Fear of Shortages Grips Indian Market
October 08, 09At the beginning of this week, we were almost convinced that a new huge bubble was in the making in Indian goods. Confronted with the facts that the prices of typical Indian rough rose dramatically in the third quarter of 2009 and that following the latest DTC Sight some of the Indian goods are being traded with double-digit premiums, one is tempted to fear that dangerous speculators are back to impair market stability. But not all the facts fully add up to reach an unequivocal conclusion.
What characterizes a bubble is trading in high volumes at prices considerably at variance with intrinsic value. When bubbles occur it is always a challenge to pinpoint the exact reasons and to conjecture when the inevitable crash will follow. That there is rough trade at inflated prices is a fact.
What is missing, though, are the “high volumes” – most large Indian manufacturers needed the rough for their own factories. The trading at the recent DTC Sight was, apparently, limited. Yes, speculation drove some prices to insane levels, but the trading volume turned out to have been wholly insignificant. However, not all players will concur.
A highly responsible Mumbai industry spokesman doesn’t see a bubble. “Chaim, we know for sure that throughout 2010 there will be rough supply shortages. We need goods for our factories. Our industry is production driven, and securing rough is of the highest priority,” he said. Prices are rising because of genuine demand, he adds.
DTC’s Varda Shine: No Return Yet to Full Production
DTC Managing Director Varda Shine, who was in Tel Aviv last night for the filming of a TV program (in which she presented the case for diamonds in a most eloquent manner), confirms that “next year De Beers will still not go back to full production but will sell fully what it produces. Given our analysis of the market, next year’s rough sales will not be anywhere near the 2009 levels,” she says.
As I don’t expect DTC sales this year to go much over $2.9 billion (compared to $5.92 billion in 2008 and $6.15 billion in 2007), it is clear that De Beers recognizes that the full market recovery will not happen before well into 2011. That seems very realistic. It is our estimate that the worldwide diamond market will eventually stabilize at 85 percent of pre-crisis levels. Varda confirms that “she has her targets for 2010,” but I was unsuccessful in getting a specific figure out of her – believe me, I tried.
The DTC’s latest Sight totaled $310 million. Contrary to market perception, Varda confirms that there were a few additional sales or so-called “ex-plan” allocations. The message from London to Indian clients is to expect smaller Sights for the remainder of the year, and that the DTC will refrain from selling much additional goods. The reason given was lack of availability. The juxtaposition of a small end-of-year sight and continued mining cutbacks is enough to feed expectations of higher prices, shortages and – thus – speculation.
One has to be careful when talking about “the De Beers full production.” The company has disposed of the Williamson mine in Tanzania and the Cullinan mine in South Africa, so it is difficult to compare apples to apples. It may be better to look at total global natural diamond production, which peaked at some 175 million carats in 2006 and which will be down to some 110 million carats this year. By 2011, it will probably stabilize marginally above 140 million carats and maintain that level for some years to follow. Thus, worldwide, 140 million carats (some $9.1 billion at current prices) may well become the “full production” of tomorrow.
No Supply Shortages
Whether the near-permanent lower level of output means shortages will depend on the pace of recovery out of the recession. The current demand for Indian goods is attributed to the fact that Indian factories that had been closed for half a year or more are now operating again. Their rough inventories had all been polished by the time they had ceased their operations. Therefore, suddenly, an industry facing depleted rough stocks now finds itself requiring the quantities needed to resume production. Note that this consumption is taking place well before the expected orders from the retail side are coming in and is based largely on expectations. And, of course, speculation also plays a role. Some Indian dealers believe that the DTC is simply not aware of how much box trading is taking place. In this instance, we side with those believing that the trade in DTC boxes was, indeed, limited.
Liquidity Burst
The Indian stock market has hugely recovered this year, and quite a few players have been taking profits. The Indian diamantaires have had no serious impediments in getting credit, and with the return to manufacturing and improved business cycles, there is no lack of liquidity in Mumbai. This enables paying higher prices for rough – also in the better qualities.
In Belgium, the industry’s banking indebtedness has bottomed out and is rising again. The five diamond-financing banks together have a current exposure of some $3.5 billion, including securitizations. ABN AMRO remains the market leader in Antwerp with a $1.1 billion local exposure (excluding securitizations), followed closely by the Antwerp Diamond Bank (ADB), which hovers around the $1 billion figure. Needless to say that asset securitization implies various degrees of risk sharing and often cannot be attributed solely to a specific bank.
What is important is that there are still large, unutilized facilities in Antwerp. Neither ABN-AMRO nor ADB has reduced credit facilities (credit lines) during the crisis, and money is available for good business and good clients. In Tel Aviv, the problems are more serious. For instance, there the overall credit facilities have been reduced from $3 billion to $1.8 billion. The total bank indebtedness there is now around $1.6 billion.
The industry debt seems to be mostly increasing in India. To quote one observer, “that is where the money is and that is where the business is.” In recession times, the Indian goods enjoy a more stable demand than other categories. Look, for example, at the United States.
Down-trading in America
Many of the Indian demand expectations are based on the first seven months of U.S. import figures. By value, U.S. imports went down by 47 percent. Measured in carats, however, U.S. imports went down by only 30 percent.
However, if one looks only at the smaller goods (less than half a carat), the value decline (30 percent) and the carat decline (28 percent) match each other. Thus, no value decline on the per-carat averages. This shows that the typical small Indian goods are “recession proof” in the sense that less goods are sold, but not at lower prices. In comparison, if one looks at goods of half a carat and up, the average per-carat import price went down 23 percent, from $3,563 per carat in the first seven months last year (pre-crisis) to some to $2,764 per carat this year.
Anecdotal evidence confirms that consumers are downsizing. Those who still buy diamonds prefer the more affordable ones. It remains a fact that the prices of the smaller goods, which did not go up during the 2008 price bubble, have also not come down. What this means for Christmas? We still don’t know.
If we look again at the U.S. market, then in the first seven months of the year, net polished imports were only $1.5 billion. This figure points to considerable destocking of the pipeline but, apparently, not enough. The DTC sales director noted that at the Hong Kong fair alone there was some $3 billion worth of polished at the various booths, which is an enormous amount for a single trade show. There is still ample polished in the pipeline. Varda cautions me not to jump to conclusion about the forthcoming Christmas season. She takes a cautiously optimistic “let’s wait and see” attitude.
Nevertheless, we shall believe that the buyers of expensive Indian types of rough should have no illusions. These rough prices will temper off, as there is no real reason to expect polished prices in the smaller goods to go up. None of this will deter speculators. The premiums on the boxes will not go away – unless, of course, the DTC will decide on some last-minute profit taking before the end of the year.
Have a nice weekend.