Last year was an excellent year for us,” said the outgoing De Beers chairman Nicky Oppenheimer at a party with clients. “If you didn’t make money, then you are obviously in the wrong business,” he semi-quipped before a stunned audience.
Looking at the macroeconomics of the diamond pipeline from rough production to wholesale sales of polished, the trading and manufacturing sectors as a whole did not make money on their trading activity, though they earned on inventory appreciation.
Those who restocked rough in the first eight months of 2011 saw DTC rough selling prices rise by some 44 percent, only to witness a steep fall of some 16 percent in the last part of the year. The DTC clearly abandoned its time-honored policy of only raising prices to so-called “sustainable” levels. Looking at the composite price index for all qualities and sizes, we saw a doubling of rough prices in the past two years that again outpaced the increases in polished, only to end at lower levels.
A Good Year?
If we take an average 15-20 percent in inventory appreciation over the year (including polished), the industry made $2-$3 billion overall, although this would be because of higher prices – and through no efforts of the players themselves. The euphoria expressed by Nicky Oppenheimer was, in a sense, not “out of place,” but it was a “good year” for the wrong reasons. Also, a large part of the (potential) paper earnings remain in inventory until they materialize, thus, actually, representing “future music.” So, last year was excellent if you were a rough producer or a jewelry retailer. That is where the real profits were, and, of course, these are the core businesses that the Oppenheimer family has now sold to Anglo-American.
Looking at the Pipeline
As it takes about a year and a half for a diamond to move through the value chain from rough acquisition to polished sales (at polished wholesale prices), the price volatility has made it far more challenging to present an accurate picture for the year that was. Even producer countries vary in their reporting methodologies of mining output values.
Just look at the volatility in the reported average values of world (run of mine) output, which totaled about $95 per carat in 2008, plunging to $72 per carat in 2009, recovering to $98 per carat in 2010, and then climbing to $121 per carat in 2011. This shows an enormous (and unsustainable) jump. For 2012, we expect the average world output to decline to $108 per carat, also because of the expected stepped-up production from the (cheap goods) Argyle mine and growing Marange output.
Last year, natural diamond production came to some 125-130 million carats valued at $15.2 billion. This output moved through the pipeline resulting in $22.6 billion worth of polished. The overhang in the 2011 pipeline is an estimated $1.3 billion of rough and polished expressed in polished wholesale prices at year-end. It is this overhang that will also impact the rough demand for 2012.
Worldwide diamond jewelry retail sales came to $70.8 billion. The market share of America in diamond consumption was reduced to 38 percent. The other major traditional market, Japan, declined further to merely an 8 percent share. In a neck-to-neck race to be the second-largest diamond-consuming nation is India, with 12 percent market share, followed by China (the mainland) with 11 percent. Hong Kong accounts for 2 percent.
The Recycling Factor
The value of the diamond content in retail sales in 2011 came to $23.6 billion. The vast majority of this amount ($22.6 billion) comes, of course, from either recently mined rough or inventories. The new reality is, however, that some of the polished comes from recycled diamonds – diamonds that consumers have held on to for many years or even for generations but now feel the need to sell in order to pay mortgages, medical care, education or even to supplement pensions or to pay debts.
We want to be very careful here – this is definitely not a new phenomenon. Anyone who has followed the trade of pawnshops or is familiar with high street family-owned jewelry businesses knows there has always been an element of selling off “old” estate jewelry. Many New York diamond manufacturers have built quite a reputation for their “re-cutting skills,” turning old shapes into more fashionable goods. However, since the advent of the last economic crisis, the volumes of diamonds held by consumers coming back into the pipeline have skyrocketed. Literally hundreds of diamond businesses have developed special niche expertise in this area. Those recycled diamonds are mostly sent to India or other cutting centers for re-cutting.
A large part of the recycling supply side takes place in invisible parallel markets, thereby defying effective monitoring. It’s easier to measure gold recycling, as there, the jewelry needs to be refined through a limited number of known refineries. When, in early 2009, jewelry scrap fabrication exceeded new mining supplies, one got a further indication of the intensity of this movement of goods back into the pipeline.
