Friday, August 26, 2011

Rough Markets - Cash Strapped

RAPAPORT... Diamond cutters, mainly in India, are facing tough times. Simply put, they no longer have the cash to support the high rough diamond prices that have defined the market for so long. Even after the successes of the first half of 2011 - among the most profitable periods the diamond industry has experienced in years - their lack of liquidity has become a debilitating factor in the market today.

It was therefore inevitable that their current limitations to buy rough, coupled with stark warnings about prospects for the developed economies of Europe and the U.S., would filter down to the rest of the industry. Diamond cutters and dealers, the majority of whom are based in India, have lost the confidence and edge they carried in the first seven months of the year. This should sound as a warning bell.

Reports from this week’s Diamond Trading Company (DTC) sight may be misleading. The large estimated sight value of $800 million and firm prices that De Beers upheld are not a fair reflection of the current market environment. Rather, one should assess the low premiums and discounts at which DTC boxes are being traded on the secondary market, along with reports of a 15 to 20 percent decline in BHP Billiton tender prices this week. The reality is that rough prices have dropped in the past few weeks and dealer trading has gone quiet. The same is true for polished.

It appears that overconfidence during the first half growth period has caught up with the industry, as has the manner in which the market developed. High rough prices have crippled cutters’ ability to get more money to produce diamonds. And while growth in the industry was encouraging - albeit against the depressed numbers of the past two years - demand for diamonds has been far outpaced by the demand for more money.

In fairness, the manufacturers hold perhaps the most challenging position in the diamond pipeline. While they are required to pay cash for the rough they buy, they are forced to give credit terms to their polished-buying clients. The situation has improved since the 2008 crisis. Gone are the days of 180 days credit and money is turning around at a faster pace than before. A 60-to-90-day credit term is now the healthier norm.

Still, the lag in which they are caught between buying the rough, selling the polished and collecting the money brings added pressure to their businesses. But none so much as the rising costs they have faced in the past few months.

Consider the average price of ALROSA’s production in the first half of 2011. The Russian mining company sold its output for an average $113 per carat during the period, compared to an average $80 per carat in the first six months of 2010. Similarly, De Beers reported that its prices rose 35 percent in the first half, after they increased an estimated 6 percent in the second half of 2010.

As a result, diamond manufacturers need to pay 41 percent more than they did a year ago to obtain the same volume of rough required to keep their factories churning. While the volume of sales across the diamond pipeline has not increased in 2011, the return made by cutters on the price-induced growth has already been reinvested in the diamond cutting process.

Rough buying was encouraged by strong downstream demand in the first half of 2011 but equally by access to easy credit in India. Now, the Indian banks have tightened their previously loose lending belts given their clients’ plight, particularly as the outlook for the global recovery became less certain. One banker told Rapaport News that the cost of giving credit has also increased. “There is a slight shortage of dollars and because of that, the rate at which dollars are lent has gone up,” he said. “So it’s not only that we have tightened our financing, in many cases we haven’t. But the dollars that are coming to us are costlier.”

There is no need to panic. But one must recognize that the industry has entered a period of uncertainty which mirrors that of the equity markets, even if only temporary. This writer certainly hopes it is and that stability will prevail.

For now, there have not been reports of major defaults and the market is by no means heading down on the 2008 path. Consumer demand in China remains strong and investment demand is on the rise. But the diamond industry is not immune to rising concerns about global economic performance. In an overheated market a correction is inevitable. And for an industry where cash is king, a lack of liquidity will weigh heavily.

The writer can be contacted at

This article is an excerpt from a market report that is sent to RapNet members on a weekly basis. To subscribe, go to or contact your local Rapaport office.

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