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New Year’s Message 2005
Jan 5, 2005 12:40 PM
By Martin Rapaport
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The advent of the New Year is an appropriate time to reflect on the accomplishments of the past year and the opportunities that await us in the year ahead. It is a time to be thankful for all the good that we have and share. Let us also stop for a moment to consider those less fortunate than us and pray for the health and welfare of the many thousands of victims of the recent tsunami disaster. May the New Year be a year of peace and prosperity for all mankind.
2004 was a very important transition year for the diamond industry. It began with a great shakeup of the distribution system as De Beers finally implemented their Supplier of Choice (SOC) strategy. Dozens of leading firms lost their access to rough diamonds — the lifeblood of their businesses. And then there followed the great rough games with price increases from De Beers and the other producers culminating in an all-out speculative frenzy as desperate manufacturers competed with each other to see who could lose the most money by turning crazy rough into overpriced polished.
The unsustainable 20 percent to 30 percent rough price surges retreated over the summer as the Indians ran out of money and overpriced polished inventory piled up. Diamond manufacturers came to the realization that polished buyers and consumers could not care less about the madness in the rough markets and that they were unwilling to pay more for polished no matter how exciting or desperate the stories emanating from Antwerp. The net result of the futile attempt by the mining companies to exploit the “market conditions” created by the newly implemented restrictive and selective De Beers Diamond Trading Company (DTC) rough supply squeeze was to push rough prices too high, resulting in ever-shrinking profit margins for diamond manufacturers.
Manufacturing
Diamond manufacturers have become the weakest link in the diamond pipeline with many cutters operating only “to stay in the game” until margins improve. Unfortunately, manufacturing margins are not expected to improve. While money can be made distributing diamonds through added-value marketing initiatives, such profit margins do not accrue to manufacturers without downstream distribution capabilities. In a rational market we would expect polished distributors to be able to source diamonds from a competitive open market of cutters and thereby allow for profit sharing between manufacturers and distributors.
Unfortunately, such open markets are being destroyed by the mining companies that distribute their rough in a way that forces the bundling of manufacturing with downstream polished distribution. Simply put, many mining companies do not sell rough to companies that sell their polished in the open market. They “prefer” to sell their rough to companies that have downstream distribution. This bundling reduces competition in the polished markets, forcing wholesalers to hook up with “sightholder” cutters. Once the “direct connection” is established and the downstream diamond buyer is captured with nowhere else to turn for the diamonds he needs, the distributor is “ready” for a series of price increases that enables the mining company and their sightholders to steal the downstream distribution profits. Frankly, the system stinks. The decline of competition in the polished markets is setting the stage for the monopolistic pricing and distribution of polished. If the mining companies continue their restrictive distribution practices we expect many, if not most “free market” diamond cutters — i.e. cutters that sell their polished in the open market — to go out of business in 2005 and 2006.
The bottom line is that as long as the rough producers have it in their heads that they can squeeze rough supply to push prices higher and/or steal downstream profits, the traditional diamond manufacturing was, is and will remain a business for suckers.
Polished Markets
Fortunately, in 2004 the polished markets operated more rationally than the rough markets. While polished prices increased significantly for larger better-quality diamonds, the increases were sustainable and for the most part driven by real demand and real shortages. Price increases for 6/4 and larger better-quality certificate polished reached double-digit percentages with single-digit increases for smaller sizes. Prices for very inexpensive pointers and small melee — 0.01carat to 0.08 carat — increased due to declining supplies of rough from Australia’s Argyle mine and consistently strong demand for inexpensive diamond jewelry from Wal-Mart and other mass-merchant retailers. In some instances, prices for mid-quality polished such as I-J, SI’s increased significantly due to the concentration of demand on mid-quality diamonds for large chain store diamond programs.
The key difference between the rough and polished markets in 2004 was that the rough markets were supply driven, resulting in speculative demand, while the polished markets were demand driven, resulting in sustainable demand and pricing.
In spite of the improved environment for polished diamonds, buyers remained selective and worked hard to maintain minimal inventory levels. Other than some speculation in large fine-quality — 2 carats +, G+, VS1+ — diamonds there was little desire by buyers to stock up on diamonds in expectation of future price increases. Cutters and wholesalers found it extremely difficult to obtain higher prices from retailers for regular commercial goods during the second half of 2004 as retailers claimed that they had already fixed their prices for the holiday season. Discussions with retailers about price increases to retailers are currently taking place and will be highly influenced by the success of the holiday season.
