Fourth-Quarter Outlook Uncertain

The main influencing factors in the sudden insecurity were growing concern about U.S. and European sovereign debt and the stalled U.S. economy, whose consistent retail sales growth hasn’t been strong enough to offset rising government debt, high unemployment and weak economic growth.

The prolonged and polarizing political debate in the U.S. around raising the debt ceiling increased doubt that agreement on containing public spending, or raising revenues, is likely to happen anytime soon. Revised economic indicators only fueled the anxiety. The Bureau of Economic Analysis (BEA) revised its gross domestic product (GDP) numbers, saying that the economy grew just .4 percent in the first quarter, rather than its prior estimate of 1.9 percent, while second-quarter growth was lower than expected at 1.3 percent. Standard & Poor’s (S&P) cited those revisions in its decision to downgrade the country’s credit rating, noting that they “show that the recent recession was deeper than previously assumed, so the GDP this year is lower than previously thought in both nominal and real terms. Consequently, the debt burden is slightly higher.”

In reaction to the GDP announcement and the S&P downgrade, the Dow Jones Industrial Average (DJIA) dropped 11 percent in a single August week and continued to seesaw in the weeks that followed before settling below the 11,000-point barrier at press time (see graph on opposite page, top). 

Bad Timing

The diamond market saw the effect almost immediately when serious buyers at the India International Jewellery Show (IIJS), which coincided with the S&P announcement, held back from making large inventory purchases because they expected prices to soften after the show.

Significantly, liquidity has tightened in India as manufacturing costs have increased with the rise of rough prices. This has caused money to be stuck in inventories because of a three- to four-month lag in selling the polished. In addition, Indian banks have tightened their lending terms. 

While loose diamond trading proved disappointing at IIJS, jewelry sales at the show were strong, which helped spark some confidence for the upcoming Diwali season, which begins on October 26. The hope among Indian diamond traders is that their domestic market, spurred by Diwali, will compensate for any negative impact that a weak U.S. economy may have on the overall Christmas season.  

Caution for the U.S. was reflected in polished prices during August and the RapNet Asking Price Index (RAPI) ™ for 1-carat polished diamonds fell 2.1 percent during the month from July 22 to August 22. The RAPI for .50-carat stones dropped 5.2 percent, and 3-carat diamonds declined by .9 percent (see graph at right, bottom). Many analysts viewed the decline as a temporary correction after the steep and consistent price increases witnessed since the start of 2011 and, in fact, extending back to November 2010. The RAPI for 1-carat diamonds was up 34.4 percent on August 22 from the same date a year earlier. The price increases have been spurred by strong activity in the trading centers and also improved demand from the major consumer markets.

All-Important U.S. Market

Gross polished imports to the U.S., the largest consumer market for diamonds, rose 30 percent year on year to $6.14 billion in the second quarter of 2011, while polished exports grew 41 percent to $5.06 billion (see chart on page 20). Net polished imports, representing the amount of goods that remained in the U.S. for consumption, fell 5 percent to $1.08 billion.

The volume of U.S. polished imports grew a more modest 9 percent to 3.6 million carats, while the average price of the imports grew 19 percent to $1,700.11 per carat. The U.S. total of net polished imports by volume was in deficit by 716,629 carats, indicating that exports exceeded imports by that amount. With the exception of the two preceding quarters, the U.S. has historically been a net exporter of polished by volume because its exports of small polished below .50 carats have increased significantly, largely to India, while larger goods above .50 carats have tended to stay in the country, boosting the overall net-import-by-value figure.

Polished imports to Hong Kong, which serves as a gateway to China and the Far East, rose 37 percent to $4.53 billion in the second quarter and exports grew 44 percent to $3.3 billion (see chart at left). While net polished imports rose 21 percent to $1.23 billion during the quarter, indicating the amount of goods absorbed in the local Hong Kong market, it is assumed that large portions leave the municipality undeclared.

Despite the caution expressed about the U.S., there is still no signal that the uptrend will reverse in the current quarter, although the pace of growth may slow, while the growth trend in the Far East is expected to continue.

Rough Road Ahead

Much of the outlook hinges on the rough market and whether the low premiums for Diamond Trading Company (DTC) goods on the secondary market will be maintained so that prices stabilize. DTC goods were selling at low single-digit premiums, and in some cases at a discount, in the weeks prior to the August sight. Cash-strapped rough dealers, stuck with large inventories they bought at peak prices, are being forced to wait out the current lull in the market.

Mining companies, meanwhile, appear confident that market fundamentals still play in their favor. Acknowledging that the financial markets have had some challenges recently, Clifford Elphick, chief executive officer (CEO) of Gem Diamonds, said it is still unclear what the long-term impact will be on the diamond market. “But the supply situation is not able to meet demand at this point,” he said, noting that demand in China may be even larger than previously thought, which should encourage the diamond market.

As a result, the outlook of rough producers remains positive, even if their pace of growth in the second half of 2011 is not expected to equal that experienced in the first half of the year.

De Beers reported that DTC sales grew 33 percent to $3.49 billion in the first half, driven by price growth of about 35 percent. Group sales increased 30 percent to $3.89 billion and net earnings rose 172 percent to $694 million (see table at right). Similarly, ALROSA reported that rough sales increased 9 percent to approximately $2.16 billion as average prices increased 41 percent year on year. ALROSA’s net income rose more than fivefold to $562 million.

But while the August DTC sight was large, estimated at $800 million, slightly smaller than the July sight, sightholder applications for goods were made before the financial markets turned in August. De Beers raised prices on some items, but the increases were reflected in the change in assortments presented.

Many industry members therefore believe that the September sight, which follows the all-important Hong Kong show, will provide a better indicator of real sightholder sentiment and whether they will hold back on buying DTC rough, which would cause a De Beers price correction. The show might also give some clue as to whether the August slowdown will extend through the remainder of 2011 or if it was just a short-term correction in the market — and, perhaps more significantly, the extent to which the strength of developing markets in China and India will have to compensate for a sluggish U.S. economy.

Article from the Rapaport Magazine - September 2011. To subscribe click here.