Media coverage

• 2010
• 2009
• 2008
• 2007

Diamond industry back in fashion - love the investment

10 June 2010

Source: Financial Mail

Author: Charlotte Mathews

Glamorous supermodel Naomi Campbell, notorious for angry outbursts, punched a television cameraman in April when asked if she had accepted a blood diamond as a gift from former Liberian dictator Charles Taylor.

Diamonds have always attracted controversy – from under-the-counter dealings that were rife in the Northern Cape for decades to De Beers’ “monopoly activity” to the way the gemstones financed conflict in Sierra Leone in the late 1990s, as portrayed in the movie Blood Diamond.

On top of that, the recession took the shine out of the diamond sector. Consumers in Western countries cut back on diamond purchases , so that global sales fell 5%-10%.

But the problem was magnified down the “diamond pipeline”. From producers to dealers, cutters, polishers, wholesalers and retailers, the “pipeline” was largely financed by bank debt, which dried up in the financial crisis. Many smaller and even some bigger businesses along the chain collapsed.

In SA, De Beers, the biggest producer (about 40% by value of the world’s diamonds), led the way, suspending about 90% of its global production in the first quarter of last year and cutting 4650 jobs permanently – more than a fifth of the worldwide workforce.

Still, even through the lacklustre times and despite the taint of bloody conflict , the stones never lost their popular appeal. After 63 years of De Beers’ marketing “A Diamond is Forever”, they are so firmly embedded in Western bridal culture that even Chinese fiancées are starting to insist on diamond rings.

Diamonds are definitely a good buy or investment now – if you can get them. “Diamonds are rare, and getting rarer,” says De Beers CEO Gareth Penny. “A good-quality diamond is irreplaceable.” Spoken like a true salesman.

Though De Beers’ dominant position is often criticised, the industry benefited from its decisive action in the crisis. “We have to thank De Beers and other big producers for cutting back,” says Rockwell Diamonds CEO John Bristow. “The smaller players are seeing the benefit.”

Some jobs will be recovered as mining operations are resumed, though the companies that have survived are now leaner and more profitable.

Since the last quarter of last year, confidence has returned to the diamond pipeline. Marginal operations have closed, rough diamond prices have started to rise and debt levels have begun to fall.

“Our board felt that though it was a difficult period, we should not drop marketing spending,” Penny says.

“It [the campaigns] definitely works – hundreds of thousands of pieces are sold. Marketing is a very important part of our business model and we were supported by our shareholders and the industry.”

Mohseen Moosa, CEO of Sandton- based diamond jewellery manufacturers and retailers African Romance, says European buyers, especially the British, are aware of conflict diamonds, but there are rarely any enquiries about conflict diamonds from American or Asian buyers. South Africans understand locally produced diamonds are not in the same category as Sierra Leone’s.

The growing market of black consumers purchases diamonds for marriage rather than engagements, says Adrienne Kleinman, MD of Foschini Jewellery, which owns SA’s dominant mass-middle- market chains, American Swiss and Sterns. “What we’re seeing in the local market is that people will buy a smaller diamond engagement ring and want something fabulous to get married with,” she notes. “Customers place a lot of value on what a diamond means. It means that you have spent a lot of money on the person you love.”

Penny says De Beers has had a sterling first five months of the year and rough diamond prices are back to mid-2008 levels, though not at the peaks just before Lehman Brothers collapsed. Volumes have not recovered to those levels either.

But forecasts show strong future demand from China and India will put the sparkle back into the sector even though the European debt crisis could spoil the party to some extent. Trans Hex CEO Llewellyn Delport says clients confirm that demand from the East is strong and that the US market is recovering .

Exceptional diamond prices at Christie’s and Sotheby’s Geneva auctions last month have exceeded expectations. Christie’s sold a flawless white diamond weighing 40,21 carats to an anonymous buyer for US$5,14m. The value of the rectangular-cut stone had been estimated at $4,5-$5,5m. The highlight of the Sotheby’s auction was a cushion-shaped, 7,64ct fancy intense blue diamond ring that fetched $8m , with at least three bidders competing.

James Allan of corporate advisers Allan Hochreiter says the diamond industry is healthier now than in the past 18 months. “Debt levels in the cutting centres have come down by about $4bn in the past year. De Beers cut production to about 10% of capacity in the first quarter of last year and with lesser cuts by other producers, the supply of diamonds to the cutting centres dropped by 36% for the year. At the same time there was only a 2%-3% decline in retail demand.”

Industry spokesmen say rough prices are unlikely to fall in the next few months and the European debt crisis should not create any immediate problems, though developments have to be watched carefully.

But there are other fears stirring. The recent surge in prices has raised concerns that speculative activity could be creating a short-term bubble. At the height of the recession the bottom dropped out of the middle market though the low end and top end continued to move.

“We are seeing some recovery, with the bridal market leading the charge. What has happened now is that rough diamond prices have shot through the roof, to pre-recession levels or even higher, because of speculators, but retail prices have not moved to the same extent,” says African Romance’s Moosa. “Either retail prices are going to have to move higher or those speculators will lose.”

Rockwell Diamonds marketing director Jeffrey Brenner agrees there is some speculation as rough diamond prices are rising faster than polished prices, so some buyers are passing on parcels of stones at a slight premium.

In the longer term, the diamond industry expects that the supply of diamonds will continue to fall well short of demand as fewer new major diamond mines are discovered.

De Beers expects to produce about 31m carats this year, well short of the 48m carats produced in 2007, and, having disposed of a number of assets, it is unlikely to return to 2007’s production levels.

Namakwa Diamonds CEO Nico Kruger says total global supply is unlikely to return to the 160m carats of 2008 because big spending is needed to extend the lives of the most significant mines, and funds are scarce.

Penny agrees it is a reality that the supply of diamonds will be limited in future. Most big diamond mines currently have a 10- to 15-year life. At the same time, new diamond-buying consumers are emerging in the Bric (Brazil, Russia, India and China) economies.

These countries’ markets are growing faster than the US. De Beers forecasts that by 2016 Asia – including Hong Kong, Taiwan, China and India – will be the same size as the US market for diamonds.

That means positive real price growth, particularly for diamonds of 0,5ct and upwards, and even faster growth for the bigger gems.

Allan confirms that in the longer term supply will be constrained. “De Beers has said it cannot extend the open pit lives of its three big mines – Orapa, Jwaneng and Venetia – beyond 2023 and maintain production at 2008 levels, and three of the Russian mines have had to go underground.

“My outlook is that with declining supply of rough diamonds over the next 10 years, and even if there were no growth in the retail market for diamond jewellery, at some point the price of rough diamonds will go through the roof.” Add growth from China and India, and prices have to go up, says Allan.

Beyond the current market turmoil, De Beers is calling this “the diamond decade” because it anticipates very strong growth. But with markets as uncertain as these, investors must look for the lowest-risk opportunities  and hold them for the long term.

Jewellery lovers can stock up because diamonds may be forever but the supply can’t last.