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Slump Leaves Diamond Industry Exposed


Post Date: 09 Dec 2009    Viewed: 503

It’s never been easy to understand with certainty what is happening in the diamond industry. Many of the largest players are either unlisted or form merely a division of those that are. The industry is willfully and instinctively secretive; a decision which it wrongly believes protects the players, writes Business Day.



This lack of information has opened up a kind of secondary market in diamond pricing, credit levels and industry gossip intended to close this information gap. Unfortunately, the players in the secondary market are themselves partial and have conflicting interests, or are just hopelessly crabby with one another, never mind the leading players in the diamond industry.



Consequently, much of what one can discern comes obliquely and with all kinds of health warnings. This is a terrible pity, as I get the sense diamonds are losing their mojo, notwithstanding some grand and innovative attempts particularly by De Beers to counter the industry’s problems.



Many of these problems are ongoing: diamond smuggling, artisanal diamond fields, blood diamonds, sustainable mining and so on. Recently, the economic downturn has ravaged the industry and shown up some financial issues. It’s as though the diamond industry has been fixated on its image and not paid attention to its internal structure.


It’s interesting to compare the fortunes of the diamond industry with those of the gold industry, although, unfortunately, the comparison is difficult to maintain. During the recent downturn investors sought gold and pushed up the price to record levels.


Diamonds, on the other hand, have apparently halved in value during the slump. It’s a bizarre dichotomy. In the first six months of last year, Gem Diamonds said it realized 2500/carat but this year was getting only 1100/carat although by midyear this had improved to about 1600/carat.



This may or may not be reflective of the diamond industry as a whole. Price information comes in dribs and drabs outside of the private “newsletters,” which are themselves much disputed. The result is the industry struggles to sell itself as a store of value the way the gold industry does, and relies on the ultimate sale of polished diamonds and jewelry to hold up prices. That works well in the good times but poorly in the bad.



The industry has only itself to blame and it has been thoroughly found out during the slump. As there is no pure and transparent diamond market, it cannot hold the public trust. There are plenty of price indications and estimates, and of course plenty of places to buy rough diamonds. But the rough diamond industry, absorbed by the notion of its own specialness, has been hubristically resistant to the notion that diamonds are a commodity.



Significant portions of the industry use archaic methods of sale, like the “sight” system used by De Beers and others, to sell a small number of boxes of diamonds to favored buyers who have to participate in complex agreements to market diamonds. It creates a complex loyalty system, and its own information underground. It also means there is no daily public market price and no hedging instrument available to reduce volatility.



And so we guess at what happens, guided by gossip, of all things, and maneuvered by the diamond industry’s grandees. Yet much has been learnt during the downturn, and not all of it good. The strands of the industry’s problems all come together in De Beers, which has twice been to its shareholders for more money, and intends to do so again for a cool 1bn.



In April this year, finance director Stuart Brown was quoted in the Sunday Times as saying: “Because we saw it early and took very dramatic steps around the business, we are in a position to weather trade in 2009 and 2010 without any recourse to shareholder funds.” Well, that didn’t work out.



Partly, diamond miner De Beers needs the money for the best possible reason; it has been investing heavily. Mineweb calculates that over the past three-and-a-half years, De Beers has generated free cash flow (operating cash flow less capital expenditure) of negative 864m. “Part of the explanation lies in significant capital expenditure, at 1,2bn in 2006 and 1,5bn in 2007, mainly dedicated to building new diamond mines in Canada.”



But part of the problem too has been a “staggering sum” of 730m in cash dividends paid out over the period. The result has been a heavily indebted company just when credit has dried up, and it has rolled over its 1,5bn in loans required to be repaid early next year. It is the result also, says the rumor mill, of some poor diamond mining at places such as Venetia.



What motivates a diamond company to pay large dividends at a time of substantial expansion? Pressure from shareholders, presumably, who have their own issues like empowerment funding paybacks, and perhaps overconfidence.



This seemingly unsteady ship raises the odd question of whether shareholders will follow their rights if the company proceeds with a rights issue. There are only three of them, the Oppenheimer family with 40%, the Botswana government with 15% and Anglo American with 45%.



One school of thought is that Anglo in fact proposed that it would pay for the entire rights issue and so become a majority shareholder in the De Beers diamond comapny. This would signal a severe breakdown of the hitherto cordial relationship between shareholders. Another school of thought is that Anglo will demur, and edge away from De Beers by not following its rights at all. Most likely, the parties will maintain the status quo.


Yet you would guess the mood music between Anglo and diamond miner De Beers can’t be great. Anglo is fighting some big battles of its own, and one of its prize investments is suddenly not only not producing any money but requiring a series of hefty cash injections. If Anglo is not seeking more influence than a board meeting every quarter, then it should be.



The closure of the Botswana diamond mines and other techniques to deal with the downturn were clearly smart moves, but they do illustrate some of the industry’s vulnerabilities: too much debt in the system, too great a reliance on the US market, and a distribution chain that is probably too long.



It also raises the question of whether De Beers’ much heralded “buyer of choice” strategy is working. No doubt, De Beers as a company is a fabulous survivor. But there is a difference between merely surviving and thriving.


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