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Excess Diamond Inventory

Editorial

Aug 8, 2014 2:01 AM   By Avi Krawitz
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RAPAPORT... By many accounts, there is a large volume of polished diamonds stuck in the middle of the pipeline. The dichotomy appears to be that the most profitable mining and retail sectors are keeping low inventory levels while diamonds are being absorbed by the manufacturers who garner the tightest profit margins.

True enough, diamond manufacturers’ inventory levels are typically high at this time of year. However, there is some indication that levels are continuing to rise at a time when polished markets are weak, placing additional short-term pressure on diamond prices.

There are a number of factors influencing current inventory levels.

On the demand side, there is a seasonal weakness in the global market as the second and third quarters are typically slow periods for the trade. With no major festivals taking place to stimulate retail demand, diamond dealers and wholesalers in New York, Antwerp and Ramat Gan take their vacations in July and August, thus reducing trading levels.

Indeed, trading was sluggish in July and polished prices softened. The RapNet Diamond Index (RAPI™) for 1-carat lab-graded polished diamonds fell 1.4 percent in the second quarter and a further 2.4 percent in July. The downtrend wasn’t limited to 1-carat diamonds with even RAPI for 0.30-carat diamonds, which has been strong for the past two years, declining during the period. Only RAPI for 0.50-carat diamonds has maintained a stable-to-positive trend since April (see the recently published Rapaport Monthly Report – August 2014).

As outlined in the report, the majority of buyers are looking to fill existing orders in their diamond purchases rather than to build inventory. That has left polished suppliers with a large inventory of their own.

In addition, there remains a large backlog of goods being graded by the Gemological Institute of America (GIA), particularly for diamonds below 1-carat, which may explain the reports of shortages for select categories in the market. However, in general, the large amount of goods stuck at the GIA adds weight to the belief that there is an excess of goods in the pipeline.

Some are questioning what will happen when the GIA improves its turnaround time and those goods are released into the market. Recently, the GIA has focused on churning out 1-carat and larger diamonds, resulting in more of these goods filtering to the market, which has seemingly coincided with prices softening. Perhaps the same will occur when the turnover of goods under 1-carat is increased.

Still, while manufacturers wait for goods to return from the GIA, they have hardly refrained from adding to their production lines. In fact, rough buying remained as robust as ever between April and July, and rough prices rose, in stark contrast to the cautious polished market. Rough imports to India, Belgium and Israel all grew in the second quarter. Simultaneously, De Beers and ALROSA sales increased year on year in the first half of 2014 by selling more goods at higher average prices.

The mining companies appear to be anticipating continued steady rough demand. De Beers second quarter production – rough which is now being sold to the market – rose 12 percent and the company raised its production forecast for the full year. ALROSA’s production fell in the first half of the year but the Russia-based company sold off excess inventory to make up for the shortfall. ALROSA has also maintained its outlook for the year, meaning that it is expected to ramp up production in the second half.

Rapaport estimates that overall global production in 2014 will be about in line with 2013, if not slightly higher, as the two majors maintain steady production growth. In other words, it is anticipated that a steady flow of rough will be made available in the coming months. At least in August, the De Beers sight is expected to be relatively large, as it was in July. Sightholders planning their purchases for the year generally request more goods during July-August as it is presumably their last chance to procure rough in order to have sufficient polished supply ready for the fourth-quarter holiday season.

True enough, polished inventories have risen in sync with expectations for the fourth quarter holiday season, even as manufacturers struggle through the summer months. The trade is pinning its hopes on the holiday season which includes India’s Diwali holiday in October, the Christmas shopping season in November/December and finally the Chinese New Year, which begins on February 19. There is every reason to expect decent diamond jewelry sales during these periods.

However, will holiday preparation sales be enough to lift manufacturers’ profit margins and deplete current inventory levels?

For now, polished trading is expected to remain weak at least until the Hong Kong Jewellery and Gem Fair in mid-September. Understandably, a lot of inventory is forecast to be available at the show, which promises to be a pre-season barometer of global demand. From then, trading is expected to improve as retail jewelers prepare their inventory for the season.

The hope is that retailers will assume the current inventory held by manufacturers, which will ultimately be bought by consumers. The greater hope is that holiday demand will influence a rise in polished prices that will restore some of the profit margin lacking in the manufacturing sector. That begs the question if polished prices will rise sufficiently enough between now and the end of the year to justify current rough prices.

Surprisingly, and it’s worth noting, polished prices have remained stable – and actually softened in many categories – during the fourth quarter of the past two years, according to the RAPI index. Rather, prices tend to strengthen more sharply in the first quarter when jewelers replenish the inventory they sold during the holiday season.

Along with stronger polished trading, the first quarter is also the period in which manufacturers are able to garner better profit margins as the polished goods they sell are prepared from rough bought at the more affordable prices that took effect in the fourth quarter. At least that was the case last year, and there is every indication that the same should happen again this year.

Rough demand will surely decline in September. By then, manufacturing for the holiday season will be in full swing and Indian factory workers will already have an eye on their month-long Diwali vacations. With excess polished presumed to be in the pipeline, rough demand should theoretically drop and prices should soften. Manufacturers simply have enough goods to last them through the year.

Garnering more sustainable profit margins largely depends on how the manufacturing sector will manage its inventory. Frankly, their rough buying in the past few months at reportedly high prices has been surprising in the context of the polished market and the GIA backlog.

Regardless of their holiday optimism it appears as if there is sufficient supply of most categories in the pipeline to fill anticipated demand. As a means to improve their margins, one would expect manufacturers to manage leaner inventories, in the same way that their mining suppliers and retail clients do. The concern is that excess supply will diminish the potential rise in polished prices. That would place added pressure on margins in an already cautious market at its busiest time.

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 © 2014 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, Rapaport
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