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A Happier Year Ahead?

Jan 2, 2015 10:09 AM   By Avi Krawitz
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RAPAPORT... Diamantaires were happy to see the back of 2014. After all, it was a tough year in which polished diamond prices declined, accelerating the general downtrend evident since mid-2011. Therefore, there is understandably some uncertainty about the trade’s prospects for the coming year as many of the core challenges facing the market persist.

To labor the point made by this column last week, banks are being more stringent in lending to the industry, liquidity is tight and profit margins are even tighter (see editorial, “The Diamond Story of 2014,” published on December 26, 2014). Given the steep declines in polished prices in December and through most of 2014, dealers and manufacturers can be forgiven for being cautious.

There are also positives. U.S. demand is stable and the economy is showing signs of strength. There is also a sense that the diamond industry is slowly getting its house in order, particularly with regard to financial compliance issues and marketing. Those processes are certainly a step in the right direction and necessary for the long-term health of the industry, even if they will inevitably endure some growing pains.

Therefore, it’s very difficult to forecast how the diamond market will evolve in the coming year. However, it’s worthwhile to keep an eye open for the stories and trends that are expected to shape the market. Here’s a look at some of the developments that we’ll be looking out for in 2015 – in no particular order:

De Beers Contract & Rough Prices

In theory, rough prices should decline in the first quarter of 2015, unlike in 2014. Last year, rough prices rose in the first quarter spurred by polished inventory replenishment and after rough prices had declined in the fourth quarter of 2013 – at De Beers sights and on the spot and secondary markets. The fourth quarter correction enabled manufacturers’ improved profit margins at the beginning of 2014 as polished prices increased.

This year hasn’t brought the same fourth quarter rough price adjustment. While prices have corrected on the secondary market, De Beers has held its prices relatively steady, including in December. As a result, profit margins and liquidity remain tight among the large manufacturers, who consequently rejected a larger proportion than usual of De Beers goods at the December sight.

Meanwhile, inventory levels remain high across the distribution chain and the extent to which demand will be driven by inventory replenishment in the first quarter – as it was in 2014 – remains to be seen.

If liquidity is being squeezed, one expects manufacturers to continue to reject high-priced rough to force the mining companies to reduce their prices.

In practice, however, that probably won’t happen. De Beers, for one, is tweaking prices on a sight-by-sight and category-by-category basis, rather than implementing far-reaching reductions. The company is also negotiating new three-year contracts, effective from April 1, with sightholders who might be reluctant to jeopardize their position by refusing to take goods – even if De Beers has simplified the selection process to ensure that existing sightholders are virtually guaranteed renewal.

Furthermore, De Beers will be introducing mechanisms to raise the competition for rough that will help defend its prices. The accredited buyer system during the next contract period presents the potential for De Beers to supply more non-sightholder companies with rough.

More manufacturers, and retailers for that matter, will gain contracted rough supply in 2015 as more of the major mining companies are offering long-term supply deals – De Beers, ALROSA, Rio Tinto and Dominion, among them.

Therefore, the divergence between contracted supply and the spot and secondary rough markets will likely become even more apparent. We’ll be watching out for manufacturers’ ability, or willingness, to pay high rough prices in both areas during 2015.

Financial Compliance & Bank Credit

De Beers has simplified the application process for its new contract. Applicants must simply demonstrate sufficient demand for rough, comply with De Beers Best Practice Principles on ethical performance, and with international financial reporting standards (IFRS).

The company argues that its insistence on financial compliance is part of a drive to make the industry more robust. With strong and well-structured financials, the industry can better cope with market volatility, De Beers management has explained.

The banks are requiring the same thing. As this column outlined last week, the reduction of bank credit to the industry was arguably the most influential story of 2014. The industry has recognized that it needs to raise its profile within the banking sector to attract greater finance, and can only do so by implementing well-structured, transparent and more regulated financial reporting and business standards.

