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Rough Price Correction – Part 2
Editorial
Jan 30, 2015 8:02 AM
By Avi Krawitz
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RAPAPORT... The rough diamond price cuts by De Beers at last week’s January sight were not far reaching enough. The mining company reduced prices by an average 4 percent, adopting a strategy to diminish supply while gradually adjusting prices in the current weak market (see full sight report here). Most sightholders, somewhat astonishingly, seemed to support the strategy, even as they are frustrated by the lack of profit from De Beers supply.
Manufacturers expect that the policy will bring stability to the market. That is while they wait for jewelry retailers to restock their inventory to a level that would influence polished prices to firm.
With that in mind, De Beers allowed manufacturers to defer 25 percent of goods offered in January to the February or March sights, relaxing its usual deferment policy. The company reasoned that given the “indigestion” evident in the market in January, the cycle of restocking will come later than usual this year (see editorial, ‘Rough Price Correction,’ published on January 16, 2015).
However, in reality, a sharp reduction of rough prices would more effectively relieve that indigestion.
The gradual approach to reducing prices is shortsighted because it will lead to market demoralization and consistent expectations that prices will decrease further. Indeed, while sightholders continue to make losses on De Beers boxes in January, they anticipate further price reductions in February.
When buyers expect prices to fall, they stop buying. Why should a buyer buy today if the price is going to be lower tomorrow? Consequently, rough market sentiment remains weak after the sight and boxes are being discounted on the secondary market.
Rather, by significantly reducing rough prices to a level that is profitable for manufacturers, the mining companies would be signaling that the correction has been made so that manufacturers can start buying again.
De Beers is unlikely to reduce prices much further but will probably have smaller sights in the coming months. However, limiting supply in order to maintain price levels presents further issues as it assumes that shortages will drive prices, rather than demand. The idea of creating shortages and waiting for the market to pick up is risky because it just might take longer than expected to properly adjust.
It seems that most are giving the market until the end of the first quarter to reassess their position, including De Beers. The question is if it will improve in April. Expectations are low for the Chinese New Year and U.S. jewelry retailers are not showing their usual hunger to buy large diamond quantities for inventory in January. There also remains a large amount of polished on the market. While polished prices have dropped in the past nine months, it is better to source polished than to manufacture rough.
Sightholders are therefore likely to remain under pressure throughout the first quarter. After all, if they were allowed to defer a large portion of their January supply to March, they’d still have to take the goods in March – and it seems they’ll still have a fairly high price to pay for the goods then.
It may be telling how much of the current intention to offer (ITO) will have been rejected by the time the contracts expire on March 31. If De Beers intends to create shortages and maintain relatively high rough prices, sightholders will continue to reject goods that they cannot afford. They’ll stop buying non-profitable rough simply to avoid going bankrupt.
Already, Maxim Shkadov, president of the International Manufacturers Association (IDMA), urged his members – or as he referred to them as “rough producers’ clients” – to “be responsible and do not buy!” In a message published on IDMA’s website, Shkadov stressed that manufacturers are making zero profit on their De Beers and ALROSA supply.
Certainly the banks are no longer providing credit for non-profitable rough purchases. With less available bank credit, manufacturers are not able to buy even if they want the rough because they don’t have the money. Therefore, by keeping rough prices high, the mining companies are further decapitalizing the market.
The problem for the mining companies is that at some point they have to generate cash flow.
Coming off a bumper year of record sales and strong profits in 2014, they may have some reprieve from navigating the current weak environment. Lower energy costs and depreciated local currencies in Russia, South Africa and Canada mean that mining costs have declined, which might cushion the effect of lower sales for a while.
However, at some point they have to sell as De Beers is not in a position to stockpile diamonds. Both the Botswana government and Anglo American, with their respective stakes in De Beers, need cash flow. Similarly for ALROSA, the Russian government needs money given its current oiled-down economic predicament.
Almost on cue, ALROSA on Thursday hinted that it will focus on cash flow rather than price growth in 2015. The company plans to raise production by 5 percent to 38 million carats and sales volume by 1 percent to 40 million carats this year. Under the current market circumstances, there is only sufficient demand for such volume at significantly lower prices.
De Beers will likewise be forced to consider a different approach to their pricing and supply policies. Creating shortages is not going to stimulate the market because polished demand is low; and very little is being done to promote consumer demand for diamonds in the face of tough competition from other products.
Consider that Apple sold 74.5 million iPhones on its way to revenue of $74.6 billion and an unearthly profit of $18 billion in the final quarter of 2014. At an average $687 for an iPhone, electronics have clearly moved into the generic diamond space. That one company’s revenue in three months almost exceeds global diamond jewelry demand for a full year should sound warning bells for diamond retailers, manufacturers and miners alike.
As such, Martin Rapaport, chairman of the Rapaport Group, explains that high rough prices hurt the diamond industry.
“Too much money goes to the mining companies who deny profits to distributors and retailers. This results in not enough money for marketing and promotion. No one is supporting generic diamond demand. The mining companies are too sharp for their own good. They are takers, not givers, and are destroying future demand in return for short term profits,” he said.
“Fiddling with the supply side to increase demand is like the sound of one hand clapping,” Rapaport added. “At the end of the day, rough diamond prices must come down to the extent that diamond manufacturing and marketing is once again a profitable activity.”
Simply put, the rough price cuts at the January sight were not far reaching enough to achieve that.
The writer can be contacted at avi@diamonds.net.
Follow Avi on Twitter: @AviKrawitz and on LinkedIn.
This article is an excerpt from a market report that is sent to Rapaport members on a weekly basis. To subscribe, go to www.diamonds.net/weeklyreport/ or contact your local Rapaport office.
Copyright © 2015 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, diamonds, Rapaport
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