If the recession taught the diamond industry nothing else, it was how vulnerable the market is to macroeconomic indicators. A host of variables, from gas-at-the-pump prices to the stock market, affect whether consumers buy jewelry and how much they spend. As a so-called “discretionary” or luxury purchase, diamonds and jewelry are not something people need to buy; they are something they choose to buy. And choosing to buy has a great deal to do with how secure and confident consumers feel financially.
In the depth of the recession, the diamond industry was focused on the negative numbers: plummeting sales and store traffic, reduced inventory turnover, the weaker dollar, low consumer confidence, the erosion of home equity values, the scary declines in the stock market and double-digit unemployment. As the country moves into a period of recovery from the recession, there is heightened concern about economic indicators that are on the rise — gas, food, fuel and commodities prices, interest rates and overall inflation — and how they will impact the economic health of the country.
If gasoline rises above $3.50 this summer, as predicted, or as high as $5 a gallon, as feared, the public will still gas up their cars — but they might drive to the malls less often. If food costs go up by the projected 2 percent to 3 percent in 2011, consumers will still put food on their tables, but they might adjust their grocery list. If clothing prices escalate on the back of soaring cotton prices and other commodity increases, shoppers might cut back on new purchases. Taken individually, none of these economic movements will keep buyers out of jewelry stores. But taken collectively, widespread inflationary increases in their cost of living could shake consumers’ confidence in their economic well-being and lead them to pull back on nonessential purchases.
Driving Luxury Purchases
“The two most important macroeconomic indicators for the global luxury market are real gross domestic product (GDP) growth and unemployment,” says David Wu, a luxury goods analyst for New York City–based Telsey Advisory Group, a financial advisory services firm that focuses on the consumer market. “Of these, GDP growth has the strongest correlation because it represents the feel-good factor in luxury buying. Unemployment — because it is a negative — has an inverse relationship.”
With the World Bank projecting global GDP at 3.3 percent in 2011 and 3.6 percent in 2012, Wu forecasts luxury jewelry and watches will grow by a few percentage points more than the GDP — putting it in the mid-5 percent to 6 percent range. “We are continuing to see real strength in the high end of the market, which has been outperforming the rest of the luxury market all along. In the past recession, from the beginnings of the slowdown in the fourth quarter of 2007, the high end held on. It wasn’t until October 2008, when the stock market fell off the cliff, that the wealthy shoppers dropped out.”
Despite isolated price volatility, overall consumer confidence trends are key to continued strength in the diamond industry. Consumers who are confident are more likely to go shopping. The good news here is that consumer confidence rose in February to its highest point in three years, with its fifth consecutive monthly increase, according to The Conference Board’s Consumer Confidence Index. The 70.4 reading even topped economists’ expectations of a reading of 65. The Conference Board’s lowest reading for the confidence index was 25.4, recorded in January 2009.
Precious Metals Too Precious?
The precious metals scene of the past three years has presented a totally unique phenomenon within the context of the global recession. When everything else was crashing, precious metals soared. Both gold and silver prices continued to set new records in 2010 and into 2011, partly because investors saw them as more stable alternative investments to volatile currency and stock markets, but also because Exchange Traded Funds (ETFs) made it easier to invest in the metals. Created in late 2004, the gold-based ETFs are vehicles that gave average investors a way to “hold” gold without physically taking possession of it, and that gave speculators a new method for trading gold holdings in the markets.
Gold producers are bullish about both the short term and long term. Richard O’Brien, chief executive officer (CEO) of Denver, Colorado–based Newmont Mining, is projecting $2,000-per-ounce gold within the next five years.
But some analysts think the price peak in metals may have already passed. “I have been saying the same thing for two years now. I hear from folks throughout the industry — from individual investors in other countries, to the dealers on 47th Street, to some very big Indian jewelry retailers. And what I hear is that nobody is easily living with the current price environment in precious metals,” says Jon Nadler, senior analyst for Montreal-based Kitco Metals, Inc. “There has been a de facto hedge fund ‘hijacking’ of the gold and silver markets over the past three years or so. However, a possible ‘sell-by’ date in these markets could come about this year, or possibly in 2012.”
Gold is, of course, the headliner among precious metals and Nadler says the gold market’s current “analysis” has been reduced to “a recitation of the metal’s price achievements and an obsession with its chart performance. Who can argue with this kind of a chart? The hype is phenomenal and emotions are running high. But that’s what happened with real estate not so long ago. The hype ran those values up, too, and everyone knows what happened.”
How Long Can Metals Fever Last?
Both gold and silver continue to set new price records in 2011, building on the staggering records set in 2010 — gold hit $1,445 an ounce on March 7, 2011, and silver peaked at $36.79 an ounce on the same day — as the fever for the metals swept investors around the globe.
