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Realigning Inventory

Editorial

Mar 27, 2015 6:10 AM   By Avi Krawitz
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RAPAPORT... The middle of the diamond distribution chain is struggling to align itself with new, lower levels of wholesale demand. The result is that manufacturers and polished diamond dealers continue to be squeezed despite growth in consumer demand.

Therefore, recent reports about record diamond jewelry demand and strong diamond price growth in 2014 were somewhat misleading. They did not account for the imbalances currently at play in the diamond market.

While consumer demand for diamond jewelry grew last year, polished diamond trading diminished. While the mining companies garnered healthy profits, diamond cutters struggled to maintain their slim operating margins. While rough diamond prices rose, polished prices fell.

Indeed, those disparities have continued into 2015, placing additional pressure on the diamond manufacturing sector.

Perhaps most significantly, slower growth in consumer demand has impacted demand for loose diamonds. De Beers estimated in a report published last week that consumer demand for diamond jewelry rose 3 percent year on year to a record $81.4 billion in 2014. However, the pace of growth in fact slowed from previous years, and apart from the steady U.S. market, there was a deceleration in other major markets, most notably in China, India and Japan, the research showed.

As a result, jewelry wholesalers and retailers are buying smaller volumes of loose diamonds. The aggressive expansion among Chinese retailers into Tier III and Tier IV cities appears to have tapered off. Consequently the strong diamond demand that was required to fill new showcases in those cities – and that had stimulated trading in the past few years – has slowed.

Chinese demand has consequently shifted to retailers buying to fill orders as they come in, rather than buying diamonds to build inventory. That strategy is especially evident in an environment of down-trending diamond prices. In fact, the new global reality is for retailers to manage tighter inventories. In the aftermath of the 2008-09 crisis, retailers, wisely, are avoiding being stuck with excess stock or dead inventory.

In the past few months, manufacturers have tried to do the same by reducing manufacturing levels. However, they’ve been caught in a bind by rough supply considerations. The mining companies have maintained relatively stable rough production levels and are loath to be stuck with inventory of their own.

Although rough supply diminished at the beginning of the year, there has been an increase again in March with this week’s De Beers sight estimated to be valued at around $700 million.

Prior to the March sight, rough supply declined as the major mining companies “allowed” manufacturers to defer taking about 25 percent of their rough allocations in January and February. The intention was to give the market a chance to diminish its polished inventory levels.

That has worked to an extent. Turnaround times at the Gemological Institute of America (GIA) are suddenly back to within two weeks, presumably due to the lower volume of goods being sent for grading as manufacturing was reduced.

However, the market seems to be at a strange crossroads of perceived oversupply coupled with evident shortages in certain areas. It could well be that demand is selective and that the shortages are in categories where buyers have very specific needs.

Either way, one gets a sense that manufacturers are not ready to ramp up polished production just yet and initial reports of a large De Beers sight this week will not help their cause. (Rapaport News will publish a full sight report in the coming week.) Sightholders have reportedly pushed the bulk of their supply in the next contract period that begins in April to the second half of the year.

Therefore, it’s uncertain whether the mining companies will be able to sustain stable rough prices in the coming months as they did in March. Meanwhile, polished prices continued to soften during the past month and manufacturers’ margins are being squeezed further.

Bain & Co. noted in its Global Diamond Report 2014 that operating margins for diamond manufacturers and traders ranged between 1 percent and 4 percent in 2013. One suspects that they’re currently at the lower end of that spectrum.

Manufacturers are under additional pressure due to the way they conduct business. As Erik Jens, CEO of ABN Amro’s Diamond & Jewellery Clients, said in a recent interview with Rapaport News, the least profitable segment of the industry carries the biggest burden of financing (see full interview here). Manufacturers buy their rough in cash, spend three months cutting and polishing, another two weeks to a month (at best) waiting for grading reports before they sell their polished largely on credit. The time lag between when they lay out cash for rough and when they receive payment for their polished can be from six to nine months.

It’s little wonder they’re under pressure in a weak market environment.

Diamond manufacturing is a risky business that requires significant value addition well beyond simply turning rough into polished. It’s especially daunting as demand is not expected to significantly pick up in the coming months. The second quarter is traditionally a slower period for the trade with no major holidays to boost retail sales. Importantly, there’s still no evidence of significant inventory replenishment as usually takes place after the Christmas and Chinese New Year seasons. While De Beers and others projected earlier that the post-holiday inventory replenishment would come a bit later than usual this year, it now appears that the rush for goods may not come at all.

Jewelry retailers, it seems, simply have enough goods and are happy to buy when they need to fill existing orders. As Rapaport noted recently in its weekly comments, “[there are] too many diamonds chasing too few buyers.” Simultaneously, while the mining companies have maintained steady production, they’re pushing rough supply onto reluctant manufacturers.

The reality is that retail buyers are hesitant to raise the volume of diamonds that they keep in inventory as they respond to a volatile economic environment and slower growth in consumer demand.

Therefore, the middle of the diamond distribution chain has to align its inventory with its retail customers rather than its rough suppliers. In order to achieve that, the market needs to focus on buying and trading polished, rather than on manufacturing rough in the short term; and then it needs to maintain that equilibrium, which reflects lower levels of wholesale demand. In doing so, it will enable a more even spread of industry profits in the long term. Perhaps then, the industry can boast of record consumer demand.

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, Jewelry, Rapaport, Sightholders
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