We have estimated that recycled diamonds sold again to the jewelry sector came to about $1 billion in 2011, which represents 4.4 percent of all polished diamonds sold at polished wholesale prices. This is quite significant, and it has definitely become a supply factor requiring serious thought by pipeline participants, especially producers, when estimating supply-and-demand trends. They do tend to soften polished retail prices, as retailers’ huge profits on recycled goods allow them more breathing space in selling polished.
The “Global Household Mine”
Just as one is very conscious about the depleting diamond reserves of existing mines, it is worthwhile to take a look at what the so-called “Global Household Mine” has in stock. What are its potential reserves? Unfortunately, diamonds last forever… they don’t just disappear, nor are they being thrown away together with old furniture, books or other junk piling up in people’s attics. The supply of recycled diamonds is driven by various functions – not only by economic necessities but also by the high prices.
One tends to assume, or one likes to believe, that diamond possession is solely a very emotional phenomenon, but this is not universally true. In India, for example, diamonds and gold in the hands of consumers are often viewed as assets. In parts of the Arab world, this holds true as well. So what are the “Global Household Mine” reserves?
Since ancient days, diamond mines have produced some 5.2 billion carats, which, at 2011 rough production values ($121 per carat), would amount to some $625 billion worth of rough. The historically adjusted gem-quality polished output would be between 1.3-1.6 billion carats. (Traditionally, no more than 15-20 percent of output was considered cuttable; that changed in the 1960s with the emergence of the near-gems.) The worldwide average polished sale price (at polished wholesale prices) is $625 per carat. Therefore, the Global Household Mine probably holds $0.7-$1 trillion worth of polished diamonds at current prices. About 40-50 percent of these diamonds would be held in America. This is a staggering amount.
In 2011, a minimum of about $1 billion of recycled polished came back into the market – which, by value, represents 4.4 percent of polished retail demand. (It could be more but it won’t be less.) The really amazing, if not frightening, figure is the “stock withdrawal” of the “Global Household Mine:” the $1 billion figure represents merely 0.1 percent of stocks by value. Indeed, theoretically, the “Global Household Mine” could meet consumers’ requirements, at current levels, for about 35-45 years! As most women will not likely part from their diamonds that easily, it is certainly not an immediate concern. But it must be part of a proper pipeline analysis.
There is an additional “recycling” market in the making: investment diamonds. So far, a dozen or so new companies or structures purchase polished for investment purposes. These diamonds will come back in at some point, but now there are mostly buyers and not sellers.
A Closer Look at Retail Environment
Everything is relative. Although mining costs in absolute terms may not have increased so much since 2008, the higher price levels of the output have dramatically doubled, and in some instances, even tripled mining profits. This is quite evident in the evolution of profit sharing in the value chain (see 13-year chart.)
There are other pipeline parameters that have gradually changed over time, making them less valid for comparison. The total retail value of diamond jewelry pieces is one of these. An analysis of the diamond content in the final jewelry product shows that the ratio between diamond and other used materials/costs has changed. A decade or so ago, diamond content (at wholesale polished prices) would represent about 20 percent of the jewelry piece’s total retail price. In some countries, such as England for example, it was even less, more like 18 percent.
On the other extreme, there were markets, such as Indonesia, where diamond content might have been at an average 60 percent of the total diamond jewelry piece. This has to do with overheads, retail structure, taxes, etc. So, worldwide, diamond content might have been at averages of some 21 to 22 percent. This has gradually changed.
Our research indicates that, worldwide, the share of diamond content in jewelry pieces has increased to some 32 percent. There are many reasons for this. One factor is the shift of markets from the United States (the so-called “junk market”) to the far more value-conscious Far Eastern market. The higher gold price has also contributed to containing more diamonds and less gold in an industry that is at pains to meet certain price points. Also less expensive materials are increasingly being used in the final product.
So, our global diamond retail sales figure of $70.8 billion actually holds more diamonds (by value) than this figure would have contained a decade ago. (Or, to say it differently, taking the $23.6 billion of diamond content sold in 2011 (which we consider a hard figure), and if one would hypothetically assume only 22 percent wholesale diamond content in the final retail piece, worldwide diamond retail consumption would have been calculated at $100 billion.)
