While industry-specific issues such as tight liquidity in India have certainly played their part, the underlying insecurity has been caused by global economic trends, particularly the slowing of growth in the U.S. and Europe. If the industry learned anything from the 2008 downturn, it is that it too is vulnerable to global economic developments.
Therefore, as financial markets screamed volatility and lost about 5 percent in value through August, and as consumer confidence dropped, it was quite natural — and in fact healthy — for the diamond market to react. Not having prices go down when they should, would create an unsustainable, artificial market environment.
There are many lessons from 2008 that one could apply to the situation today, even if the atmosphere is not comparable. Back then the market was far more fearful and uncertain, and prices fell by far more. Liquidity across the board was scarce as the banks dramatically tightened their lending to the trade.
The answer then was to neither freeze prices nor trade, but to turnover inventory at new price levels, regardless of historic costs. Such was the success of the Indian industry. The advice given at the time by Martin Rapaport, chairman of the Rapaport Group, is therefore relevant today as prices have dropped in August (see editorial entitled “Transparency” in the December 2008 issue of the Rapaport Diamond Report).
“How to make money when prices go down? Sell cheap and buy cheaper,” Rapaport wrote. “Let’s say you have a diamond that cost you $1,000 and you can now replace it for $700. Sell it for $770, pocket the profit and replace it or hang on to the cash. As long as you can replace it, you can tell yourself you have not lost money. Don’t hang on to old inventory because of historic cost. A diamond is only worth what you can buy it or sell it for.”
The August market correction presents an opportunity for shrewd diamond cutters to profit as they were unable to do during the perpetual increases in rough prices over the preceding nine months. This correction should allow cutters to profit, rather than compete in an environment that is fully stretched with high prices feeding the mining company coffers.
Make no mistake —the biggest winners in the market surge in the first half of 2011 were the mining companies. Consider BHP Billiton’s diamond unit, whose production fell 18 percent year on year during the period, but managed to post 15 percent growth in earnings before interest and taxes (EBIT) to $537 million, as revenues rose 12 percent to $1.01 billion on the back of higher prices. The profits of other major miners such as De Beers and ALROSA have been well documented in these reports.
Assurances by mining company executives not to raise prices for the remainder of the year may sound assuring, but are in fact ridiculous. One would hope that their prices always reflect the state of the market, including when rough demand slumps.
No one is denying them their business success. But as rough prices in the dealer market have dropped, the opportunity is ripe for cutters to buy reasonably priced rough, sell their polished at lower prices but more profitable margins, and steadily raise their liquidity levels. As Rapaport stressed, “Diamonds may be forever, but cash is king. Get liquid, stay liquid and spend your cash wisely.”
The opportunity is especially true as rough inventories are reportedly high while polished inventories are said to be low. And it is especially relevant as weak economic data continues to filter in from the U.S. as we head into the all-important fourth quarter. Just this week, the Conference Board’s Consumer Confidence Index for August fell to its lowest level since April 2009, or as one analyst put it, “back to recessionary levels.”
That is not to be a prophet of doom. By all means the outlook for global diamond demand remains positively driven by China and India. But uncertainty prevails and the diamond market should reflect that reality. The industry needs to realize that it is not immune to a volatile and risky world. Only then will it recognize opportunities when they truly present themselves.