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Leading the industry to the Crash of 2012 |
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In the eyes of the industry’s
largest grading laboratories, it was
only a matter of time before this
day would come. Synthetic, or labgrown,
colourless diamonds
created using the chemical vapour
deposition (CVD) process are
becoming more common in the
market. And not everybody’s being
honest about what they are selling.
This spring, a parcel of
hundreds of CVD synthetics was
submitted to the International
Gemological Institute in Antwerp,
while another, albeit much smaller,
group of CVD synthetics surfaced
at the Gemological Institute of
America’s Hong Kong lab in June.
Diamonds in both parcels were, for
the most part, of high colour and clarity and ranged in size from 0.30
carats up to 0.70 carats.
This pair of parcels shared at
least one other common trait:
neither was submitted with proper
disclosure. In the case of the
diamonds in Antwerp, the dealer
who submitted the lab-grown
diamonds paid natural prices for
them and, according to those
involved with the situation, was
unaware he had purchased labgrown
stones.
News of what had happened
in Antwerp sent ripples through the
industry worldwide and in Belgium,
ground-zero for submission of the
larger parcel of undisclosed
synthetics, the country’s federal
police have opened an
investigation. |
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1) The undisclosed lab-made diamonds
detected by IGI 2) Mr Tom Moses 3) Mr Peter Yantzer |
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For the industry’s grading
labs, however, the identification of
synthetic diamonds is not breaking
news but a reality that they have
spent a decade preparing to deal
with, and one that leaders say they
are equipped to handle. Tom
Moses, senior vice president of the
GIA lab, likens the situation to that
of a student who’s been dutiful
about doing his homework and is
well prepared for an upcoming
exam. “It makes this issue less
daunting,” he says. “We have a lot
of respect for it. We have invested
a lot in it. But I must say we have a kind of quiet confidence that we
really feel that we can deal with
this situation.”
The science behind synthetics
While the heads of the world’s
largest grading labs can’t give an
exact year, they all date the
practice of screening for synthetics
back to the late 1990s. Peter Yantzer,
executive director of American
Gem Society Laboratories (AGS
Lab), specifically recalls making a
trip to London around that time
with AGS CEO Ruth Batson. The
purpose of the trip: to learn about
two new machines being rolled
out by diamond giant De Beers,
the DiamondSure and the
DiamondView.
Shortly after this trip across
the Atlantic, first-generation
DiamondSure and DiamondView
machines arrived in the United
States. Today, they are key
components of the behind-thescenes
work that allows
gemmologists to sort the natural
from the man-made. “De Beers,
they saw what was going on,”
Yantzer says. “Kudos to them.” |
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As the GIA noted in an article
in its summer 2009 edition of Gems
& Gemology, knowledge of
diamond type is what helps labs
better determine if a diamond is
natural, treated or synthetic.
According to the article, which
cites decades of research,
diamonds can be sorted into one
of two broad Type categories. Type
I diamonds, which contain nitrogen
impurities, and Type II diamonds,
which lack the former. The Types
are further broken down in Type Ia
(aggregated nitrogen impurities),
Type Ib (isolated single nitrogen
impurities), Type IIa (no nitrogen or
boron impurities) and Type IIb
(boron impurities). (Type I
diamonds are broken down further
into Types 1aA and 1aB.). Moses
says that more than 95 percent of
natural diamonds turn out to be
Type Ia but that it is “difficult” to
grow Type Ia diamonds in a lab.
CVD synthetics of any colour are
Type IIa or IIb.
When gemmologists place a
diamond in the DiamondSure, they
are checking for a spectroscopic
characteristic of a Type Ia
diamond; basically to see if the
diamond is instantly recognizable
as natural or if it needs to go on for
further testing. Those diamonds
flagged by the DiamondSure go
on for further analysis and expert
interpretation, which can include
De Beers’ other machine, the
DiamondView. The DiamondView
blasts stones with high-energy UV
radiation to allow for real-time
imaging of fluorescence features
in diamonds, exposing their growth
structure.
