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Supply Versus Profit

Editorial

Jun 29, 2012 5:00 AM   By Avi Krawitz
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RAPAPORT... The first half of 2012 ended in a state of despair for the diamond industry. Prices have ‎softened and trading is muted all around. De Beers and ALROSA have reduced supplies but ‎maintained high prices, despite that liquidity in the manufacturing sector has tightened.‎

While sightholders have been bent on maintaining their long-term relationship with De Beers ‎by taking its high-priced goods, they finally came to their senses at the June Diamond ‎Trading Company (DTC) sight by refusing their allotments. They have recognized that they ‎can no longer sacrifice short-term profitability for the promise of long-term supply.‎

Manufacturers must be sure that they can profit on the rough they buy in the second half of ‎the year if the industry is to avoid a prolonged crisis. Prices at DTC and ALROSA, the two ‎largest rough suppliers, are unsustainably high, reflected by the fact that sightholders ‎rejected the DTC goods in June.‎

ALROSA’s management recently told analysts that its prices were stable in the second ‎quarter of 2012 and that it expects they will remain at these levels for the remainder of the ‎year. ALROSA prices rose 5 percent in the first quarter.‎

DTC this week responded to the situation by informing sightholders they can defer up to 50 ‎percent of their next sight allocation provided they take the goods before March 2013, ‎when the current intention to offer (ITO) program expires. This action will enable DTC to ‎continue to hold its prices firm in the short term. By “enabling” the deferments, DTC is ‎essentially telling sightholders they can reject the goods at these prices, but these prices ‎will remain.‎

However, price pressures will persist as long as manufacturers are unable to profit on their ‎rough. Soon enough, sightholders will demand that DTC accompany its lower supplies with ‎cheaper prices. As Des Kilalea, an analyst at RBC Capital Markets, stressed, “It is hard at ‎this stage to see sightholders willingly taking more rough post July unless the world looks ‎healthier and rough prices are more economic to process.”‎

Rapaport Group has long maintained that price volatility is to be expected and accepted as a ‎normal part of doing business.‎

‎“Firms should develop strategies for dealing with downward moving markets. Smart sellers ‎recognize that inventory cost should be based on replacement cost rather than historic cost. ‎They remain profitable and support market prices by selling cheap and buying cheaper. ‎Lower prices are a healthy part of the economic cycle as they create excellent buying ‎opportunities and higher profits for smart buyers who ensure that diamonds remain an ‎excellent value in uncertain times,” said Martin Rapaport, Chairman of the Rapaport Group (October 2011).‎

The reality that manufacturers enable mining sector profits at the expense of their own, by ‎paying high prices, must be a thing of the past - particularly as the economic outlook ‎diminishes and especially since diamond market sentiment has weakened.‎

In fact, the mood in the diamond industry has turned quite pessimistic in the past few ‎weeks, and expectations for the second half of the year continue to diminish.‎

Certainly the diamond market dynamics have changed. The U.S. has proved to be a ‎mainstay of stability, even as demand there is selective, while luxury purchases in the ‎growth markets of China and India have slowed.‎

These undercurrents were evident at the June trade shows in Las Vegas and this past ‎week’s smaller Hong Kong Jewellery & Gem Fair. The glum outlook has resonated through ‎the trading halls in Mumbai, Antwerp and Ramat Gan.‎

The subdued atmosphere marks a significant difference from the first half of 2011 when ‎dealer trading was in overdrive and Indian and Chinese polished buying accelerated. Back ‎then, a seller’s market prevailed as U.S. retailers played catch up with their Asian ‎counterparts who were prepared to pay higher prices as they competed for goods.‎

While easy credit to Indian buyers drove up prices throughout the pipeline last year, the ‎market has now turned as that easy access to cash has disappeared.‎

Indian liquidity has depleted for a number of reasons. Consumer confidence is down, ‎government support is weak, inflation is rising and its currency depreciating. In contrast to ‎‎2008-09, when domestic demand sheltered the Indian industry from the global economic ‎crisis, the local economy today is serving to aggravate the uncertainty.‎

The dramatic devaluation of the rupee, which has lost about 25 percent in value from one ‎year ago, has stifled diamond trading. Indian industry’s rupee-held debt has become more ‎expensive to pay back, while bank credit, which was too loose for a number of years, has ‎tightened. One banker told Rapaport News that they are viewing new proposals with greater ‎caution as the market has weakened. Traders in Israel and Antwerp are also feeling the ‎credit pinch.‎

Polished prices have declined in the second quarter of 2012, as they did in the first quarter. ‎The RapNet Diamond Index (RAPI) for 1-carat diamonds is expected to have fallen by 3 ‎percent to 4 percent during the first half of the year when final data is published next week.‎

The steepest decline emerged from mid-May to the present, reflecting the caution that has ‎enveloped the market in the past month.‎

Polished dealers are sniffing for bargains, while retail and wholesale buyers – taking their ‎cues from the weak economy - are still willing to hold back on their purchases as they ‎expect further price declines. Cash-strapped suppliers have signaled a willingness to sell ‎cheaper as they try to rejuvenate turnover.‎

These trends are bound to continue in the coming months as the trade works to stimulate its ‎profit margins. Increasingly, suppliers will sell cheap in order to buy cheaper, and innovate ‎to add value and spur profits.‎

Sightholders will leave goods on the table even beyond the July deferral window if DTC ‎prices do not reflect the market.‎ While De Beers and ALROSA appear intent to keep their goods in the ground and wait for ‎market prices to catch up to their own, the opposite will prove true.‎

As the trade expects the second half of 2012 to be as challenging as the first, the ‎downward market presents an opportunity for shrewd diamond cutters to profit – as long as ‎they have the courage to enforce just that. The long term supply promise means little if they ‎can’t make money today.‎

The writer can be contacted at avi@diamonds.net.

This article is an excerpt from a market report that is sent to Rapaport members on a weekly basis. To subscribe, go to www.rapnet.com or contact your local Rapaport office.

Copyright © 2012 by Martin Rapaport. All rights reserved. Rapaport USA Inc., Suite 100 133 E. Warm Springs Rd., Las Vegas, Nevada, USA. +1.702.893.9400.

Disclaimer: This Editorial is provided solely for your personal reading pleasure. Nothing published by The Rapaport Group of Companies and contained in this report should be deemed to be considered personalized industry or market advice. Any investment or purchase decisions should only be made after obtaining expert advice. All opinions and estimates contained in this report constitute Rapaport`s considered judgment as of the date of this report, are subject to change without notice and are provided in good faith but without legal responsibility. Thank you for respecting our intellectual property rights.

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Tags: Alrosa, Avi Krawitz, De Beers, Diamond Trading Company, diamonds, DTC, Rapaport, Rough Diamonds
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