RAPAPORT... The recent rise in demand for rough diamonds has injected a new wave of optimism about the industry. De Beers Diamond Trading Company (DTC) sights have edged up in value, rough tender prices have increased and a rare, cushion-shaped, 7.03-carat flawless blue stone sold at Sotheby’s Geneva for a record $9.5 million, or $1.4 million per carat. All these factors have contributed to another month of rising confidence in the diamond industry, and investors have started to think about diamonds again.
With the upswing, diamond manufacturers are hoping for an increase in polished prices so they can get higher margins on existing inventories. Buyers, however, are resisting the upward pressure and prices are holding steady. The question is why? Surely, if rough prices increase, polished should follow.
One needs to examine the correlation between rough and polished diamond prices. If rough rises, or declines, by X percent, does polished do the same? Over the past year, as the markets crashed, rough prices fell 30 to 50 percent on average, and even 70 percent in some cases. Yet the decline in polished prices was less steep at only about 20 to 30 percent.
By expecting an increase in polished prices on the back of rough, manufacturers are looking at the wrong side of the distribution channel. Polished prices are not a derivative of rough prices, but depend on demand at the retail level. When rough prices increase, polished prices are capped by resistance from consumers and, for now, there is no indication that consumer spending has gone up.
So what’s driving the rise in rough? Essentially, the increases should be viewed as a correction necessary to bring rough prices in line with the current level of supply and demand from manufacturers, who wish to resume production in anticipation of improved market conditions. Demand for polished has stabilized and is higher than the lows of December through February. As a result, manufacturers, who closed their factories and refrained from buying rough for the past six months, are now starting to operate again. Supply is lower as mining companies shelved their output through their first-quarter depression. Therefore, as manufacturing resumes, there is upward pressure on rough prices.
Fragile UpturnAs demand remains at extremely depressed levels, it is premature to expect further sharp increases in rough prices. While the DTC May sight was valued at an estimated $250 million, an increase of 25 percent from the month before, one must remember that the same sight a year ago was valued at $660 million. De Beers is expecting rough sales to drop 50 percent to a total of about $3 billion in 2009. But DTC sales have already fallen approximately 73 percent to $660 million over the first four sights of the year.
In order to reach its estimation of a 50 percent decline, the remaining six DTC sights of the year need to be about $400 million per sight. Signs of a real recovery would only be evident when DTC consistently achieves sales well above this level. At such a point, strong retail sales would be filtering through to wholesalers and diamantaires.
The recovery has to start at the cash register. But, stores are still showing a negative trend. Retail sales in the U.S. fell 0.5 percent in April, following a 1.3 percent decline in March, according to the Commerce Department. “The recent optimism about the economy took a bad hit this week, especially because of the 0.5 percent drop in retail sales,” wrote Standard & Poor’s (S&P) analysts David Wyss and Beth Ann Bovino in a May 15 note. “We continue to believe that the economy is not at bottom yet, but that the pace of decline has slowed.” Weak sales are also expected from the major jewelry retailers when they publish first-quarter earnings toward the end of May after press time.
Backing the S&P assessment, U.S. economic data continues to point to a sustained recession. While the pace of job losses appears to have slowed, another 539,000 people became unemployed in April, bringing the total job losses for the past six months to an astounding 4 million.
A different phenomenon has developed in the diamond industry. As diamond manufacturers in India restart their operations, and offer employment again, workers are hesitant to return to Surat from their rural homes and new jobs as they fear another downturn. Furthermore, Indian labor costs to the diamond industry are now increasing. All this points to a jittery market and a fragile upturn.
Another Month of ConfidenceThe most notable trend in the past month is that confidence has continued to grow as polished prices remained stable. The JCK Vegas and Hong Kong jewelry shows in June are fueling expectations that the good mood will continue. There is stronger demand in the U.S. for rounds, princesses and cushions from 1.50 to 3.00 carats, F-H, SI1-I1, Gemological Institute of America (GIA)-certified diamonds, stimulated by the bridal market. In India, markets have slowed due to summer vacations but demand remains good for 0.50- to 1.00-carat, H+, VVS+ stones. Far East buyers are driving better demand for collection goods of 0.50- to 2.00-carat, D-F, VS1-SI2 stones.
Dreaming of a Bright ChristmasOverall, the same trends that were apparent in April held true through May and that is encouraging. Should current market conditions continue, the diamond industry may be rewarded with a stable Christmas 2009. Some analysts have forecast that a sustainable economic recovery may begin to show in the fourth quarter. The good news is that with a disastrous Christmas 2008 behind us, the bar is set low and there is a good chance that sales will meet expectations.
The industry also needs to be actively preparing for Christmas 2009 with effective generic marketing. Unfortunately, little has been heard from the big five — De Beers, ALROSA, Rio Tinto Diamonds, BHP Billiton and Harry Winston — since they assumed trusteeship of the generic marketing campaign in 2008.
If a real recovery for the diamond industry lies in the hands of the consumer, the industry needs to act urgently to raise the profile of its product. Delaying effective marketing beyond the third quarter is an opportunity missed. The industry needs to refocus on the consumer. After all, diamond markets are driven by demand, not supply.
Article from the Rapaport Magazine - June 2009. To subscribe click here.