The long-term fundamental picture for diamond prices is strong but, the sector faces looming and significant difficulties in the short- and medium-term, writes Mineweb.com.



According to a report issued by RBC Capital Markets titled "Diamonds - Where Will All the Rough Come From?" there is a chance that a recovery in global diamond demand could create another price bubble.



As a result of the recession, many of the big miners have cut diamond production; as the report points out, during 2009, De Beers made aggressive cuts to output, Alrosa produced but did not sell diamonds, Rio took production holidays; only BHP's Ekati kept the pace. This is especially concerning from a production point of view when one considers that about 90% of all rough diamond production comes from De Beers, Rio Tinto, Alrosa and BHP Billiton.



And, while this may have made sense at the time, if demand begins to pick up, it is doubtful that a similar level of diamond production will be available to be brought back on stream quickly.



The reasons for this are two fold, firstly, although credit markets have loosened substantially since the height of the crash, funding for new diamond mines remains difficult to secure.



Especially because, historically, diamond mines haven't been great investments. As RBC says, the sector has been "possibly the worst sector in the resources space, and the price of rough diamonds is at a low with the bottom of the cycle behind us.



"There will be no immediate spur to jewelry sales due to the fragile economic recovery - the continued recession in the US is a major threat, Europe and Japan are also likely to hit sales and Japanese polished diamond imports have stalled."



Added to this is the fact that diamond cutters and polishers are unlikely to be able to build up inventories in the current climate where debt is hard to come by.



More importantly, in terms of the availability of new production, part of the reason for the value placed on the stones is because they are rare and new mines are hard to come by.



"Finding new deposits takes years and is costly as diamonds are so scarce; for example, the Ekati mine took 10 years to find and seven years to prove and build. Even once found, it takes a long time to bring a diamond mine into production; the Star Project in Canada for instance, owned by Shore Gold, has had around $300m spent on it so far but is unlikely to start producing until 2012-2013.



Indeed RBC explains that even if many of the active new diamond projects come on stream, it is unlikely these new mines will be able to match the production levels of existing African and Russian mines that are getting ever older and are increasingly producing less.



Some of the new diamond mines on the cards are:

1. Gahcho Kue in Canada

Owned by Mountain Province (49%) and De Beers Canada (51%).

Taken 10 years to date and may be in production at end-2012 producing 3m ct per year for 15 years.

Remote and has been working on this for 10 years so far



2. Renard in Canada

Owned by Stornoway (50%) and Soquem (50%).

Started exploring in 1999 and unlikely to be a mine before 2013.

Annual diamond output could be ~1m ct/year.. but needs infrastructure



3. Star Project in Canada Owned by Shore Gold.

Bought the claims in 1995 and spent ~$300m so far.

Could produce 1m-2m ct of diamonds a year but production still a way off - perhaps 2012-2013



4. AK6 Mine in Botswana

Owned by African Diamonds (28%) and De Beers (66%)

Could be producing 0.5mct-1mct a year for 12 years by mid 2011



5. Lace Mine in South Africa

Owned by DiamondCorp (74%)

Could produce 0.5m ct per year by 2012"



The flip side of the supply demand coin, however is looking slightly better, albeit a little wan in the short term.



America remains the big gorilla on the diamond consumption front accounting for around 40% of current stock but, the recession has, understandably, had a major impact on current consumption levels.



China currently accounts for about 8% of total diamond consumption but it is still growing strongly and is expected to roughly double its share by 2015, according to RBC. India too has still got a strong growth trajectory.



So, if the recovery occurs in the US, as many analysts expect it to do over the next few years, and this is combined with the strong growth from Asia there is likely to be a significant growth in demand over the long term.



But as RBC acknowledges: "Polished diamond inventories are still too high, with no pull through at the retail end, therefore recent rises in rough diamond prices may simply be due to restocking of the diamond pipeline and thus will be shortlived. The lack of demand means that cutters and polishers face bankruptcy, and the lack of bank debt and speculation will likely dissuade diamond cutters and polishers from building inventories, creating trouble for small miners. Synthetic diamonds are also a potential threat to the pipeline.