But this clearly isn’t the case; it is merely pointed out, as some analysts may also arrive at higher diamond jewelry retail values for a variety of reasons. This often has more to do with methodology and data collection than with anything else. Tacy Ltd. has done its pipeline for 23 consecutive years, and we believe our figures closely represent the reality. We recognize, however, that some researchers base figures on telephone surveys of consumers, on feedback from jewelers, on financial reports from large retailers, or statistics, etc. For the diamond industry, there is only one figure that really counts: how many diamonds were sold in 2011. That figure is $23.6 billion at polished wholesale prices.
The 2011 Pipeline in Perspective
In the pipeline, each and every diamond is only counted once, and every stone is basically cut and polished only in one principal location. Looking by value, we see now that close to 70 percent of all diamonds by value are manufactured in China and India, with some 13 percent in the southern African and Russian beneficiation countries. The role of Belgium, Israel and the United States as traditional cutting centers has gradually been diminished to close to insignificant figures. In terms of manpower, these latter countries’ cutting labor force can be measured in the hundreds rather than in the thousands. In terms of “number of stones,” we can certainly say that 14 out of 15 diamonds are cut and polished in India and China.
It is important to neutralize “double accounting,” which is difficult as every stone may move many times through multiple jurisdictions. If one looks at Belgium, for example, its 2011 polished exports are close to $15 billion, well over 30 percent higher than the previous year. But in terms of added value produced through manufacturing, there wasn’t more than $200 million, and only $1.1 billion (7.5 percent of total polished export value) can be attributed to domestic manufacturing. Like the Israelis and Americans, Belgians do most of their manufacturing in China, southern Africa, Asia and elsewhere. The 2011 pipeline likes to capture the added value generated between the various phases of activity.
The traditional conventional wisdom that trading centers also require domestic manufacturing has valid marketing purposes as it adds to the illusion that one can find “freshly cut and polished diamonds” in that market. That “wisdom” definitely belongs in the past.
In the Aftermath of the Crisis
In terms of numbers, global retail demand in 2011 increased by 10.3 percent compared to the previous year. However, it is still slightly below the 2007 pre-crisis level. In 2012, our models, developed jointly with my colleague Pranay Narvekar of Mumbai-based Pharos Beam Consulting, show that global retail demand is set to increase by 8.3 percent. This definitely takes us well above the pre-crisis levels. The total polished wholesale demand in 2011 of $23.6 billion is about 19.4 percent above the previous year. That sounds like a lot, but given the price movements it doesn’t point to an increase in volume terms. One of the reasons for the year to have been challenging is that in 2010, polished demand from the cutting centers was 38 percent above the previous year. So, the growth sentiment in 2011 was only half of that experienced in 2010. This is not the time to discuss the ripple effect, which clearly validates those figures.
On the rough demand side, 2011 saw a 35.2 percent increase over the previous year. This trend will not continue, and our models suggest that rough demand will actually decline slightly in 2012. The same counts for the cutting centers. Though in 2011 we saw a growth of polished demand of 19.4 percent, this will slow down to 6.2 percent in 2012. So, while 2011 was quite a trying year for the downstream industry in which profits mostly came from higher diamond values, 2012, if anything, will be more difficult.
There is also concern about the producers’ pricing of rough. There is strengthened fixation on their bottom lines, which triggers considerable rough price volatility. As mentioned earlier, the historical commitment to sustainable rough prices is something of the past. BHP Billiton pioneered the linkage of its long-term contract prices to the behavior of spot-market auctions. It seems that De Beers is following in their footsteps and that the prices secured by the Diamdel auctions may well guide the pricing of DTC sight boxes under the new three-year contract. Expect in 2012 continued volatility of 5-10 percent in both directions – with the overall price levels going sideways.
The cutting and trading centers may be in for quite a squeeze in 2012. Earnings need to come from activity rather than from stock value appreciation. Actually, such a squeeze shouldn’t bother the downstream players too much – they have grown used to it.