Moses says that diamonds
grown in a lab using the CVD or
HPHT process exhibit a telltale
growth pattern that consistently gives them away as being
manmade. For example, the crop
of 10 synthetics recently submitted
to GIA Hong Kong exhibited
“typical CVD growth striations”
when placed in the DiamondView,
the GIA said. “No matter what you
do to treat or disguise synthetics,
those two growth features, in HPHT
and CVD, cannot be removed. It
can’t be changed,” he says. This
DiamondView fluorescence image
of a diamond grown using the
high-pressure, high-temperature
process (HPHT) shows the four-fold
growth sectors typical of HPHT
synthetics. |
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4) Mr Roland Lorie |
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Another aspect of the
synthetic market that Moses doesn’t
see changing is the ability to
determine if a stone is natural or
synthetic with a single tool. During
a presentation to the Diamond
Manufacturers and Importers
Association of America in New York
last month, Moses shot down the
idea of the development of a
“black box,” one instrument that
can wholly determine if a diamond
is synthetic or natural. Moses also
has expressed skepticism about the
DiamaPen, the $199 pen-shaped
device said to be able to instantly
discern lab-grown yellow
diamonds from their natural
counterparts. The DiamaPen’s
capabilities currently are being
tested by both GIA and IGI.
Mitch Jakubovic, director at
EGL USA, concurs that development
of a so-called black box seems
unlikely. “Although we have not
tested this new device (the
DiamaPen), the development of a
single inexpensive unit that can
instantly identify mined diamonds
from synthetics seems very unlikely,”
he says. “In some instances, multiple
tests may be needed to determine
if a diamond is a natural or lab
grown and it would be very difficult
to imagine a machine that can
implement all those pieces.” He
adds that some of the advanced
pieces of equipment used in the
process generate graphs that are,
in turn, read and interpreted by
senior researchers, all of which
create a story about each
individual stone.
The labs’ role
The latest crop of undisclosed
synthetic diamonds to appear on
the market — the 10 diamonds
submitted to GIA Hong Kong —
were the first such submission from
this particular client, Moses says.
While GIA does not disclose
client names, the July Gems &
Gemology eBrief announcing the
submission mentioned one very
familiar name: Gemesis. The labgrown
diamond company is also
the one linked to the large parcel of synthetics submitted to IGI in
Antwerp, though the company has
issued public denials of its
involvement. The eBrief stated that
the diamonds had gemmological
and spectroscopic features “similar
to those observed in Gemesis CVD
synthetic diamonds, suggesting
that post-growth annealing at high
temperature was used on the
diamonds to improve their colour
and possibly their transparency.” |
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None of the heads of the
industry’s largest grading labs
expressed surprise that synthetic
diamonds are hitting the market in
larger quantities, or that they are
not always being represented
properly. The technology for
growing colourless diamonds using
the CVD process has improved. In
turn, the stones themselves are
larger and of higher quality and
are showing up more frequently in
grading labs around the world.
It was little more than two
years ago, May 2010, when the
GIA identified its first near-colourless,
CVD-grown diamond that
weighed more than a carat.
“Clearly, CVD synthetic diamonds
of better quality and size are being
produced as the growth techniques
continue to improve,” the GIA
stated at the time.
It’s not unnatural that industry
players looking to turn a profit
would resort to selling synthetic
stones as natural. As Jerry
Ehrenwald, president and CEO of
IGI North and South America, put
it, “Since the moment synthetic
diamonds were commercially
available the ability to either
consciously or not consciously
defraud someone was able to
happen. It was just a matter of
time.” The introduction of the
seemingly inevitable criminal
element, however, raises questions
about the labs’ role in bringing
those that attempt to defraud to
justice.
At GIA, Moses says that the
first time a client submits synthetic
diamonds without proper
disclosure, such as just happened
in Hong Kong, the lab informs them
that the stones submitted were lab
grown and issues a synthetic
diamond report. “If that happens
one time, it’s not really appropriate
for GIA to take action at that point,”
he says. If it keeps happening,
though, he says the GIA has the
right to stop doing business with
the client and, if circumstances
warrant, to notify appropriate trade organizations, trading bourses and
even law enforcement. |
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Other labs agree on making
the industry aware but stop short of
wanting to be the ones to bring in
the law. IGI Worldwide co-CEO
Roland Lorie says that when the
parcel of hundreds of undisclosed
synthetic stones came into their
lab, it contacted the Belgian
Federation of Diamond Bourses.
