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An Abnormal Company

Editorial

Jun 24, 2010 3:42 PM   By Avi Krawitz
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RAPAPORT... De Beers managing director Gareth Penny stressed in a recent interview with London’s Financial Times that the company has shed its “mystique” as the interviewer termed it. “Our business is absolutely normal,” Penny said. “But it deals with an abnormal product.”

Indeed, Penny stressed that the rarity of the product is what makes it so unique. That may be so, but try as it may to operate like any other business in the industry, De Beers faces some unique challenges that maintain its position as the primary decision maker.

Penny makes two points in particular that ring true: In the mid to long term, demand out of China and India is growing rapidly and there is a serious supply problem due to the lack of new mines coming on stream.

A long-term scenario characterized by growing demand and diminishing supply is exactly the one a mining company would want. But while other major miners have taken a more insular approach, it has been left to De Beers to decipher how that supply-demand equilibrium will be rebalanced in the wake of the recession.

After halving production in 2009 to about 24 million carats, De Beers is aiming for its 2010 production to total about 60 percent of its 2008, pre-recession levels, which Penny has indicated the company will not attain again. In 2011, production will likely plateau at around 40 million carats, he said in another interview this year.

De Beers realizes that if it were to return to full capacity at its mines immediately or even in the long run, this decision, combined with its policy against stockpiling diamonds, would flood the market with rough diamonds it doesn’t have sufficient demand for. The result would be an oversupply of goods, a potential price crash and another crisis for the industry.

This necessity to hold back production is not required of the other major miners, which are steadily ramping back up to full capacity.

ALROSA, the number-two miner, has basically maintained full production throughout the recession, selling half its stock to the state-owned repository, Gokhran. The market continues to hope that Gokhran holds true to its promise to hold that stockpile until the market can efficiently absorb it; otherwise, we run the risk of incurring the same problems posed by a De Beers oversupply. The other two major diamond miners, Rio Tinto and BHP Billiton, have other assets to fall back on if their mines run dry and so they may not be considering long-term supply issues from the same perspective.

Whether or not De Beers has it right at the moment is a different debate in a climate where shortages of certain goods also prevail. But the fact remains that the size of its market share – 40 percent – and the decisions of its competitors have left De Beers alone to provide a realistic take when it comes to supplying rough diamonds to the market. As a result, others will continue to look to it for signals of where the market is moving.

Many will want to know whether De Beers is cautious or optimistic about the current market environment. To what extent does the company see demand for rough being spurred by consumer demand for polished? Can it justify the high prices in the market? Is the company factoring in speculative rough purchases? And perhaps most importantly, how does it see global economic trends playing out in the second half of 2010 and beyond and how this will impact consumer spending?

Certainly, De Beers would weigh reports that there are shortages of certain goods and a strong demand for rough, despite current price levels, as signs of market confidence. In addition, the company might take a favorable view of the fact that many diamantaires returned from JCK Las Vegas with renewed optimism about the U.S. market and went to this week’s Hong Kong show as confident as ever that the Far East market will provide strong returns.

However, De Beers would also account for the risk that high government debt in the euro-zone, the U.K. and the U.S. could still derail the recovery. Even this week, Fitch Ratings warned that China’s record loan growth and debt repackaging and selling by its banks has considerably raised credit risks and could lead to another financial crisis.

The permutations are endless and De Beers will no doubt consider all of these factors as it assesses prospective diamond consumption for its production and sales forecasts. According to Penny’s interview, the company appears to be taking a far more positive view of the market than before. Based on its current production, however, the company remains cautious.

So one would expect De Beers to remain “cautiously optimistic” as it says it has been in the past year and as the market’s inconsistencies dictate. Despite the appeal of a positive outlook, the industry should follow suit. In this sense, De Beers continues to be the diamond industry’s spokesperson, as well as a somewhat abnormal company in an abnormal industry.

Note: This article is an excerpt from a market report that is sent to RapNet members on a weekly basis. To subscribe, go to www.rapnet.com or contact your local Rapaport office. The writer can be contacted at avi@diamonds.net.

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©Copyright 2009 by Martin Rapaport. All rights reserved. Rapaport USA Inc., Suite 100 133 E. Warm Springs Rd., Las Vegas, Nevada, USA. +1.702.893.9400. This Rapaport Market Report 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: Avi Krawitz, Alrosa, Avi Krawitz, Banks, BHP Billiton, China, De Beers, Gareth Penny, Gokhran, Government, Hong Kong, India, JCK, Production, Rio Tinto
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