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The Great Struggle
Jan 15, 1998 1:23 PM
By Martin Rapaport
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RAPAPORT...
Publisher
Here is a trick question for you. Does De Beers control diamond prices? Some people say yes, some say no. Lots of people just don't know. Given the fact that Far East demand has collapsed and De Beers is responding by severely restricting the amount of rough it allows on the market, the question is no longer academic. 1998 is going to be a very interesting year. Perhaps too interesting. We are going to find out just what De Beers controls and what it doesn't control.
Now the answer to our trick question is not simple. It's sort of like one of my favorite rabbi stories. There was this Rabbi, one day a women walks into the Rabbi complaining bitterly about her husband. After thoughtful consideration, the Rabbi says "You are 100% right," and the lady leaves. A few minutes later the husband comes in ranting and raving about his wife. Once again the Rabbi proclaims, "You are 100% right". Finally, the rabbi's wife asks him "How can they both be right?" And the rabbi replies, "You too are 100% right."
The lesson here is that everyone is right. De Beers does and does not control diamond prices, depending on just what kind of diamond prices are we talking about? Rough Prices? Polished Prices? Prices for cheap inexpensive diamonds? Prices for high end hard to find larger diamonds? The real question isn't just if or how De Beers controls diamond prices but rather what can we do about the current market situation. How can we play 1998? Not just to survive but to make money.
For many years the diamond industry has been preoccupied by supply side considerations. Frequently our greatest concerns were that Russian/Angolan dumping or the De Beers Argyle breakup would create a severe oversupply of diamonds which would then force diamond prices downwards. The greatest fear of the diamond industry was that De Beers would somehow lose control of the rough market and diamond prices would collapse.
While De Beers lost control of the market for small inexpensive rough due to Argyle's departure from the cartel and a severe oversupply of small rough, they have recently made large purchases of rough from Russia and have been the strongest buyers for Angolan rough. Furthermore, De Beers is committed to sharply reducing the amount of rough they sell at the sights. It is likely that the first three sights of 1998 will be reduced by 50% from last year's levels. We expect these sights to come in at about $280 million each, the same level as November and December of 1997. Finally, De Beers has changed the assortments in a number of boxes so as to improve sightholder liquidity and profitability (see side bar).
All of the above indicate that De Beers is going to maintain their price control in the face of very difficult market conditions. While De Beers does not control prices for inexpensive small rough, De Beers does control prices for better quality larger rough, particularly in the ¾ and larger rough sizes. Furthermore, it looks like De Beers is going to try and maintain rough prices at current unrealistically high levels even as the polished markets enter a deflationary period. As De Beers new managing director, Gary Ralfe recently explained, "We intend to maintain our diamond prices in rough, and, of course, the way we will do this is by reducing the flow of diamonds into the cutting centers."
Collapsing Demand
Frankly, the diamond industry's preoccupation with the supply side is misplaced for two reasons. Firstly, De Beers will take care of rough wherever possible because it is in their self interest to maintain their inventory values and market position. Secondly and more importantly, our industry now faces a huge crisis that is well above and beyond mere supply side considerations. Global diamond demand is collapsing.
Rarely, if ever, did we concern ourselves with the overall level of global diamond demand. We just assumed that demand would grow forever. Many of us look at our industry backwards. We think supply is somehow more important than demand. Nothing could be further than the truth.
For all too many years the diamond market has taken diamond demand for granted. Rarely, if ever, did we concern ourselves with the overall level of global diamond demand. We just assumed that demand would grow forever. Many of us look at our industry backwards. We think supply is somehow more important than demand. Nothing could be further than the truth.
We are now facing a crisis in global diamond demand. Make no mistake about it Korea, Thailand, Indonesia, and even Taiwan and Hong Kong are not just going through a temporary phase. These markets are totally restructuring in a way that will have immediate and long term implications for the diamond industry.
Some firms are still in denial, they think that things will somehow improve over the short term. This may be due to the incredibly fast pace of recent events. The collapse of currencies, stock markets and real estate appear to be only the first stage of retrenchment. Objectively speaking it looks like things are going from very bad to worse. Right now, consumers are selling their wedding rings to raise money. Diamonds are cheaper in the Pacific Rim today than they are in the cutting centers because everybody is selling and no one is buying.