The continued trend toward integrated guaranteed pricing programs for retailers and the direct support of such programs by mining companies will encourage a more seasonal approach to price increases by the mining companies in 2005. As the price-setting role of the “free market” diamond dealer is diminished and replaced by a direct mining company/cutter connection we expect tighter, more focused and better-timed price increases that will enable the mining companies to capture as much price increase as possible from the well- “connected” retailers.
While final U.S. holiday season sales were below optimistic expectation, overall global polished diamond demand increased steadily at about 5 percent in 2004. We estimate global diamond jewelry demand reached $50 billion in 2004 and will continue to grow in U.S. dollar terms at 5 percent or more in 2005.
External Economic Forces
Polished diamond demand and prices are highly influenced by external economic forces. We expect great changes in the economic environment during 2005. These changes will have a major impact on the polished diamond markets.
U.S. interest rates are definitely heading higher and consumer debt is at an all-time peak. While fuel prices have come down a bit they have still increased 28 percent in 2004 and we expect significant increases in inflation during 2005. All of this and more add up to lower disposable income for consumers. Simply put, consumers will have less extra money available to buy diamonds in 2005. While some consumers may put off a diamond purchase, many will seek to buy less expensive diamond jewelry. Others may choose to shop at Wal-Mart, Costco or the internet where they perceive, and perhaps receive, more flash for their cash. Retailers will have to deal with the fact that shoppers are going to be increasingly value conscious, price points will be sticky and money may get tight and expensive — not just for the consumer, but for the retailer as well.
While all of the above indicates a declining diamond market, we must recognize that U.S. disposable income is but a small part of the diamond story. Something more powerful and important is going on. Diamonds are a dollar commodity in a global economy, and the dollar is declining rapidly. Since September 2004, the dollar has plummeted 11.15 percent against the euro.
The lower dollar has three primary effects on diamond prices. First of all, it directly lowers the real price of diamonds in foreign countries. In other words, the cost of diamonds in the European community has fallen 11.15 percent since September and therefore more Europeans will be buying more diamonds. The same holds true for other countries whose currencies have increased against the dollar. Second, since 50 percent of diamond demand is foreign, as long as demand remains stable the price of diamonds in U.S. dollars will go up because the dollar has gone down. Finally, the declining dollar and increasing gold prices —7.26 percent since September 2004 — encourage people to consider diamonds and alternative assets as a better store of value than the dollar. As diamonds go up in price and the dollar declines, demand for diamonds as a store of value will increase.
Few are going to appreciate me saying this — relatively low interest rates and a rapidly declining dollar are all a recipe for investment diamonds. Commoditization due to enhanced certification, consumer access to live discounted internet
prices and improved information systems all point in the same direction.
U.S. retailers should be aware that they might face a period of price-sensitive U.S. demand and higher diamond prices driven by strong foreign purchasing power. Furthermore, they should be prepared for increased competition in the U.S. from discounters who are tuned into and meeting consumers’ increased demand for value.
Regulatory Environment
The Kimberley Process (KP) has done a good job of regulating the flow of rough diamonds to the cutting centers. Real benefits have accrued to developing countries with more diamonds officially exported and increased government revenues. The industry must address the need to comply with antimoney- laundering laws and the soon to be issued regulations of the USA PATRIOT Act. In addition, many firms and organizations are implementing best business practices to ensure that their companies and the diamonds they sell meet acceptable standards of social responsibility. All of this is good and necessary for the proper development of the diamond industry. Implementation of these regulations will take our industry to higher levels of customer appreciation and acceptance.
A primary concern shared by many in the diamond industry is the role of De Beers in the regulatory environment. Discussions with the European Commission (EC) regarding implementation of De Beers DTC SOC program continues with many dissatisfied and concerned members of the trade finding it impossible to communicate their objections, concerns and damages to the EC through diamond trade organizations. Due to the mingling of sightholders and nonsightholders in trade organizations and the conflict of interest between these groups regarding opposition to DTC policies, diamond industry trade organizations have been unable to present vital issues of importance to government regulators. Furthermore, De Beers through Diamdel has compromised the ability of trade leaders to represent their constituents. While individual firms with complaints against De Beers are being heard at the EC, to our knowledge no one is representing the legitimate interests of the industry in general and the small firms in particular to the EC regulators. This is unfair and incorrect. We expect that it will lead to unnecessary litigation and class-action lawsuits in the future.
Of additional and even greater concern is the recent proposal of De Beers and ALROSA to the EC, whereby commitments are being made that would allow Russia’s ALROSA, the second-largest diamond producer, to sell diamonds to De Beers, the largest diamond producer. We are shocked and horrified that the EC would consider such an outrageous proposal and allow its formal presentation. While we will present a detailed analysis of our objections in the near future, at this time we wish to express our utter amazement that the regulators at the EC have not addressed the issue of price-fixing by De Beers and ALROSA.
