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Not Bad

Jan 3, 2002 3:01 PM   By Martin Rapaport
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The diamond and jewelry industry is greeting the New Year with a sense of relief. While the holiday season was weak, overall sales were much better than expected. Inexpensive jewelry did well showing reasonable single digit gains over last year. While the market for better diamonds and more expensive jewelry was decidedly mixed, many firms that maintained a strong sales force during the important holiday season sold relatively well and gained market share. There were also a few surprises. European demand came on very strong, bolstering the mood and supporting prices in the Antwerp market.

The introduction of the Euro is expected to have a beneficial impact on the European economy and is encouraging some wealthy individuals to exchange expiring currencies for diamonds. The sharp drop in U.S. interest rates also played a major role in reducing financing costs and stimulating demand. Finally, strong last minute U.S. holiday shopping helped retailers sell off excess inventory and increase cash flow, although the sales were driven by fierce competitive discounting that significantly eroded profit margins.

A key accomplishment of this holiday season was the positive impact it had on market and consumer sentiment. The overly pessimistic gloom and doom attitude that permeated the markets following the U.S. terrorist attack has been replaced with a new sense that things are not and will not be as bad as feared.

The great cloud of fear and uncertainty that spread out across the world from the destroyed New York World Trade Center has dissipated. The New Year and “Not Bad” results of the holiday season have brought about a consensus that September is behind us. In spite of concerns about the future and recognition of the fact that tough times remain before us, there is an overwhelming desire by society to affect a return to normalcy. One gets the sense that there has been a sea change in attitude and that the worst is over. While this improvement in consumer and market sentiment is not enough to compensate for the difficult economic realities of the moment, it does set the stage for a more hopeful outlook as we move into the New Year.

Not Good

It is important to recognize that while holiday sales were “Not Bad,” they were “Not Good” either. While most of the major retailers realized their sales forecasts, many had to slash prices to the bone in fiercely competitive “Sale Wars” with other retailers. These “Sales” have conditioned consumers to expect and demand significantly lower prices for a broad range of product categories in almost all price points. We are reaching the stage where a majority of consumers refuse to buy at retail prices, preferring to wait for the inevitable sale. In many instances, the experience of shopping has become disassociated from the experience of buying as even the least sophisticated consumers realize that they can get a better deal by waiting.

Consider the attitude of this consumer. She prefers to give her family and friends gift certificates (i.e. dollar value coupons for later purchases) because she knows that everything will be much cheaper after Christmas. The gift certificate is given in time for Christmas, but the gift itself is only purchased later at the after-Christmas sale when retailer prices and profit margins are significantly lower. While the concept of value shopping is not new, the availability, opportunity, efficiency and consistency of such buying opportunities has now become a standardized norm. While difficult and uncertain times have tightened the purse strings of consumers and encouraged them to be more value conscious, we must recognize that the new norms of consumer purchasing activity are being established. These norms will have an impact on consumer expectations and buying behavior long after the economy recovers. Retailers are going to have a very difficult time reestablishing profit margins in the months and years ahead. The severe price competition being experienced by retailers will undoubtedly work its way back up the supply channel as retailers seek to survive by squeezing the supply side. A shakeout of smaller retailers is inevitable in the current environment.

In light of the above, it should come as no surprise that the strongest sales gains this holiday season were realized by superstore discounters that took significant market share away from full-price department stores. Yet in spite of these sales gains, the share prices of the discounters have come under pressure as stock analysts come to the realization that increased sales have not had the expected beneficial impact on profits.

Busyness

To a large extent this past year has been a year of thrashing about — of buying and selling without making any money. At all levels of our industry — mining, manufacturing, dealing, wholesaling and retailing — there has been lots of busyness but little business. We have been working hard to move goods but most of us have not been making any money. The name of the game has been survival and profits have become the new illusion of the diamond industry.

Perhaps the one good thing to come about from all this busyness is that we are surviving. While many retailers are not making any money, they are getting rid of excess inventory. Retailers have been very conservative buyers of diamonds over the past year. Their overly optimistic expectations in 2000 left them with huge inventories in January 2001 and so diamond purchases throughout 2001 have been minimal. As we go into 2002, inventory levels are much healthier than they were at the same time last year. This sets the stage for a decent rebound in the wholesale markets when the U.S. economy finally recovers and consumer demand for diamonds surges. The only question is when this will happen. As my father used to say: “Everyone is destined to be a millionaire — some people live that long and some don’t.”

We should also consider another very important positive aspect of this holiday season. Money. While it is a bit disheartening that retailers had to discount and drop profit margins in order to maintain sales levels, the fact that these sales were made and money will now be recycled back up the distribution channels to the manufacturing centers is critical good news for the diamond manufacturing community. Over the past year, liquidity has been a major concern for the diamond industry, as well as the banks that have so generously financed us to the tune of $6.5 billion.

Tough Year

The situation in 2001 was bleak. Retailers stopped buying due to excess inventory accumulation and goods backed up in the cutting centers. By midyear, many diamond manufacturers had ceased operations and rough prices began to plummet. Israeli polished exports fell 15.5 percent for the year and Indian exports were down 20.5 percent, but much of the these exports were not sales, but simply inventory on memo overseas. Bank debt did not decline along with manufacturing activity because there was not enough money coming into the system from retailers to pay off debt. While some bank loans were used to finance liquid receivables, quite a bit was tied up in inventory from the cutting centers to retailer showcases. Naturally, the banks tightened up credit policies fearing that they would be left holding the bag. By midyear, due to bank pressure and a desire to avoid a collapse in rough prices, De Beers abandoned its sales target of $4.8 billion and sharply reduced rough allocations. The issue was not merely the negative price effect of large Diamond Trading Company (DTC) rough allocations, but more to the point, the banks refused to continue financing sights unless they knew the polished was sold profitably and they could “see” how the money was going to be repaid.

To its credit, De Beers and the banks acted and continue to act responsibly. DTC sights have been at about $300 million and are likely to stay that way through at least the first quarter of 2002. The DTC also adopted flexible allocation policies allowing sightholders to select from boxes or pass on sights. At next week’s January 14 sight, the DTC will introduce new assortments that will hopefully make its boxes more competitive in relation to outside rough sold by Leviev and others at free market prices.

Conservative buying by retailers and restraint by De Beers and the banks significantly reduced industry exposure by the time the 9-11 shockwave hit the diamond markets. Yet inexpensive rough prices continued to plummet as the Indian market struggled with large oversupplies and a severe cash crunch. By December, Argyle had cancelled its sight. At this stage, there was nothing anyone could do other than wait out the situation. All eyes were on the American market. Would the U.S. generate enough sales and resultant cash flow to keep the diamond markets afloat?

Fortunately, the U.S. has come through. While profits are nil, critical cash flow will keep the industry afloat and prevent the dumping of diamonds to meet liquidity requirements. We may not be making money, but we are surviving.

Serious uncertainty about future short-term demand remains, and the next three to six months may be very slow as retailers do not rush to reorder. The De Beers deal with Russia eases some concerns, but there is still plenty of Russian polished waiting to be sold at prices lower than the cost of producing De Beers’ goods. It is too early to tell if competitive forces will bring down polished and/or rough prices in the quiet months ahead.

While we can’t say that this has been a good season, we can take consolation in the fact that our industry has come through an extremely dangerous and difficult period relatively unscathed. Considering what could have happened in a year like this — that’s not bad. Not bad at all.

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Tags: Argyle, Banks, Consumers, De Beers, DTC, Economy, Jewelry, Leviev, Manufacturing, Russia, Sightholders, Sights
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