It seems that manufacturers and dealers will have little choice but to comply with these standards if they wish to secure rough supply and financing in 2015.

Grading Laboratories

If the laboratories were the talk of the trade in 2014, one expects the buzz to quiet slightly in the coming year. At least the backlog at the Gemological Institute of America (GIA), which had impacted liquidity and the flow of trade last year, seems to have diminished as the institute has vastly improved its turnaround time.

The other “lab” story is more likely to linger, and probably intensify. With a number of lawsuits filed against a U.S. jeweler over misrepresentation of diamond qualities by using EGL International grading reports, and Rapaport Group subsequently banning EGL from its RapNet Trading Network, the trade is hopefully heading toward more standardized grading practices.

Rapaport contends that it is an unfair trade practice to grade diamonds using GIA grading terminology while applying alternative standards that over-grade the diamonds.

The noise surrounding the EGL story will hopefully force sellers to be responsible for what they sell, which includes that the grading report fairly reflect the quality of the diamond being sold.

This coming year, the trade, along with its jewelry retail partners, will increasingly wrestle with the issue of over-grading diamonds and the terminology used by the various laboratories that often imply different qualities.

Branding Generic Diamonds

They’ll do so in order to defend the integrity of their product to consumers. In fact, it seems the industry is finally ready to raise its profile in the consumer space. The 2014 launch of the World Diamond Mark (WDM) – and the announcement this week of its first Authorized Diamond Dealer – may get the generic marketing campaign rolling.

While the presence of branded diamonds and jewelry is expected to continue to grow in 2015, the World Diamond Mark Foundation is claiming the diamond itself is a brand and should be sold as such in order to regain its position as the most desirable luxury product.

The WDM grabbed some attention in December with its World Diamond Conference in New Delhi and has some marketing events planned in the coming months in Turkey and Dubai.

The program is the trade’s answer to the call for generic marketing after De Beers shifted its budget to promote its own brands. The extent to which the industry gets behind the WDM with both funding and participation in 2015 will make or break the initiative, and test the long-term effectiveness, or need, that generic marketing has for the industry in today’s brand-focused world.

U.S.-Driven Growth

The aim of the WDM program is to raise consumer demand, and consequently improve retailers’ profit margins that will hopefully trickle down to the trade.

Diamond jewelry sales are forecasted to grow at the same low single-digit percentage points that it has in the past few years. Growth is being spurred by the U.S., where all recent economic indicators have been encouraging. The economy is expanding at a robust 3 percent annual rate, while official unemployment has stabilized well below 6 percent and disposable income is on the rise. The stronger dollar and the drop in oil prices is expected to increase disposable household income (see RapUp section on page 5).

Other major diamond jewelry markets have grown cautious with demand in China and India slowing from the boom years to more sustainable rates. However, the Chinese government’s anti-corruption campaign and its program to transition the economy to being consumption-driven remain a caveat to the 7 percent growth the country has sustained.

Still, the greater concern for the trade is whether the expected growth in consumer demand will translate to its own bottom line. With inventory levels said to be relatively high for this post-Christmas holiday time of year, one might expect the first quarter to be a period of further inventory depletion – especially over the Chinese New Year period. That might then stimulate stronger trading later in the year with the sincere hope that profit margins will improve, along with demand, as diamantaires learn to better manage their finances and rough purchases. As 2015 evolves and the stories of the year come to light, there’s no reason it shouldn’t be a happy New Year.

The writer can be contacted at avi@diamonds.net.

Follow Avi on Twitter: @AviKrawitz and on LinkedIn.

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.


Copyright © 2015 by Martin Rapaport. All rights reserved. Rapaport USA Inc., Suite 100 133 E. Warm Springs Rd., Las Vegas, Nevada, USA. +1.702.893.9400.

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, De Beers, diamonds, EGL, GIA, Rapaport, Rio Tinto, world diamond mark
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