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Contrasting Quarters

Apr 4, 2015 8:01 PM   By Avi Krawitz
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RAPAPORT... The first quarter of 2015 was a tough one for the diamond industry but it certainly was not dull – as this writer mistakenly suggested in a conversation this week. If anything, it offered a stark reminder of just how quickly market conditions can change. At this time, just one year ago, the trade had completed a relatively strong and profitable first quarter. In contrast, sentiment in 2015 is decidedly weak.

In general, the first quarter tends to be all about trading as steady consumer demand during the Christmas and Chinese New Year seasons motivates jewelry retailers to replenish inventory. That restocking influences polished diamond demand which filters to the trade and the rough market, as was the case in 2014.

Back then, polished suppliers enjoyed improved profit margins as rough prices had declined in the preceding fourth quarter of 2013 – when manufacturers had forced rough prices down by refusing supply. With their lower-priced rough purchases, the polished production that came to the market three months later resulted in a period of short-term profitability for the trade as polished prices subsequently rose.

Unfortunately, the good times were short lived. Polished prices have been on a consistent downtrend since the second quarter of 2014, as noted in the Rapaport Monthly Report – April 2015, “Reducing Inventory” that was published this week.

Much has happened in the year since then that caused the first quarter of 2015 to be different.

Firstly, there was no rough price correction in the fourth quarter of 2014 that might have enabled greater profitability for the current market – as it did a year ago. Rather, rough prices among contract suppliers were kept stable through to the November selling cycle. Manufacturers started to refuse goods in December – and continued to do so during last week’s March sight. Rough prices have softened since then, but contracted rough supply from De Beers and ALROSA is expected to remain low and prices relatively stable in the coming months.

The second difference is that growth in consumer demand has slowed, particularly in Greater China as the economy there matures. Add to that the effect of China’s anti-corruption campaign on luxury sales and a slowdown in retailers’ expansion to Tier III and Tier IV cities, both of which place additional pressure on wholesale demand. As China’s diamond jewelry retail sales slowed from double-digit down to 5 percent to 7 percent growth in 2014, a bottleneck naturally developed in the market.

Consequently, jewelry retailers had sufficient inventory levels throughout 2014, particularly after their strong buying in the first quarter of last year. And as polished prices declined they were hesitant to build up further inventory in a down-trending market. Furthermore, Christmas sales were fairly disappointing in the U.S. Despite positive economic reports, middle-income Americans continue to struggle and are spending less on discretionary items.

U.S. jewelry sales data collected by Rapaport News has been weak in the past five months, reflecting some softness among independent jewelers, which had already lowered their inventory requirements in the past few years. In addition, the large jewelry retailers ended the fiscal year with higher inventory levels than a year earlier, and many of the majors in both the U.S. and the Far East are manufacturing more of their diamond supply in-house. Signet Jewelers, Chow Tai Fook, Chow Sang Sang and Tiffany & Co., all have significant cutting and polishing operations.

The retail sector, therefore, has less requirements from the diamond market than it did a year ago.

The third significant development is that lower bank credit has impacted liquidity levels. ABN Amro, and other banks, reduced its financing from 100 percent of rough purchases to 70 percent effective January 1, 2014. That decision only started to have a real effect on liquidity from the second quarter of the year. In addition, Antwerp Diamond Bank has since started to wind down its operations, withdrawing its $1.4 billion exposure to the industry.

Manufacturers and dealers don’t have the access to bank credit that they did a year ago. Erik Jens, CEO of ABN Amro’s Diamond and Jewellery Clients, in an interview with Rapaport News published last week, stressed that the banks view the diamond industry as high risk and that the trade needs to bring in alternative sources of income to compensate for the banking sector’s reduced lending to the industry

So far, the industry has failed to do that in a significant way and the subsequent lower liquidity levels are putting additional pressure on polished prices.

As long as a diamantaire has money in the bank, there’s no pressure to sell as there is money to pay workers, buy rough and do what is required to keep an operation running. However, as soon as one runs out of money, which in the current environment is happening due to a combination of weak demand and tighter bank financing, manufacturers are forced to sell their goods at lower prices to generate cash. That reality had not sunk in yet last year to the extent that it has in 2015.

That sightholders refused about 30 percent of their March rough supply – just before a new De Beers contract was announced no less – is testament to the lack of liquidity and demand in the market.

As a result, perhaps the biggest change between this year and last year at the end of the first quarter relates to market expectations. In 2014, most expected that the second quarter would be quiet as part of the regular business cycle for the year. However, few foresaw a downtrend that would extend into April 2015. Currently, there is a tension between looming supply shortages, weak demand and reduced bank credit that is putting pressure on the diamond market, and influencing a bleak outlook for the months to come.

The cycle will undoubtedly turn. With reduced rough supply and manufacturing, shortages will ultimately help stabilize the market and stimulate demand. And the recent rough price reductions, and expected looming ones, should influence a period of improved profitability when polished demand picks up – much as it did just over a year ago. It may just take a little longer for that to happen as expectations are low that polished wholesale demand will improve in the near term.

In the meantime, the diamond industry continues to manage the contrasting trading environment from a year ago. In doing so, it needs to improve liquidity levels by raising demand and its access to credit to be sustainable in the long term. That’s not an easy task in the current tough market environment; but it’s certainly not a dull one. 
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Tags: 2014, 2015, Avi Krawitz, editorial, first quarter, new year, polished markets
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