“People come to us because we
are the experts. We are not the
ones to decide who is dealing
honestly or not,” he says, when
asked why the lab did not reach
out to law enforcement authorities.
“People come to us just to know
what they have in their hands,
because a lot of times they don’t
know.
“We are not there to take up
the role of any of the industry’s
authoritative and regulatory
associations,” he says. “Otherwise,
there’d be no reason for those
associations to exist.” If IGI
Worldwide perceives that there is a
potential problem with a client,
Lorie says, then it contacts the
diamond bourses, which are
Mr Roland Lorie
responsible for the integrity of their
members. He says IGI is still doing
business with the unnamed client
that submitted the parcel of
hundreds of undisclosed synthetics.
“He didn’t know, and the bourses
agreed that he didn’t know,” he
says. “The person who sold it to him
probably knew.”
As to whether or not members
of the industry are being aggressive
enough in the case, Lorie’s answer
is, simply, that the industry should
be aggressive. “For the moment, I
haven’t heard anything. I didn’t
hear about anyone that was
punished or expelled or suspended
from the bourse,” he says.
Jakubovic says EGL also
would notify industry organizations
if confronted with a situation
involving hundreds of synthetics,
such as IGI was, though he is quick
to point out that EGL USA hasn’t
had that happen. The lab has had
many synthetic diamonds
submitted without disclosure over
the years but only in smaller
amounts-a few stones here and
there from varying sources — and
the lab doesn’t believe there was
intent to defraud in the vast majority
of those cases. “There are definitely
people in this industry who are
inappropriate, without a doubt,”
he says. “But is it our place to get
law enforcement involved? I don’t
think so.”
However, Jakubovic says, if
faced with an “extreme
circumstance” the lab would
consult with its legal advisors. “This
has to be contained. The end
consumer has to be protected,” he
says. “Our responsibility as a major
laboratory has grown and will
continue to grow as these are in
the marketplace.” |
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Undisclosed Synthetics pose a Dilemma By: Chaim Even-Zohar and Pranay Narvekar |
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“The crash of 2008 was far more benevolent
than the coming diamond crash of 2012,” remarked a
large DTC sightholder, explaining the difference as
follows: “In late 2008 and early 2009, the business
came to a virtual standstill. We didn’t buy, nor did we
sell. Accounts receivables came in. Our banking debt
went down. In early 2009, when the business gradually
normalized, our activity resumed, prices stabilized –
and we emerged from the crisis without major damage.
There were hardly any bankruptcies.”
Continues the sightholder: “Today, it is different.
There is activity, we buy DTC sightboxes and, month
after month, we lose between 10%-20% on the polished
we sell. We are destroying value; we are creating a
‘hole’ that is growing month after month. The ‘smart’
DTC sightholders last week deferred their purchases –
which is a code name for ‘leaving goods on the
table’.” De Beers’ management reportedly takes
mistaken pride in
“defending its prices.”
However defending
unsustainable prices
that cause lasting
damage to clients, the
market and to De Beers
itself is a fallacy, a
delusion, that will
backfire.
By our estimates,
some 20-25 percent of
the last sight was not
taken. De Beers sold
$100 -$125 million less
than it had budgeted.
And those sightholders who didn’t take their full
allocations are the smart ones. As one DTC broker
intimated: “DTC prices are still some 7%-10% too high
and they must come down. So those who didn’t take
the goods now will pay less for them at the following
sights.”
