The diamond industry is undergoing fundamental disruption as political, economic and social forces break the supply chain, reduce demand, and shift consumer attitudes. We are heading into a perfect storm with new realities, challenges, and opportunities. Much of the change is external, beyond our control, sudden and shocking. Other changes have been building for a long time and are now activated due to the Russian invasion and sanctions.
So much is happening at once that it is difficult to process the consequences. The situation is confusing and creating great uncertainty about the future. What will happen? What should you do?
Analysis
There are three primary forces impacting the diamond industry.
- Russian Invasion
- Economic Transformation
- Social Responsibility
It is useful to consider three perspectives: political, economic and social.
We should also consider how forces interact to intensify their impact. For example, the Russian invasion significantly increases inflation, as do Covid’s supply chain disruption and US excess money supply.
Russian invasion
The Russian invasion of Ukraine is a global game changer. We are witnessing the start of an economic world war pitting the US and EU (West) against Russia and probably China (East). Sanctions are forcing countries and companies to cease economic activity with each other. International banks are refusing transactions with Russia out of fear they may be sanctioned and excluded from the global dollar-denominated financial system. Money is being weaponized.
The era of East/West free trade is ending. Globalization is bifurcating as national security interests define economic friends and foes. Getting the best products at the best prices is no longer the first rule of business. Who you do business with is more important. Compliance dominates decision making. Politics is more important than prices.
The war and resultant sanctions are intensifying shortages. Supply chains already under pressure due to Covid are now further disrupted if not entirely closed. Critical commodities are under increasing pressure. Since the invasion, oil and wheat prices are up 21% and 26% respectively as of May 22, and US inflation is up 8.26% as of April.
A primary economic impact of the invasion is global inflation.
Sanctions will have a dramatic effect on the diamond trade. In 2021, Russia’s Alrosa produced 32.4 million carats of rough diamonds valued at $2.898 billion. That’s 25.5% of global carats and 23.97% of the value of total global rough production. India, the manufacturer of about 93% of the world’s diamonds, is trying to maintain a neutral position regarding the sanctions. But so far international banks are not willing to handle payments to Alrosa, nor are shipping and insurance companies willing to move the diamonds out of Russia to any destination. For now, there is no way to pay for or move Russian diamonds.
The powerful short-term effect of sanctions is mitigated by extensive polished inventory, India’s vacation season, and a slowdown in Chinese polished demand due to Covid. Indian manufacturers are also shifting production to synthetic man-made diamonds. Over the medium to long term, it is likely that payment and shipping solutions will be found, allowing the Russian goods to reenter the diamond markets.
A legal loophole in the regulations limits US sanctions to “Russian Origin” diamonds, which are rough diamonds mined or polished diamonds manufactured in Russia. If diamonds are cut outside of Russia from Russian rough, they are deemed to have been “substantially transformed” and therefore are no longer “Russian Origin” and not subject to sanctions. For example: If an Indian manufacturer buys US-sanctioned Russian rough diamonds and cuts them in India, such polished diamonds are not subject to any sanctions and can be legally imported into the US with no restrictions. We call these polished diamonds cut outside Russia “Russian Source” diamonds.
Another important factor is the role of China and the development of alternative non-dollar payment systems. China can purchase Russian rough that will then be cut in China or India. We expect Russian diamonds to find their way into the market and sell to buyers from China and other neutral countries not sanctioning Russia. Legally the US sanctions on Alrosa are ineffective due to the “Russian Origin” limitation.
The primary effect of the Russian sanctions will be the bifurcation of markets: separate markets for Russian diamonds and non-Russian diamonds. The issue of shortages will depend on the level of US/Western demand for “Russian Source” diamonds cut outside of Russia. If buyers don’t care and Russian rough diamonds become available through China or otherwise, then shortages will not be an issue.
On the other hand, if jewelry brands and other socially sensitive buyers demand “Ethical Diamonds” — which exclude Russian Source diamonds no matter where they are cut — then there will be shortages and higher prices for documented “Ethical Diamonds” from known legitimate sources outside of Russia. These diamonds may be in short supply and fetch higher prices.
Ethical challenge
The fact that the US has not closed the “Russian Origin” loophole is creating ethical challenges for the US diamond industry. Consumers are horrified by the images coming from Ukraine. They read about the sanctions on Russia’s state-owned Alrosa and they don’t want to buy Russian diamonds. Yet it’s perfectly legal to sell the “Russian Source” diamonds cut outside of Russia, even though the money from these diamonds goes to the Russian government and supports the war.
And so, the legal vs. ethical question arises. Should the diamond trade sell “Russian Source” diamonds that fund the war, or should the diamond trade take an ethical position and refuse to trade in “Russian Source” diamonds even though it is legal to do so? How ethical should our diamond industry be? Should we do more than what is legally required?
The ethical questions get more interesting when we consider the money factor. “Russian Source” legal diamonds will compete with higher-cost “Ethical Diamonds” that require supply chain monitoring. Since we cannot force everyone to be ethical, we will see separate markets and competition between legal and ethical diamonds.
A good way to think about this is that ethical diamonds are an added-value proposition. We can create value by creating a supply of ethical diamonds based on honest standards and capture that value by marketing them as better diamonds for higher prices. The value of a diamond is not limited by its 4Cs. A diamond is worth more if it has a transparent, ethical supply chain. The challenge for the diamond trade is to add value to diamonds, not just find ways to sell them at cheaper prices.
Please review “What Should We Do About Blood Diamonds” article and bibliography at sr.rapaport.com/State-of-the-Diamond-Industry-Bibliography.
Article from the Rapaport Magazine – June 2022. To subscribe click here.
