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Editorial

Nov 15, 2013 12:50 AM   By Avi Krawitz
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RAPAPORT... For investors looking for exposure to the diamond market, 2013 has not lived up to expectations. In fact, while U.S. stocks have rallied this year, pure-play diamond companies have struggled along. If the rise of the Dow Jones Industrial Average and S&P 500 Index reflect confidence in the U.S. economic recovery, the sub-par performance of diamond mining sector echoes the caution in the diamond market.

True enough, investors have shied away from mining shares in general in the 2013 bull market, but one gets a sense that diamond miners are not living up to the story, or the diamonds, that they sell to investors.

Granted there are very few pure-play diamond companies for investors to choose. While the most significant of those, ALROSA, went public in Moscow just last month, the other high-volume diamond mining companies, De Beers and Rio Tinto Diamonds, are part of larger conglomerates and not available to trade separately.

That leaves just four pure-play mid-tier diamond producing companies in the sector, which tend to attract relatively low volume trading, and carry fairly low market values. The largest of these, Dominion Diamond Corporation, has a market cap of about $1.2 billion, followed by Petra Diamonds valued at around $900 million, Lucara Diamonds at $506 million, and Gem Diamonds at approximately $330 million.

The shares have tended not to pop. Of the above mentioned companies, only Lucara shares have shown significant gains in 2013, largely due to its ramped up production and inaugural revenue stream from the Karowe mine in Botswana, evidenced in its better-than-expected earnings published last week. It could well be that the other three carry inherent risks in the development projects that they have undertaken.

Gem Diamonds is considering going underground at the Letšeng mine in Lesotho and developing the Ghaghoo mine in Botswana, which is scheduled to launch production next year. Petra Diamonds is engaged in expansion projects at the Finsch and Cullinan mines, while labor disruptions in South Africa have put downward pressure on its shares.

Frustrated Dominion shareholders in September expressed their concern that management has allocated cash to develop the Jay pipe at the Ekati mine, rather than use it in a share repurchase program to raise the company’s equity valuation. Caerus Global Investors, which authored an open letter to the Dominion board, estimated at the time that the share was about 50 percent below what they perceived to be fair value.

These companies are likely to be undervalued, particularly Dominion given its position in the market and its low price-to-earnings ratio. However, they also carry risk that investors are not yet convinced will pay off. Such is the nature of development as diamond mines go deeper and become more costly to bring to commercial production. 

But perhaps investors are also looking at the diamond industry dynamic and expressing caution through these stock valuations. The companies’ long-term sales pitch may be valid, but there is persistent uncertainty in the diamond market that has been evident this year.

It is true that demand which is being driven by emerging wealth in China and supported by a stable U.S. market will continue to outstrip supply in the foreseeable future. In theory, rough prices should rise, driving the revenue and profits of companies who have the goods to sell. But, as shareholders would have gauged, diamond markets have been quiet and prices have been volatile in 2013.

That has been the reality for the diamond trade in the post-2008 era. While there have been strong periods of price growth, there have also been prolonged downtrends, as the current market conditions suggest. Polished prices rose significantly from January 2010 to July 2011, but have declined since then to levels about in line with pre-crash levels, according to the RapNet Diamond Index (RAPI™).

This year, the polished market has been selective with strong demand and price growth for 0.30-carat to 0.40-carat diamonds, while RAPI in most other sizes declined. Perhaps to their dismay, mining companies are unable to select which category of diamonds to extract. And rough demand has been equally fragmented.   

Diamond manufacturers, the clients of the mining companies, are working with low profit margins and are faced with tight liquidity as producers attempt to maintain steady rough price levels in these volatile markets. Eventually, mainly in the third quarter, manufacturers rejected high-priced, unprofitable goods and prices softened, thus diminishing the investment pitch of long term price – and revenue and profit – growth. 

At face value, investors may be looking elsewhere along the diamond pipeline for value. Branded jewelry companies such as Tiffany & Co., Signet Jewelers, Zale Corporation, and Blue Nile have rallied with the market this year. Retail has a lower capital outlay than mining and it may simply be easier to sell goods at marked-up prices to consumers than to wholesalers.

The two sectors have therefore balanced each other out. An electronic traded fund (ETF) by PureFunds that contains a mix of gem-related companies across the exploration, mining and jewelry sectors is basically flat for the year. Ultimately, different sectors respond in different market environments and the ETF has likewise failed to inspire significant returns.

For now, investment demand is limited to buyers of unique stones. Certainly on the very high end of the market, investment demand for rare diamonds has risen to new heights in 2013. Just this week, Sotheby’s sold an oval, 59.6-carat, fancy vivid pink, IF diamond for $83M ($1.4M/ct.), while Christie’s sold a pear-shape, 14.82-carat, VS1, fancy vivid orange diamond for $35.5 million, or $2.4 million per carat.

As with other commodities, such as gold, it is better to invest in the actual product than the companies which mine them. Unlike gold, the current investment in individual diamonds is limited to select goods and, by default, select investors. That may change as new investment products are tested in the market. 

But for now, diamond miners are having a tough time wooing shareholders to their stock. While these volatile trends are likely to continue, the mid-tier mining companies have no choice but to focus on their long-term production potential. Given the recent market reality, whether that will be enough to stimulate strong shareholder returns is not as clear as it once was.

The writer can be contacted at avi@diamonds.net.
 
Follow Avi on Twitter: @AviKrawitz

This article is an excerpt from a market report that is sent to Rapaport members on a weekly basis. To subscribe, go to www.diamonds.net/weeklyreport/ or contact your local Rapaport office.


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Disclaimer: This Editorial is provided solely for your personal reading pleasure. Nothing published by The Rapaport Group of Companies and contained in this report should be deemed to be considered personalized industry or market advice. Any investment or purchase decisions should only be made after obtaining expert advice. All opinions and estimates contained in this report constitute Rapaport`s considered judgment as of the date of this report, are subject to change without notice and are provided in good faith but without legal responsibility. Thank you for respecting our intellectual property rights.
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Tags: Alrosa, Avi Krawitz, Blue Nile, De Beers, diamonds, Dominion Diamond Corp., Gem Diamonds, Lucara Diamonds, Petra Diamonds, Rapaport, Signet, Tiffany, Zale
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