Nadler’s message: “They can’t keep going higher indefinitely.” He bases that on the fact that “fundamentals do matter” and “reversion to the mean is the natural course of markets over the long term. The fact is that the fundamentals don’t warrant $1,400 gold or $35 silver. What they might more realistically warrant is $850 gold — and maybe a trading range of $680 to $890, the mid-$700s.
“For silver, you can make a cogent, fundamentals-based case for a trading range of $15 to $25 an ounce,” explains Nadler, “but can you also make a short-term case for $35 silver when you consider the impact of hedge funds amassing 1,100 tons in the final six months of 2010? Of course you can, and the market did. The question is the same: How long can that kind of value be sustainable?”
Nadler believes that both metals will begin their pullback later in 2011, rolling back gold to about $900 an ounce by 2014 and silver to near $20 an ounce the same year.
“Investment demand is now the key driver in the market, having outstripped fabrication demand — mainly for the manufacture of gold jewelry — which collapsed as the price of the metal shot up,” Paul Walker, chief executive officer (CEO) of London-based Gold Fields Minerals Services (GFMS) told the Denver Gold Forum in the fall of 2010. “My problem with investment demand,” said Walker, “is that it’s fickle as compared to jewelry demand, which is more consistent.”
A Stash For Cash
The economic environment during the recession, of course, was right for gold and silver, too. With the global economy moving into a virtual collapse, consumers didn’t know where to put their cash. The stock market? You’ve got to be kidding. Real estate? Never mind! Savings vehicles paying near zero percent interest? Why bother?
“Low interest rates made it conducive for speculative funds to borrow cheap dollars and invest them in gold and silver,” explains Nadler. “When such ‘easy money’ is available and hedge funds decide to ‘pounce’ on an asset, they can have a considerable impact on prices. The problem with markets being small, as gold and silver are — relative to other markets like equity and bond markets — is that even a little extra money sloshing around in them can have a big impact — and this was anything but ‘little money.’”
“When real interest rates get back up into positive territory, then investors might ask, ‘Why bother with so much money in risk assets?’ They will perhaps see ‘greener’ pastures in other market areas,” continues Nadler. “On a historical basis, it is not logical to have a situation in which gold and stocks would be rising at the same time. The two asset classes are traditionally thought to be counter-cyclical. In fact, gold built its reputation as a hedge against conventional ‘paper’ assets such as stocks, bonds and currencies.
“The ‘easy money’ has probably already been made in the decade-long ascent in gold and silver. The risk-reward equation now enters into the picture. If nothing else, investors should be scaling their overall metals exposure back a bit. If a hedge fund started with, say, 5 percent to 8 percent of its allocation in gold and now finds it at 15 percent or more due to the increased price of the metal, that’s considered to be an ‘overweighting’ in the asset, and its portfolio might need to lighten up,” says Nadler. “Balance comes from stability in price. I would rather see gold stable in the $800 range than running wild from $680 to $1,450 since late 2008 and in the opposite direction, from $1,017 to $680 from March to November of 2008. With some stability in the market, gold producers will better be able to factor in price risk, principal users won’t turn their back on gold and retail consumers will feel more comfortable with a purchase of gold jewelry. This is preferable to the current gold market factions and the bull and bear camps warring with each other.”
The other problem with the outsized influence of ETFs in a given market is that they can accelerate price gains in the commodity when they are in acquisition mode but they can also aggravate price declines when a good portion of owners pull out of the market, according to Nadler.
Other Precious Metals
In platinum, demand and supply are expected to be close to balance but still in a surplus in 2011, according to refiner Johnson Matthey. Increased production is expected from Russia and Zimbabwe. Global demand strength for platinum emanates mainly from the autocatalyst industry, with smaller increases in other industrial sectors. ETFs also have been introduced for platinum group metals.
The palladium market is considered by Nadler to be more “robust” than platinum’s as it hovers in a small deficit situation in terms of supply and demand fundamentals. Demand for the noble metal is strongest from the automotive and electronic sectors. Meanwhile, Russian supplies have been anything but reliable and have largely been absent from the market in 2010.
In rhodium, primary demand is increasing from the autocatalyst industry because of heightened global emission standards, and it also comes from the glass and chemical industries. Unlike other precious metals, rhodium is a byproduct of platinum and palladium mining processes — there are no known dedicated rhodium mines in existence or pure rhodium deposits to be mined.
Everyone Working With Cost Increases
Just as consumers must reconcile themselves to higher food and gas prices before they resume “discretionary” spending in jewelry stores, so, too, must the diamond and jewelry industry work with its own inflationary increases in diamonds and precious metals.
Article from the Rapaport Magazine - April 2011. To subscribe click here.