IDEX Online Research: Diamond Industry Headed Into “Untested Times”, Says LKI

The diamond industry is entering untested times, according to Maurice Tempelsman, chairman of Lazare Kaplan, a global supplier and marketer of diamonds.  Tempelsman repeatedly emphasized this theme in his address to shareholders during the company’s annual stockholders meeting last week in New York. 

Tempelsman has cited four areas of concern in the diamond industry:

1. Cyclical adjustments – Inevitable cyclical adjustments in diamond demand are untested under the recently implemented Supplier of Choice program.  Tempelsman said there is a distinct possibility of a cyclical decline, which is part of any business cycle. According to Tempelsman,   this could be “problematic”.  
2. Over-leverage of the diamond pipeline – At $12 billion and rising, diamond industry debt is at record heights.  Tempelsman is particularly worried about this excessive leverage, since a substantial portion is related to memo goods.  If diamond demand is weak in the upcoming holiday season, diamond suppliers could see huge returns of memo goods.  This could send weak suppliers crashing into insolvency.   
3. Rough diamond price adjustments – Diamond price “euphoria has run away from reality,” according to Tempelsman.  Shortages of rough diamonds, real or perceived, have been the driver of prices, he noted.  Without the DTC’s buffer stock, Tempelsman expects more price volatility in the industry.  Furthermore, Tempelsman noted that rough diamond prices have been adjusted way ahead of polished prices.  His company has reduced its purchase of rough diamonds, pending some signs of market equilibrium.   
4. Global economic worries – High energy prices worldwide coupled with normal economic cycles could have a negative impact on diamond demand in 2006 and perhaps beyond.  Tempelsman noted, much to the delight of his shareholders, that economic problems will affect demand in the mass market much more than the luxury market that Lazare Kaplan serves. 

Lazare Kaplan (LKI) shareholders heard about the company’s diverse sources of supply as well as the many markets where it sells diamonds.  LKI receives diamonds from the DTC (as a Sightholder), Russia (joint venture with Alrosa in cutting and polishing operations), Angola (partnership with SODIAM), Namibia (partnership with NamGem to cut and market quality stones), and South Africa (partnership with Nozala, a women’s empowerment group). 

In addition, the company is in discussion with the government of Botswana for a diamond cutting and polishing license in that country.  Finally, the company is in the final stages of redrawing its contract to produce Bellataire enhanced diamonds.  General Electric, LKI’s former joint venture partner in the Bellataire project, has sold off the division that produced the enhanced stones. 

Lazare Kaplan’s consumer markets include Asia (where sales are very active), Japan (now in a revival), Europe, the U.S., Latin America, and China. 

The table below illustrates rough and polished diamond sales by region for Lazare Kaplan for the past three years.  It is notable that the U.S. market has declined from just over one third of the company’s revenues to about one fifth in the fiscal year ended May 2005. 

Tempelsman noted that political pressures by producing countries will continue to be a challenge for the diamond industry.  Some African countries will never be able to compete with China and other countries that can produce high volumes of product at very low costs, he predicted. 

Tempelsman also alluded to the diamond industry’s impending untested times in his letter to shareholders in the company’s annual report, where he said, “The transformation of the diamond industry continued to fare well in the past year in light of the demand generated by a sustained global GDP growth.  However, it is important to note that the new dispensation that increasingly depends on how the unpredictable, yet unavoidable, cyclical swings in supply and demand impact diamond pricing has so far remained untested.”

Tempelsman went on to say, “That test will take place sometime in the future and at a time that cannot be foreseen.  The high and increasing level of bank and trade financing of both the polished and rough pipelines is, and will remain, an area for concern.” 

“This concern,” Tempelsman said, “is particularly applicable to diamond pricing, as it does not lend itself to risk attenuation through the use of financial instruments.  Anyone who holds diamond inventory has a long position.” 

While it is possible to hedge in most other commodity categories, diamond price hedging is not possible, despite implementation of the Supplier of Choice which is supposed to allow the market to determine the price of diamonds.