Love Me Tender

Next month it will be two years since the sharp drop in BHP Billiton’s tender prices marked the big dip in rough diamond prices, an event that shook the diamond industry. Perhaps symbolically, today Gem Diamonds announced changes to its marketing strategy, adding a number of channels to what was previously a tender-only system. Is this a change in direction?

Rough diamonds were almost always sold to regular clients. A diamond miner, after investing in exploration and mine development, wants to make sure that it can sell the goods. Not just for a good price, but quickly and regularly, to cover the cost of the cash intensive mining operation. If you ever wondered why De Beers doesn’t like to hear a 'No' from a Sightholder, this is a main reason - it wants to know that it can move the goods. Cash flow, as you know, is at the core of every successful business.

A few years back, South African diamond miner Trans-Hex started tendering its rough in what has become a turning point for the industry. At about the same time, the U.S. auctioned its stockpile. It was not long before De Beers’ Diamdel added regular tenders to its selling system, later joined by BHP Billiton that moved its entire marketing system to tenders.

The industry, meaning anyone south of the miners, doesn't like tenders. A manufacturer, especially one that has clients with regular and specific needs, wants to make sure that he gets his raw material in a steady and pre-known fashion. Without access to a regular supply, he'll need to run around the market searching for the goods.

So with this contradictory position, where did it take the industry? With the backing of a supportive banking system, Indian traders started to bid on rough in a way that pushed many other diamantaires out of the game, paying high premiums on the goods in the process. Conventional wisdom holds that on average, tenders push up the prices by about 10 percent. The logic behind the willingness to pay so much more was long-term – proving financial might, trying to secure long term contracts, or simply to look good in the eyes of the producer – commonly referred to as Political Bids.

This created, for all intents and purposes, a futures market, where buyers are practically betting that the price of the resultant polished will be high enough to cover the cost of rough. If you guessed right – you made it. But if you guessed wrong – you lost money.

When the market turned sour in 2008, BHP Billiton paid the price and the final selling price of the tendered goods fell some 35-40 percent in October of that year, compared to the previous tender. No other producer saw its prices tumble so much. That is the downside of tenders from a producer's perspective.

In the two years that passed since, De Beers, just like Gem Diamonds' Letseng, is trying to somewhat spread the risk by suggesting that its clients buy at Diamdel tenders.

It's not all good for producers and bad for manufacturers. Holding tenders for very large productions, such as De Beers' or Alrosa's, is not very practical. Small manufacturers with occasional and very specific needs can do well in tenders, buying from the big guys – something that otherwise they wouldn't be able to do.

There are other reasons for tenders, such as to check prices. Aber/Harry Winston and Rio Tinto do that. They shave off the extremely high and low bids and average the bell curve for the market price.

Gem Diamonds will probably do well. This is the Rio Tinto pink diamond concept – keep the Crème de la Crème out of the regular selling stream, polish it on your own, drum up media attention and then tender exquisite and rare polished diamonds only to increase the margins. Meanwhile tender some of the bread and butter items for good margins and some sell to contract clients for stability. This is a win-win situation that works very well for small- to mid-size mines as well for a variety of buyers with different needs. It also provides flexibility in varying economic climates.

A number of mines are about to go online in Southern Africa and Canada in the near future, and they are currently contemplating the system by which the goods will be sold. The fear of some Sightholders that the DTC will switch to an all tender system is not justified – it won't happen. We are looking at multiple channels for greater flexibility. Despite the belief that this is an old-school kind of industry, we know that it is an evolving one that keeps reinventing itself. Amen to that!