The international market

Notwithstanding tightening in the diamond market as a consequence of the current global economic downturn, the positive fundamentals of the market provide a compelling case for investment, with experts agreeing that demand is predicted to outpace supply.

In spite of the growth in exploration expenditure worldwide prior to recent cutbacks, there have been no major discoveries since the Ekati and Diavik mines in Canada in the early 1990s. Mine supply has reduced as existing reserves are depleted and the only two stockpiles of any consequence, Russia and De Beers, have been largely eroded.

Diamond supply

Structural constraints in the diamond mining industry, combined with a steadily declining mineral reserve base and a continued lack of major new discoveries, continue to hamper the prospects of further supply growth. Inventories of rough diamonds are at historically low levels, with the De Beers and Alrosa stockpiles now virtually eliminated. Even in the most optimistic supply scenario there is a sizeable market shortfall.

Finding economic kimberlites is difficult with less than 1% of all orebodies discovered being brought into production. There are only approximately 30 major diamond mines globally, and of the annual US$12 billion world diamond production, only 13 mines produced US$300 million or more each. In addition, the time taken from the discovery of a kimberlite to the start of production is usually in excess of seven years.

On the supply side, the only significant new mines coming into production recently or in the next five years are De Beers’ Snap Lake and Victor operations in Canada and the AK6 kimberlite in Botswana. Snap Lake and Victor will add some 2 million carats to world supply, while AK6’s production should be around 900,000 carats.

In a global supply of US$12 billion, this is not a great deal, particularly as Diavik, Ekati, Argyle, Venetia and some of De Beers’ older mines will be slowing. The chart below shows the steady decline in global diamond reserves:

In 2007 global diamond production fell 0.6% to US$12.1 billion. Total production by volume fell 4% to 168 million carats, whilst value per carat rose 5% to US$71.98 a carat for the year. The supply picture worsens this year, with diamond production predicted to decrease by 10% to 138 million carats in 2008. Going forward, production is expected to remain relatively flat, unless there are any new major discoveries, whereas demand will continue to rise.

In September 2008, a survey conducted by Rio Tinto (and reported by Rapaport) concluded that diamond professionals consider the shortage of rough supply as the most important challenge facing the diamond industry during the next five years.

Demand drivers

Industry commentators agree that, in the medium term, demand for diamonds is likely to continue increasing at a steady rate of around 3% per annum. The key drivers of demand are growth in GDP per capita, rising income levels globally and cultural adaptation. Diamond consumption is driven by the later stages of economic development and demand will benefit from the secular rise of the emerging economies. Increased globalisation will continue to drive overall GDP growth and urban household income growth in the world’s major cities.

Whilst the US remains the main driver of diamond demand, accounting for some 45% of total diamond consumption at present, the developing economies of China, India, Russia and the Middle East represent the key growth areas. Diamond jewellery sales in China and India have entered a period of accelerated growth fuelled by the rapid change and progress in these two markets. Brand investment by retailers and manufacturers in these markets is strong and there is a cultural preference to display wealth and invest in jewellery.

Research and Markets Group, having reported total Chinese jewellery sales at US$26 billion in 2007 (up 12.5% on 2006), has identified jewellery as the third largest consumer "hot spot" in China after real estate and cars. Given that China currently accounts for just 6% of global GDP and 4% of global consumer expenditure, but represents 22% of the world’s population, the growth opportunity is evident as the region is aggressively targeted by luxury goods retailers.

Diamond consumption per capita in emerging regions is currently far below the established regions of the US and Japan as illustrated in the chart below, and we can expect to see a corresponding uplift in demand for diamonds in line with rising disposable incomes. It is predicted that 550 million Chinese will enter the ‘middle classes’ in the next 10 years.

In spite of current poor economic conditions in the US, slow but steady growth is expected over the longer term, as diamond jewellery demand is expected to continue to grow in line with GDP. Growth will be mainly driven by the increasing number of households entering high income brackets, the continued expansion of discount retailers offering low-priced jewellery and an expected effort by manufacturers and retailers to provide new product options.

Whilst there are fears about a US recession hurting demand for diamonds in the short term, there is evidence that the rapidly rising demand in emerging markets is helping to make up for a US downturn. Harshad Mehta, Chairman of the retail arm of Rosy Blue, one of the world’s largest diamantaires, stated in May 2008: "Demand in the US will slow down by about 15% this year, but demand from elsewhere will offset the sales

Higher demand at the high end

The major beneficiaries of a forecast shortage of rough diamonds for the jewellery trade will be producers of better quality and large gems, the stones being truly rare and in very short supply.

Rapid growth of emerging economies such as China, India, Russia and the oil-rich Gulf states has multiplied the number of high net worth individuals (HNWs), many of whom are willing to pay ever higher prices for fabulous jewellery and rare gemstones. There are currently 9.5 million HNWs globally, a rise of 8% on the previous year.

The map above shows the number of individuals with over US$1 million in investable assets as of 2006, with their % growth over last year – Source: Merrill Lynch / Ledbury Research May 2008

The new wealthy

The number of ultra HNWs (those with more than US$30 million) may represent just 1% of the HNW population but their numbers are growing at a faster pace, having increased at a compound annual growth rate of some 13% over 2002-2006.

The number of ultra HNWs in China rose to 6,000 in 2008, overtaking the number in Japan (5,300) for the first time. Solid economic growth should ensure that the number of HNWs in the Asia-Pacific region continues to grow at a rate of 8% per year over next four years. By 2012 their wealth should reach US$13.9 trillion, up from US$9.5 trillion in 2007 (source: Cap Gemini Asia-Pacific Wealth Report 2008.)

To such ultra wealthy consumers, price is irrelevant and their demand for the small supply of top quality diamonds has meant that prices for such stones have shown solid growth over the last few years.

Therefore, it is not surprising that we are witnessing increased investor interest in diamonds, with one dealer likening the opportunity to buy a rare diamond to that of buying a rare work of art, with the price likely to appreciate significantly over time. To take advantage of this trend, a fund named Diamond Circle Capital, which was admitted to the London Stock Exchange in June 2008, became the first ever publicly-listed fund to invest directly in polished diamonds as the physical underlying asset, specifically targeting large, high-end stones.

Synthetic diamonds

It is now possible to create ‘man-made’ diamonds in laboratory conditions, but sophisticated detection procedures are in place which can identify them as such. Disclosure remains key and it is accepted that an industry priority should be to reduce the number of descriptors for man-made diamonds to enable consumers to make an informed decision.

Synthetic diamonds currently remain a very small proportion of total supply. Improved technology could lead to greater penetration and could impact the lower end of the market. However, cultural trends and consumer preference for natural diamonds are likely to protect the higher end of the market.

The natural diamond market is very well established, having been in place for hundreds of years, and despite cheaper alternatives being available, from cubic zirconia to Swarovski crystals, the market for natural diamonds has continued to grow. A natural diamond offers a unique, intrinsic emotional value and is the gift of choice for life’s most special and meaningful occasions, including engagements, births and anniversaries.

Conclusion

The argument for significant, sustained rough diamond price increases is largely supply driven. However, the demand picture, and in particular the ability of diamonds to maintain and enhance their appeal over long periods of history, and to broaden their socio-economic and geographical attraction, is also of great importance.

Sources: BHP Billiton, Bloomberg, BMO Capital Markets, Cap Gemini, Cazenove, De Beers, Economist Intelligence Unit, IDEX, Kimberley Process Certification Scheme, Ledbury Research, Merrill Lynch, Polished Prices, Rapaport, RBC Capital Markets, Research and Markets, Rio Tinto Diamonds, WWW International Diamond Consultants