The Missed Boom...
May 24, 07In our “musical chairs” column last week, we mused about the contraction of the rough diamond supply sources that is likely to occur after the current surge of acquisitions and mergers in the mining world will end. This week, we are pointing out that no matter the music, in diamond mining, the tone isn’t pleasing to the ear. There is something fundamentally wrong in diamond mining; this message was underscored this week by an investor who asked me, “Why invest in diamond mining when returns on copper, cobalt, gold, zinc, nickel are sky-high and rising?”
Earlier this year, either in March or April, DTC Managing Director Varda Shine told Sightholders in a consultation meeting that “rough prices are very much where they were in
There are many explanations for the non-diamond boom – demand from
Gold and silver are used primarily for jewelry production, and De Beers’ Managing Director
That may be true, but it doesn’t even start to explain why, out of all the metal and mineral commodities, rough diamond prices have simply missed the boom. Looking at all the graphs, it is hard to escape the diagnosis that there is something “quite sick” in diamond mining or, more precisely, in the management of the diamond-mining sector. The past years saw the steepest rise in commodity prices to historical heights, while the diamond producers (De Beers, Rio Tinto, and others) reported a steep decline in (2006) diamond earnings.
Gareth Penny knows what he is doing when attempting to dump low margin diamond assets – the alternative uses for his capital will undoubtedly present better yields and greater future upside earning opportunities. (We understand that Rio Tinto and Petra Diamonds have shown an interest in purchasing the De Beers Cullinan mine, which has a mine life of some five years left, unless new developments are financed. It may indicate that Rio Tinto primarily seeks carats, while De Beers seeks value. By potentially not paying too much, Rio Tinto might actually get both. Just watch Keith Johnson.)
There is something that troubles me about the non-performance of diamond prices. We journalists, analysts, and mining experts like to show graphs that clearly illustrate that we are facing rough diamond supply shortages well up until 2015. I have gone as far as stating (at India’s Mine to Market conference) that there will still be supply shortages even under the most conservative growth estimates, in which consumer demand for diamond jewelry will only grow in tandem with GDP per capita in the main consumer markets and not outperform that minimum (almost automatic) pace of growth. Therefore, everyone in the chorus is predicting increases in rough diamond prices.
That’s all in accordance with the most elementary and fundamental rules of economic supply and demand theories. Somehow, I am not convinced that all these simple truths are, indeed, applicable – or already applicable to an industry in transition. Except for the larger goods (in which a few strong downstream players control the market), I am wondering whether rough diamond prices will indeed follow in the footsteps of other commodities.
Historical Technical Correction
In the past, diamond mining was considered one of the most – if not the most – profitable of all mines and minerals in the mining industry. The margins were huge. This was largely – if not solely – because of the sector’s cartel structure. De Beers was the price setter.
It is probably still too early to write about all the ways in which cartel members optimized revenues, but “cheating” on producer and host governments certainly was part and parcel, which is one reason for the current “payback time” attitude of African governments. The cartel structure was also a major factor in the maintenance of an opaque, non-transparent, fragmented structure of the downstream industry; it served De Beers, which at some point had a few hundred, mostly small, Sightholders.
The cartel period represented the Golden Age of diamond-mining profits. In the real world product pricing is one of the most challenging tasks faced by companies. McKinsey recently wrote that “the fastest and most effective way to enhance earnings is to raise prices: for a typical S&P 1500 corporation, a one percent increase lifts operating profits by 8 percent — an impact nearly 50 percent greater than that of a one percent fall in variable costs (such as direct labor) and more than three times greater than the impact of a 1 percent increase in volumes.”
In the diamond world, final (polished) product price increases traditionally were already reflected in the rough prices well in advance of the strengthening of polished prices. We almost consider it normal that rough and polished are not in sync. Indeed, in the supply-controlled environment, prices were “pushed” through the pipeline – and the producers were the main (if not only) beneficiaries.
A few decades ago, the late George Evens, a legendary figure in the rough diamond markets, told me that the industry doesn’t benefit from high prices. “We are all only living on the margins between buying and selling prices. If diamonds would be more affordable, the market would grow much faster.” Though one could make various counter arguments, his basic point is correct: only producers benefit from high diamond prices.
When the cartel decided to de-cartel (or un-cartel) itself, and to force the industry to operate in a demand-driven environment, I am not sure whether the polished prices at that (rather arbitrary) moment in time were at any sensible or logical level. De Beers remains committed to raising rough prices only if it finds that these increases are sustainable in the long term. Since the deep crisis of the early 1980’s, when the cartel temporarily lost control of the market, there was never a formal DTC price decrease. In the post-cartel period, we have twice seen formal, officially announced price decreases: in 2002 and in 2006 – twice within a five-year period. So much for “sustainability” or for price-setting in a non-cartel environment...
This isn’t criticism, and I am not criticizing. De Beers is operating in “uncharted territories.” All its traditional models for managing prices were clearly inadequate for the new post-cartel environment. McKinsey has observed, in reference to international corporations, that, “distributed responsibility for pricing decisions across functions and geographies leaves no one managing the total price-profit-volume equation. Without a common process for making pricing decisions across different brands and channels, as well as a common set of data to support these decisions and monitor performance, pricing becomes unmanageable. The results are inevitable: pricing performance varies enormously among business units, channel conflicts lead major customers to demand price protection, and brand managers compete among themselves for the same consumers and shelf space.” Though the quote may be slightly out of context, it underscores the complexity of price setting – and I wonder how much of the lack of growth of demand for diamond jewelry can be linked to prices.
We have been “conditioned” to think that it is purely a matter of marketing spent, more advertising, etc. – but is this really so? To me it sometimes seems as if polished diamond prices have hit some kind of glass ceiling and they cannot break through it. Will higher rough prices enable lifting the ceiling or will they simply lead to a decrease in demand?
The tragedy of unproven producer-marketing strategies is that, mostly, the downstream players pay the price. In all fairness, however, it must also be recognized that producers’ margins have greatly declined – and that diamond mining isn’t the great business it was in the past. The producers still enjoy considerable “rough placing power,” which enables them to still sell at rather high prices in terms of polished price levels.
The cartel structure never necessitated lengthy discussions on the price elasticity of diamonds, and whether a change in prices impacts the demand for the diamond product. We can only (sadly) observe that the industry growth seems to be stagnating, that prices have underperformed in comparison to other commodities, and that we missed out on getting our share during the U.S. economic boom. The margins of most players in the pipeline are under pressures. If we now add the producers themselves to the list of parties hurting, this may trigger a greater reluctance to develop new diamond mines.
One cannot just “miss” a great economic boom – and believe that business will continue as usual. It cannot and it should not.
Have a nice weekend.