It’s Hot in a Rough World
April 15, 10Word is that the Diamond Trading Company (DTC) will increase rough diamond prices next week. The market seems to expect something in the 5 percent-7 percent range. Back in February, the DTC had informed clients that prices had firmed and that there would be another single-digit increase for the second DTC Sight. It said then that it would “anticipate a period of stability in respect of prices subject of course to any further major changes in market conditions.”
The key question now is whether we face a “major change” warranting another price increase. As of press time, no formal DTC decision had either been made or communicated to clients. But it is a safe bet that the DTC will indeed hike its selling prices. And why shouldn’t it?
Analysts and commentators are almost all singing in tandem that “the strength in the market continues” and that the “longer-term [rough] supply looks extremely constrained.” The views are more divergent, however, on the economic drivers for this strong growth demand.
Buying for Current Requirements or for Overhang?
One commentator believes that the legitimate rough replenishment phase in the recovery process has been completed, and that traders are buying rough to create a new stock “overhang.” They are willing to pay more, expecting that by the time they hit the market, polished prices will have gone up. We cannot find justification for that reasoning: there seems to be a genuine need for rough to meet current requirements. There are still genuine rough shortages – and that’s the way producers like it, especially those who prefer to keep the stock under the ground rather than above.
Our analysis shows that global rough demand for 2008 came to about $14.3 billion, and because of the severe ripple effect, the rough demand last year dropped to the area of $7.5 billion. For 2010, we believe that the market will need between $11.2-$12.5 billion worth of rough. This is in line with our expectations that global polished demand in 2010 (in polished wholesale prices) will be $17.1 billion, which is about equal to 85 percent of the 2007 level.
If we assume that the stock overhang was severely diminished, or even depleted, throughout the crisis, and that this year’s polished pipeline sales will need to be matched by current rough supplies, then the industry will need some $12 billion of rough, including the restoration of higher working-stock levels. This is all part of the aforementioned ripple effect.
The question is where does the rough come from? De Beers’ mining plans allow for a return to some 66 percent of its pre-crisis levels. In volume, De Beers will mine some 31 million carats this year as compared to 48 million in 2008. The DTC initially planned to sell some $4 billion this year; the accumulative price increases may drive that figure up to $5 billion – it may still sell the same reduced volume, just at a higher price. In a meeting earlier today (Thursday) in Mumbai with the management of Diamonds of India Limited, DTC Managing Director Varda Shine mentioned that there is a “shortage of natural diamonds.” Of course, there is a shortage - when diamonds are left in the ground… It is a good way of revenue optimization for producers.
Just remember what happened to Argyle when it first had a problem in its mine a decade or so ago. When it was forced to reduce output, it was able to get much better prices. Total revenues grew…
The market is hot because supplies are truly insufficient. Thinking that the industry has returned to speculative buying may be true in specific instances, but it doesn’t reflect the market as a whole. This makes the pricing issues infinitely more complicated.
DTC’s Selling Price as Benchmark
Let’s leave aside the market for the large goods, which has become so commoditized that there are hardly any margins in it. In all other more bread and butter ranges in polished, we are seeing quite a healthy demand. This is trade demand – the various phases in the pipeline are replenishing; the consumers have not yet returned to the stores. Retailers will sell in 2010 at the level of 2009 – but the slide in retail sales that started in September 2008 has halted. The improved situation has restored trade confidence and the willingness to replenish at a higher stock level.
According to our models, it seems that the DTC prices, before the expected increase, allow a high single-digit margin on the resultant polished. One manufacturer said 9 percent; no one went higher. This implies that non-DTC rough may definitely be too high and leave uneconomic margins, if any. It seems that the DTC goods are rather accurately priced. A DTC rough price increase would bring the manufacturers’ margin down, though it seems that the DTC will be banking on polished prices inching upwards a couple of percentages in the months ahead. Wishful thinking?
Looking at the overall market, rough prices are still below their peak levels of June 2008. But the price is getting there. One might say that today’s situation looks more like it was around March-April 2008. When looking at pre-crisis levels one must not forget that at that time, rough prices were some 30 percent out of sync with resultant polished. Polished prices have firmed, but again, except for the large goods, a large gap is still there.
Here is where the confusion sets in. While polished has moved up and also seems to be back to its early 2008 levels, there are still manufacturers that tell us that rough prices are far too high, at least on non-DTC goods. The premiums on the DTC boxes would really support the latter argument. A premium doesn’t always mean that DTC rough is too cheap; it often points to other rough as being “too expensive.” By and large, the rough prices still seem too high – but about that, nobody seems to care.
The Need for Liquidity
The so-called “successful absorption” of a DTC rough price increase largely depends on the good will of the banks – or more specifically, upon their reading of the markets. Credit remains very tight (except for India, where the situation is more comfortable) and there is little room for unnecessary rough purchases. There is certainly no credit available for speculation or for buying “for a new overhang” purpose. At the end of the day, one of the other crucial determinants of any “excess” rough purchases is the interest rates. When rates go up, the appetite for “excess” goes down.
When interest rates go up (or are expected to rise), it is in the best interest of the downstream players to maintain stable inventory levels, without any overhang, certainly in the near and mid-term future. So much has been said – also by this writer – about the “new normal.” In terms of “rough buying,” there is no new normal, apparently.
DTC’s decision to extend client contracts for another year has been widely applauded by clients, who don’t need to spend time and resources on making profiles, business plans, etc. Some rough dealers who remained intensely loyal to De Beers during the early crisis days are somewhat disappointed. If no new contracts and allocation levels are set, those who were not loyal will be “punished” only a year later as well. Sounds like sour grapes. Guess that in a rough world, you can’t win them all.
Have a good weekend.