marketplace' and
create a market that is less of a jungle and more of a society.
Clarification
In last months "Crisis" article I wrote "De Beers lies to us.
Statements from CSO directors: 'If you don't make profits, we don't
make profits,' are an insult to our intelligence and demeaning." It
was not my intention to insult or attack the personal integrity of De
Beers directors. In fact, De Beers directors have always communicated
to me in a very honest, open and forthcoming manner.
My objective was to present my view and the trade's view that the
statement is unacceptable because it communicates De Beers denial of
the severe lack of profitability in our industry. The simple fact is
that De Beers can not help fix the problem if they deny it. The
essence of the Singapore resolutions is to clearly communicate to De
Beers that the trade is unprofitable.
Over the long term De Beers statement is certainly true. De Beers
cannot exist if their customers go broke. The problem is in the short
term.
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Tags:
China, Consumers, De Beers, Economy, Hong Kong, India, Japan, Manufacturing, Martin Rapaport
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