We hereby protest in public and in writing and call for a full investigation of charges that De Beers and ALROSA have been, and are currently engaged in, the price-fixing of rough diamonds. Furthermore, we call upon EC Commissioner Neelie Kroes publicly to immediately investigate the competency of the EC regulators who have been negotiating with De Beers. Why are these regulators not addressing the issue of price-fixing between De Beers and ALROSA? Not only should De Beers not be allowed to buy diamonds from ALROSA, they should not be allowed to talk to them about diamond pricing. We call upon De Beers to practice their best business practices and stop trying to get away with unfair business practices. What is going on here is wrong.
And now to end this article on a more positive note. One of the most important events of the year took place December 20, 2004, when the government of Botswana gave Debswana, their joint-venture mining company with De Beers, a 25-year license for their diamond mines — the best diamond mines in the world. This agreement ensures the long-term continuation of De Beers as a dominant force in the diamond industry. We congratulate De Beers and Botswana and are pleased that De Beers will have enough diamonds to promote its programs, which greatly benefit the diamond trade.
We thank De Beers for all the good that it does and wish it success in its growth and development.
These words might come as a surprise as they follow the paragraph before them. And so perhaps is our lesson for the New Year. Let us learn to appreciate all that is good in the world and in all those around us, be they friends or adversaries. Let us support each other wherever and however we can.
And let us never fear to stand up for what we believe is right and important. Let us oppose what is wrong not necessarily who is wrong. Let us never be afraid to say what must be said and let us pray that our friends — even and especially those
that we disagree with — listen with an understanding
mind and an open heart.
Contract Cutting
Nontraditional diamond manufacturing — i.e. contract cutting — is doing well and may be the wave of the future. China has become a major diamond-cutting center and will continue to grow significantly in the future. While many of the factories are owned by Belgian, Israeli and even Indian diamantaires, the Chinese companies essentially operate as contract cutters, charging fixed costs for cutting and making a small profit on their labor. The Chinese are too smart to buy rough. Today you can contract cut diamonds almost anywhere in the world — New York, Belgium, Israel, South Africa, India and China.
Proposed Commitment to EU from De Beers and ALROSA
De Beers undertakes that the maximum amount of rough diamonds that it directly or indirectly purchases from ALROSA — or from any company that at present or in the future controls or is controlled by the ALROSA group of companies in any calendar year 2 will not exceed the amounts specified in the following table:
Maximum annual
supply cap (U.S.$million)
2005 $700
2006 $625
2007 $550
2008 $475
2009 $400
2010 $275
De Beers further undertakes that in 2011 and thereafter, the maximum amount of rough diamonds that De Beers directly or indirectly purchases from ALROSA in any calendar year will not exceed U.S. $275 million.
Purchases on the Secondary Market
• Notwithstanding Clause 2 above, De Beers may purchase rough diamonds from parties other than ALROSA subject to the following conditions:
1) De Beers shall not make any purchases from parties other than ALROSA with a view to circumventing the Commitment given in Clause 2; and
2) De Beers shall, in good faith, take such steps as are reasonably practicable to ensure that it does not purchase directly or indirectly rough diamonds originating from and sold by ALROSA to parties other than, De Beers in circumvention of these Commitments.
Implementation
De Beers shall implement the above Commitments by concluding a trade agreement with ALROSA, which is similar in principle (in particular, pricing, sorting and valuation) to the notified Trade Agreement, but includes an obligation on ALROSA not to sell rough diamonds to De Beers and an obligation on De Beers not to purchase rough diamonds from ALROSA in volumes greater than those specified in these Commitments. De Beers is aware that ALROSA is under a parallel obligation on the basis of its Commitments to
the European Commission (EC).
Review Clause
Pursuant to Article 9.2 a. of Regulation No 1/2003, De Beers may request the Commission to reopen the proceedings with a view to modifying the present Commitments where there has been a material change in any of the facts on which the Commitment Decision is based.
Monitoring
• De Beers agrees to appoint a Trustee to carry out the monitoring of the Commitments provided herein in accordance with the provisions set out in the Annex, which forms an integral part of these Commitments.
•The implementation provisions regarding the Trustee, as set out in the Annex, as well as the Trustee Mandate are subject to the Commission’s approval.
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Tags:
Alrosa, Argyle, Australia, Belgium, China, Consumers, De Beers, Debswana, Diamdel, DTC, Economy, Government, India, Israel, Jewelry, Kimberley Process, Manufacturing, Mining Companies, Regulation, Russia, Sightholders, South Africa
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