We must recognize it is likely to take years before the Pacific Rim countries are able to generate the level of consumer demand that we have taken for granted. Realistically we must recognize that for the short term and possibly the medium term these markets and the diamond demand they represented are kaput.
It is important to point out that while Japan is also experiencing declining diamond demand (about 30% off from last year) it should not be lumped together with the Pacific Rim countries. Japan's crisis has been evolving over the past few years. They were the first to go into recession and they will be the first to regain prosperity. Furthermore, the great sense of crisis and even panic that is working its way through the Pacific Rim is not really taking place in Japan. In fact, some of the high-end brand name retailers operating in Japan (such as Tiffany's) report healthy demand from Japanese consumers. In any case, there is concern that the deteriorating situation in the rest of the Far East may yet bounce back on Japan and delay their recovery or make it more difficult.
Given the fact that the Pacific Rim markets account for about 17% of global diamond demand value and Japan for another 20% it is only natural that the restructuring of the Far East is going to force great changes on the international diamond industry. The cutting centers are going to have to adjust to reduced supplies of rough from De Beers and restrict diamond cutting activities. Dealers that had based their sales on Far East markets will be forced to find new markets and work with different types of goods. It looks like 1998 will be a rather difficult shake out year.
Fortunately, for our industry the U.S. market remains healthy, growing and strong. Overall U.S. jewelry demand was up by about 8% this season and many firms specializing in better quality jewelry report gains of 10% or more. Unfortunately, the U.S. is not strong enough to compensate for the fall off in Far East demand.
Of primary concern to the diamond industry is the impact of declining Far East demand on polished diamond prices. As stated in earlier articles, prices for inexpensive small diamonds have already declined sharply due to severe Indian overproduction. The decline of the Far East will undoubtedly aggravate this problem. Furthermore, even better quality small diamonds are now under price pressure as the Far East off-take of high color/clarity stones under the carat is sharply reduced. Productions of fine make better quality melee from Thailand and China are going begging for buyers.
Lower color diamonds, particularly in larger sizes and high clarities (IF-VVS2) are also in trouble. Hong Kong and the Pacific Rim markets for these items have disappeared. To some degree, the lower clarity I-L colors in VS2 and lower clarities are well protected because they fit in perfectly with popular price points for which there is very strong U.S. demand.
Another problem is the spill over effect from the Far East. Firms that used to sell the Far East are crowding into the U.S. market and creating price pressure due to severe price competition. While some areas may be affected and large retailers will be able to play off large sellers, the underlying market for items which are in strong demand in the U.S. should remain stable. Buyers are not going to switch suppliers all the quickly, especially if the sellers are unfamiliar with the U.S. market, can't give credit and do not have local service resources.
In general, items that sell well in the U.S. will continue to sell well and their prices will remain stable.
Items that do not sell well in the U.S. or are in an oversupply situation are in very big trouble. In some instances they may not have prices. They may not be liquid and instead of being sold they will simply be loaned out on memo.
It is likely that the sharp CSO reduction in diamond sales will also create severe shortages of D-G, VVS-SI, 0.75 to 4 carat sizes which are in strong demand. In spite of the weak market in the Far East these stones may go up in price as the CSO squeezes too tight to maintain rough prices. Selective buyers are going to find the going very tough because there will be much less goods to select from. While the overall supply of diamonds in the U.S. will boom the overall supply of the right kind of diamonds is going to be much tighter due to CSO supply side restrictions.
Certs will probably do great in the year ahead because they are instant merchandisers
and tend to be in the sizes, colors and clarities that are strongest in demand. Cert trading will probably also get very competitive this year as cutters use them to penetrate the U.S. markets instead of just selling parcels to Far East buyers in the cutting centers. Undoubtedly, jewelers that know how to buy well will do great in the year ahead because there will be plenty of buying opportunities.
The secret to survival in the difficult year ahead is specialization, specialization, specialization. You can't make money trying to sell the kind of diamonds other suppliers are giving away. You must specialize in the types of diamonds that are in strong demand and hard to get. Undoubtedly, there will be a great struggle among suppliers to see who can get the best stones and who can find customers. Those that have been able to carve out a specialized market niche should do well. Not everyone will survive but those that do will be the strongest and the best.
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Tags:
Argyle, China, Consumers, De Beers, Hong Kong, Japan, Jewelry, Martin Rapaport, Russia, Sights, Tiffany
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