Media coverage

• 2010
• 2009
• 2008
• 2007

Diamonds' appeal shines brightly for investors

09 April 2010

Source: Interactive Investor

Author: Fiona Bond

Diamonds may well be a girl's best friend, but with rising prices, the gem's sparkling allure is proving just as enticing to investors.

Rough diamond prices have risen by 55-60% since their March 2009 lows, while supply has continued to remain constrained and is forecast to be around 7% below 2007 peak levels by 2012.

These figures have made diamond stocks an attractive bet for investors.

While diamond production spans the world, from Russia to Brazil and back to Africa, it is the latter that plays host to some of the world's largest diamond mines and accounts for as much as 50% of global production.

At present four large producers dominate; Rio Tinto (RIO), BHP Billiton (BLT), De Beers and Alrosa who between them account for 90% of all rough diamond production.

The majority of mining activities are centred around the southern regions of the African continent with Angola and Lesotho, South Africa and Botswana all proving popular. However, it is the latter two, nestled in the most southern regions, which really get pulses racing.

Two years ago, Botswana's new leader President Ian Khama declared he would continue to develop the country's diamond industry as a key driver of its economic growth.

He has so far been true to his word: Botswana currently produces almost a quarter of the world's output per annum.

The production of diamonds contributes up to 36% of GDP, 75% of merchandise exports and 45% of government revenue, according to the latest figures from the Botswana Mining Report.

Botswana is also hailed as the world's top spot to explore for kimberlite. Little wonder that Debswana, the joint venture company between bespoke jeweller De Beers and the Botswana government, has snapped up Orapa, the world's largest kimberlite mine.

The Orapa field has an economic ratio of more than 10%, which is significantly higher than the global average of 1% and produces approximately $1 billion in revenue per year, making it one of the richest diamond mines in the world.

However, the smaller miners are also in on the action. AIM-listed Firestone Diamonds (FDI) holds the largest amount of land in the Orapa kimberlite field and in the second quarter will unleash the fourth diamond mine in the cluster, the BK11 kimberlite.

The economics are attractive, with revenue of $16 per tonne forecast at operating costs of a much lower $6.50 per tonne.

Charles Kernot, analyst at Evo Securities, commented: "The earlier than originally anticipated pre-strip of low grade kimberlite will allow Firestone to access higher grade and higher value per carat material earlier rather than later."

In the past year alone, Firestone Diamonds' shares have risen 54% and just recently the AIM-listed company said it was putting the finishing touches to its debut on the Botswana Stock Exchange, which it hopes will attract a new set of investors.

The allure of Botswana lies namely in its attractively low operating costs. Mining and processing costs are estimated to be in the region of $10-15 per tonne, which contrasts favourably to $45-50 per tonne in Angola and the Democratic Republic of the Congo and $85-110 per tonne in Canada's Northwest Territories, according to RBC Capital Markets.

African-focused Petra Diamonds (PDL) is also shining brightly. The majority of its core operations lie in South Africa. Currently ranked number three in the world for diamond production, South Africa produced 12.9 million carats in 2008, worth some $1.2 billion.

In the past year alone, Petra's shares have shot up over 140%, buoyed significantly by the record-breaking $35.3 million sale of its world-class 507 Cullinan Heritage diamond.

While the likelihood of recovering a stone of similar significance over the next decade is low, analyst Tyler Broda of Canaccord Adams believes the historical regularity of large diamond recovery is an important note to make.

"We are increasing our target price to 125p after factoring in the benefit from the Cullinan Heritage, the recent weakness in the British pound, a slight upgrade to our near-term diamond prices, commentary surrounding the January tender continues to point to positive momentum in the rough diamond market. We expect the risk to diamond prices to remain to the upside in what has been a very strong rough diamond price environment," Broda said.

Panmure Gordon has also hailed Petra Diamonds as its preferred sector play, believing it to offer stronger growth prospects and better-long term value.

While the discovery of world-class diamonds is undoubtedly a key factor in the company's value, it is the attractive supply and demand dynamics of the African diamond mining industry which are proving the real driving force behind companies' appeal.

Mines in place are growing older and will need to go underground in order to extend their lifespan. Botswana's Jwaneng mine, the richest diamond mine in the world, is currently an open pit mine, producing on average between 12.5-15 million carats per year, but will be transformed into an underground operation in 10 years to extend its life by a further 10-15 years.

RBC Capital Markets says finding deposits is a time-consuming exercise and a positive drill hole discovered now is unlikely to be transformed into a mine before 2015 at the very earliest. The greatest challenge now facing the market is the supply of rough diamonds as demand recovers and the availability of bank credit.

Marc Elliot, mining analyst at Fairfax, commented: "Rough diamond prices are nearly back to their previous highs, helped by the response of major producers slashing their supply drastically following the global crisis."

In 2009, Alrosa kept up production levels but did not sell, while Rio Tinto took a temporary break and De Beers slashed its output. While the sharp contraction is set rebound this year, levels are still far off their peaks.

"Rough diamond prices have increased strongly as a result of a shortage of supply. We expect a 10% increase in rough prices in 2010 relative to December 2009 levels and for prices to rise by a further 8% in 2011 and 2012 and thereafter 5% per annum," analyst Alison Turner of Panmure Gordon commented.

The upward forecast is based on jewellery demand, which will be driven by particular growth in China and India, as well as a gradual recovery in the US, coupled with muted supply.

In 2009, China is estimated to have accounted for 10% and India 8% of global diamond jewellery sales and both are on course to grow between 16-20% a year.

Future supply constraints are also arising from the fact that majority of money in the sector focuses on operations, rather than grassroots as new mines prove expensive business, RBC Capital Markets said. To put it into context, over 6,000 kimberlites/lamproites have been found with fewer than 1% proving economical.

While the AK6 mine in Botswana, partly owned by UK-listed African Diamonds (AFD), could be producing 0.5-1 million carats a year by late 2011 and the AIM-listed DiamondCorp (DCP)-operated Lace Mine in South Africa could produce 0.5 million carats per year by 2013, exploration funding remains scarce and production forecasts could prove difficult to achieve.

Tyler Broda, analyst at Canaccord, said: "We continue to believe that long-term positive supply/demand fundamentals are putting pressure on industry participants and that this is exacerbating the price moves in the near term and that the risk is still to the upside. Market commentary surrounding tenders in the past three months is also similarly positive."

For investors, it's difficult not to be optimistic.

Source: www.iii.co.uk/articles/articledisplay.jsp?section=Markets&article_id=10093801