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Adjusting to China’s New Normal

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Jan 14, 2016 7:15 AM   By Avi Krawitz
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The diamond industry has a lot riding on the Chinese New Year season and recent events in Shanghai have done little to inspire confidence. As stocks plummeted and the Renminbi depreciated against the dollar, fresh concerns rose about China’s growth prospects, its impact on the global economy and on the diamond and jewelry trade.

The Shanghai Stock Exchange (SSE) Composite Index plunged 11 percent in the first week of 2016 and then another 7 percent over three days to January 13. The sell-off caused shock-waves in other markets with the Dow Jones Industrial Average losing 6 percent in the first week and oil prices slipping to $30 a barrel.

The slump followed reports China’s manufacturing output slowed in December, signaling a slackening global demand for Chinese products. Shares also dived as the central government guided the Renminbi more than 1 percent lower to help exporters and discourage locals from buying U.S. dollars.

“I suspect retailers are not entirely sure about how the Chinese New Year will be because the currency devaluation and stock market uncertainty is just another curve-ball being thrown at them,” said Ken Grant, a director at FDKG, a Shanghai-based luxury sector researcher and consultancy. “It’s just very difficult to predict things in China, especially under these conditions.”

As economic growth in China is expected to have slowed to below 7 percent in 2015, the central government has been campaigning its citizens get used to the “new normal,” Grant explained. He noted consumers were slowly getting their arms around that idea and gaining confidence to spend, which might bode well for the season. The one caveat, he cautioned, is their confidence may have been shaken by the sell-off.

Slight Improvement but Gloomy Mood

The declines have exacerbated concerns the diamond industry harbored throughout 2015 - the Chinese economy is in a clear downward swing. Anshul Mehta, a manager at Mumbai-based diamond manufacturer Rosy Blue, pointed out some improvement in Chinese demand ahead of the season but stressed jewelry retailers have only placed sporadic orders in the past year. Chinese demand has been order-specific and inventory purchases are very limited, he cautioned.

Chinese jewelers overbought in 2014 and the inventory they are holding is sufficient for the Chinese New Year season – or so-called Spring Festival – which begins on February 8, Mehta explained. Besides, orders for the season were made by mid-December as the jewelers would need most of the diamonds beforehand to have the jewelry ready for sale in February, he explained.

“I just don’t see a hunger for diamonds from Chinese retailers,” Mehta added. “Certainly, not the way we saw in the past.”

Diamond buyers are very cautious as retailers have an overhang of inventory, while consumer demand for jewelry has also slowed, Ephraim Zion, the managing director of Hong Kong-based Dehres Ltd, which specializes in large precious stones and fancy shapes and color, said.

Chow Tai Fook, the region’s largest jewelry retailer, last week reported group sales dropped 11 percent year-on-year in the third fiscal quarter that ended December 31. Sales in Hong Kong and Macau dropped 20 percent, while revenues from Mainland China declined 6 percent. Luk Fook Holdings, a top five jeweler, reported even steeper declines during the same period.

With earlier financial reports also showing weaker results at major jewelers, Zion is keeping expectations low for the season, especially in light of the stock market crash. Global economic trends are also not helping, considering the plunge in oil prices and the decline in other commodities and currencies, he added. “All these developments don’t bode well for Hong Kong or China,” Zion said. “The mood is very gloomy, people are depressed and unfortunately it has a direct effect on us.”

Waiting for Consumers

Given that caution, manufacturers are still hesitant to increase polished diamond production as they’re unsure how much new stock retailers will require after the season. To cope with over-supply that was evident toward the end of 2014, they’ve kept output at about 30 to 50 percent below capacity for more than a year, which resulted in shortages among select categories of diamonds evident today.

While polished prices firmed in the fourth quarter of 2015, Mehta explained the increase was influenced by restricted supply rather than a rise in demand. He expects the same dynamics to remain in force in the first half. A stronger Chinese New Year season might create some momentum, and traders are waiting to see how the consumer landscape develops over the next few weeks.

While most have watered down expectations, Grant projects if the stock market stabilizes in China, consumers will regain some of the confidence lost this past week. Besides, he noted, a lot of the spending during the Spring Festival is done with gifted money – known as hongbao – which is a red envelope filled with cash given to loved ones. Consumers might have a sense they’re not spending their own savings and splurge, he suggested.

But, if the stock market continues to fall, Grant acknowledged the amount of money given as a gift might be lower because of the wealth effect of stock markets on consumer behavior. That may be particularly true as it is the older generation that is predominantly the gift-giver and they are the ones who are more likely to have a higher level of exposure to Chinese shares.

Expect Some Spending

That said, Grant forecast the season will be roughly in line with last year’s holiday period – which was a disappointing one for the jewelry sector. Grant estimates retailers touch about 20 percent of their annual turnover in the festival period, with jewelry sales largely driven by life events since the New Year is a period when families typically get together. “It’s a good time to announce an engagement or have a wedding,” Grant said.

Spending in Mainland China might also get a boost from a weaker currency as it encourages consumers to hold Renminbi rather than dollars and buy locally instead of making luxury purchases overseas.

There has already been a shift in Chinese tourism-shopping patterns as Grant notes consumers are choosing shorter-distance destinations such as Japan and South Korea over Europe or the U.S. for their luxury-shopping expeditions. Zion added that Hong Kong, which saw a boom in Chinese tourist shoppers in the past decade, has lost its appeal and that has dramatically impacted the retail environment and sentiment in the city.

However, as Grant points out, Chinese consumers might just feel that it’s easier and cheaper to shop at home this year. Whereas shopping was previously the primary purpose of their travel, more Chinese tourists are now traveling for the experience. They’re swapping the mall for the museum, he suggested.

Chinese consumers, like their American counterparts, are also making more purchases online than they did in the past and Grant expects a spike in online traffic this season, following the success of the November 11/11 Single’s Day campaign. The introduction of payment platforms such as Alipay and on WeChat, the Chinese equivalent to WhatsApp, has also made it easier to buy online.

Demand-Driven Goals

Those trends may be among the short-term benefits of the government’s reforms as the Chinese economy slowly and painfully transitions from being export-driven to one that is focused on domestic consumption.

Through that transition, Grant says brands can still expect the number of individuals buying luxury items to grow in China, but the average price point is likely to drop. That may be especially true for diamond jewelry, as the engagement ring and diamond buying culture is still developing in the country.

To capitalize on that trend, Zion stressed the need to boost demand through educational and advertising campaigns and is encouraged by the De Beers generic marketing program introduced in China ahead of this Spring Festival. He expects the company, along with the Diamond Producers Association, will take its advertising spend to a higher level in the coming year.

That might help Chinese jewelry retailers reduce their inventory and return to the market for replenishments. In doing so, it would also help the diamond industry transition from being a supply-driven market that is supported by shortages to a demand-driven one. At least in the short-term, the trade is hoping the Spring Festival will give that effort a boost.

“It all depends on the Chinese New Year,” Mehta said. “If the season goes well, prices will shoot up because there will be further shortages and confidence will rise to increase supply and fill new demand. If it doesn’t, it might affect stability in the market.”

In this coming ‘Year of the Monkey,’ the diamond industry is hoping China will inject some normalcy in the trade, just as the country is adjusting to a new – somewhat volatile – normal of its own.
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Tags: Avi Krawitz, China, Chinese New Year, Chow Tai Fook, De Beers, diamonds, Hong Kong, jewellery, Jewelry, Luk Fook, Rapaport, Spring Festival
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