Juggling With Rough Diamond Prices

The issue of diamond prices is always delicate. While the manufacturers tend to increase the cost for rough stones annually, the customers are seeking for more cost-effective offer. There should be a kind of balance found between the two, though there is hardly a chance both sides will be fully satisfied. Yet here is the tendency for rough diamond prices raising below and the way to find a compromise by various diamond mining companies:

Philippe Mellier this week threw down the gauntlet to the diamond industry, and sightholders in particular. The De Beers CEO told Bloomberg News that the company plans to raise rough diamond prices by 5 percent every year as it aims to meet parent company Anglo American’s targets.

Anglo wants its diamond division to increase its “return on capital employed” from the 11 percent reported in 2013 to 15 percent by 2016. In other words, Anglo expects a more efficient use of capital from De Beers. With relatively fixed mining costs to contend with, Mellier and his team can most effectively improve profitability by driving up sales. Furthermore, as the firm anticipates production to remain stable at around 32 million carats in the near future, sales growth is expected to be fueled by steady and consistent price increases rather than by raising the volume of supply.

“We know the long-term trend; we know demand is going to be bigger than supply,” Mellier said. “One of our objectives is more stable prices and to drive volatility out.”

That said, Mellier’s 5 percent goal may be slightly aggressive, even if it will sometimes be attainable. ALROSA executives are working with a stated 3 percent annual rough price increase in their projections.

De Beers set the bar in 2013, reporting that its rough prices rose 5 percent during the year. Mellier told Bloomberg that the company has already raised its prices by 5 percent in 2014, adding that further increases are unlikely this year.

That will be music to the ears of manufacturers, who have endured – and are partly to blame for – the steep rough price hikes implemented in the past four months. In fact, Mellier may be understating the extent to which rough has risen in 2014. Rapaport estimates that rough prices have increased by between 7 percent and 10 percent since January, which may give De Beers some leeway to reduce prices if necessary at upcoming sights and still achieve the company’s 5 percent target for the year.

Certainly, Rapaport expects the rough market to cool in the second quarter and there are already signs that demand has softened. Initial reports from this week’s De Beers sight (May 5 to 9) suggested that the sale was smaller than the first three sights of the year, and prices were basically stable – if not slightly lower for select goods. Trading on the secondary market has quieted since De Beers raised prices at the beginning of April and premiums have dropped.

There are a number of reasons why this column believes the rough market will remain cautious and that prices should decline by a few percentage points during the next five to six months.

Firstly, rough prices rose too high too fast in the first quarter of the year. Demand understandably increased after manufacturers refrained from buying rough in the fourth quarter of 2013. They subsequently, and aggressively, bought rough as they sought to fill orders for polished from jewelers who were replenishing inventory sold during the Christmas and Chinese New Year seasons. Now that has come to an end, but perhaps more modest increases over a longer period of time would have been more sustainable.

Then again, a cyclical nature has developed in the diamond industry calendar. A strong first quarter tends to be followed by a period of consolidation in the second and third quarters. The slowdown in April was therefore largely expected, with trading affected by various holidays in different markets. Currently, as many India-based manufacturers take vacations during the May school summer holiday, rough demand remains subdued.

Another reason the rough market is projected to be restrained is that polished demand has not warranted the rough price hikes that took effect. The polished market has undoubtedly improved in 2014 from last year, but demand remains selective. Certified polished prices, as measured by the RapNet Diamond Index (RAPI™), increased across the board in the first four months of the year, despite the declines observed in April (see Rapaport Monthly Report – May 2014). However, only the 0.30-carat to 0.50-carat goods have increased by more than 5 percent in 2014, meeting the same growth margin as average rough prices. RAPI for 1-carat diamonds rose 1.8 percent from January through April and yet is still down 3 percent from one year ago.

Manufacturers have long argued that a disconnect exists between rough and polished prices. As a result, they note that while polished sales have increased, their profitability has not. In addition, the banks which lend to the diamond industry have constricted their credit terms, including in India. Liquidity has tightened and manufacturers are consequently expected to reduce their rough buying.

Therefore, while a 5 percent annual rough price increase might help improve De Beers profitability and return on capital, it will not necessarily ensure manufacturing profits. Sightholders will ultimately refuse rough that is unjustifiably high.

Mellier’s comments assume that the trade, and market conditions, will allow De Beers to consistently hike prices to that extent. To do so, polished demand will need to grow by a higher margin.

Mellier told Bloomberg that De Beers predicts global diamond demand will grow by 4 percent to 4.5 percent in 2014, driven by high single-digit growth in the U.S. and “good momentum” in China. These, too, might be ambitious estimates as the diamond jewelry consumer landscape has not changed that much in 2014. Consumers are resisting higher diamond jewelry prices or they are adjusting to lower-quality goods that better fit their budgets. Similarly, as Far East markets mature, consumers there are opting for smaller and lower-price-point diamonds – which explains the strong rise in demand for 0.30-carat to 0.50-carat and SI-clarity diamonds in the past year or two.

De Beers certainly realizes that one category doesn’t make a market. It is questionable whether there is sufficient demand in other areas to justify an average annual rough price hike of 5 percent. It’s a challenge that De Beers clients will have to face as De Beers management aims to satisfy shareholder, rather than sightholder, needs.

For its part, De Beers will feel that tension as it tries to affect consistent price growth while operating in an ever volatile market. In such an environment, the company will more effectively boost revenue – and return on capital – from its other business units such as Forevermark, Element Six and its fledgling diamond grading segment, than from its core mining and rough sales operations. While diamond demand may be more significant than supply in the long term, the resulting rough price increases will be a mere illusion if profitability is not assured for the middle market diamond manufacturers and dealers.

This article was taken from http://www.diamonds.net/News/NewsItem.aspx?ArticleID=46876&ArticleTitle=Rough+Price+Illusions

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