Shortages
February 18, 10
In the old days of communism, people would watch the leaders of the
When the diamond industry was still opaque and non-transparent, the intentions of the dominant producer were also very often subject to interpretations based on reading between the lines and looking at who appears with whom. It was quite a guessing game.
Today we don’t have to guess what De Beers believes or thinks. We just have to listen to what the company says. In the last few weeks, DTC sightholders and others, myself included, have heard Managing Director Gareth Penny repeating two lines. One is, “We don’t mind leaving the goods in the ground” while the other is, “We don’t mind extending the life of our mines.”
We find these statements highly significant. Although we have frequently heard that the world may be running out of diamonds, it is probably far more accurate to say that De Beers may run out of diamonds. The Namibian land operations have a limited lifespan;
When you are the dominant producer, reduction of output may not be easily compensated with increased supply from other sources.
De Beers sold $3.23 billion worth of diamonds in 2009 as compared to $5.93 billion in 2008. We have learned that for 2010, the DTC’s sales target is in the low $4 billion range. This raises some very interesting questions. Our economic forecast for 2010 (taking the stocking and de-stocking of each pipeline level into consideration) estimates the industry’s worldwide rough requirements at $12.5 billion, compared to $7.5 billion in 2009.
We believe that in 2009, De Beers kept its relative market share at 43 percent. If De Beers indeed goes for about $4 billion in sales in 2010, its market share would dip to some 32 percent and the industry will face shortages.
Severe Pressure on Prices
If De Beers does not sell much beyond the $4 billion figure, there will be tremendous upward pressure on rough prices. Looking at recent De Beers selling prices, we see they fell by 25 percent in the first half of 2009. In the second half, they went up by an average of 12.8 percent, and at the end of the year, prices were still some 13.5 below what they were at the beginning of the year. In the January DTC Sight, prices went up and the DTC already announced that there will be a further price increase this month.
According to De Beers, it will then take a wait-and-see attitude and maintain a stable price level. It very much depends on what other players will do,. By the end of February, DTC rough prices should be in the same area they were in January 2009. In other words, we should be back to “normal” and the steep rise and fall which characterized the bubble will have become a part of the past.
The price may be sustainable provided that the resulting polished will fall in line and that there are no other falls in supply. However, by our calculations, De Beers needs to sell some $5.4 billion worth of rough in 2010 for it to maintain its market share and also to maintain equilibrium between supply and demand.
Of course, it is not just up to De Beers. But De Beers has the ability to create shortages and it may have a valid, justifiable reason to do so. Because the lives of its mines are limited, the company stands nothing to lose by keeping the goods in the ground, especially when producing at a later date will only give them higher prices. It also gives more time to
Changing Strategies
From a historical perspective, De Beers had been running a cartel for most of the past century. In that situation, it artificially maintained perennial supply shortages. Around the turn of the century, it changed its business model and controlled distribution by managing the behavior of its clients through the Supplier of Choice marketing strategy. This strategy is now, for all practical purposes, dead. The final death blow was received early last year when clients who took boxes in good times refused to take boxes in bad times.
We have a feeling that De Beers is now entering a new period of what I would call revenue optimization through output reductions. Getting better prices for fewer goods, and extending the lives of the mines. If we read the map correctly, we are entering a new era. The main beneficiaries will, as always, be the other producers. They have always enjoyed a good profitable ride on the De Beers coattails.
But supply shortages may lead to further de-synchronization of the prices of rough and polished. At this point in time, when financing is getting tight, and many companies already had to bring in equity from home last year, this might lead to widespread insolvencies, bankruptcies and industry consolidation. This is something that many thought would have happened anyway – and then it never did. Maybe this is the fate that awaits us in 2010.
Ultimately, it may all depend on the banks. Will they be ready to extend the financing needed, especially as the rough will become overly expensive? Or will the banks become “beneficiary” from a producer policy of starving the market – there would be fewer goods around to finance.
There has been a lot of talk about “normal” and “new normal.” It was never clearly defined what the “new normal” in the diamond business might look like. Supply shortages motivated by the desire to leave goods in the ground for a little bit longer may well be a strategy which the industry has to learn to live with in the years ahead. If that indeed is the case, we’ll be in for a rough ride.
Have a nice weekend.