Failure of Price Management
One must differentiate between two separate
issues: the extreme price volatility of rough, and the widening gap between the rough prices and those of
the resultant polished. If one takes the end of 2007 as
an arbitrary point of basic price equilibrium, which
was before the world’s financial markets imploded,
we see that the industry came through the crisis well
intact, and by the third quarter of 2009, the rough and
polished price movements again were in equilibrium –
albeit both at a lower price level. Whoever bought
rough at that time would be able to sell the resultant
polished at break-even or profitable prices. |
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Mr Chaim Even Zohar |
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Throughout 2010, admittedly a profitable year
for the diamond industry, both rough and polished
prices rose more or less in tandem; there was a
manageable gap in the pace of growth between
rough and polished. Keeping rough somewhat“expensive” is ultimately a time-proven way to push
polished upwards. There is also a natural time gap,
where price increases work their way through the
pipeline, and, throughout 2010 and 2011, many traders
were willing to speculate and buy rough at (too) high
prices, “assuming” that polished would have increased
by the time their resultant output reached the markets. They miscalculated in a big way.
Thus in 2011, the market went into a steep upward
spiral price-wise: by the third quarter of 2011, rough
prices had doubled since the third quarter of 2009,
when rough and polished prices had been in
equilibrium. Polished price growth, however, then
lagged some 25 percent behind the corresponding
rough. That is unsustainable. Then came the third
quarter 2011 crash, and most diamond companies
literally saw the profits made earlier wiped out. Though
producers still made record profits, many of their
clients lost money and were left with stocks that had
lost, and still were losing, enormous value.
Looking at the demand and supply
fundamentals, it became clear that rough prices
needed a downward correction to close the gap with
the polished prices. At the end of 2011, Mumbai/
Dubai’s Pharos Beam Consulting and Tacy Ltd.
predicted that rough prices needed to fall – and they
did. [This was also stated by us at the PDAC in Toronto
in early March 2012 as widely reported by Reuters,
Forbes and elsewhere.] It was clear that De Beers had
dropped its time-honoured policy of “maintaining
sustainable prices,” and it was now using – or abusing
– its market power as the largest and dominant
producer to “overshoot” price-wise. That’s where we
still are today.
The new De Beers management, after Philippe
Mellier assumed the helm in mid-2011, seems to pursue
a short-sighted policy of driving up rough prices while
totally disregarding the polished markets. It also seems
to have little consideration for the company’s
customers who distribute or manufacture De Beers’
output, and who should have an inherent right not to
lose money. De Beers doesn’t have ill intentions; the
miner simply lacks good market feedback. Mellier
may not have realized that clients fear telling him
straightforward “how bad things are” – especially in a
period preceding client selection. De Beers
overestimated the demand side; it assumed supply
shortages that were more imaginary than real. That is
still the case today.
If rough and polished prices had been in
equilibrium by the third quarter of 2009, two years later,
that gap had widened by more than 25 percent. DTC
sightholders don’t need sophisticated economic
models to know what went wrong – they see that they
are losing vast amounts when manufacturing their
DTC sight boxes. At the June 2012 sight, the sightholders
rebelled. We are not sure whether this is recognized as
such in London – at both De Beers and at Anglo
American. |
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Sightholder Rebellion
At the end of the most recent sight, DTC brokers
and representatives, realizing how many goods were
“left on the table,” were quick to remind clients that
under the terms of the present DTC sightholder contract,
not taking one’s ITO (Intention to Offer – the pro-forma
supply commitment by the DTC) will “potentially lead
to the reduction in the starting point of future ITO’s
when contractual allocations are not fully taken up
during this ITO period.” [Quote from a broker’s June
internet sight newsletter.]
Indeed, many DTC clients face a dilemma: Will
I do what is good for my business and refuse to buy
rough that guarantees financial losses on the sale of
the resultant polished, or do I honour my commitment
to the DTC to purchase whatever is offered to me at
whatever price it is offered? There is no unequivocal
answer, though I told one friend facing this dilemma
that he should stop being a sucker and ensure the
financial solvency of his business; by simply transferring
money to the DTC month after month at losing prices,
he will not be around anyway when the next ITO is
formulated. So why worry about the level?
On a different level, it seems to reason that De
Beers is bluffing. It cannot afford to reduce ITOs next
time around. It cannot be sure that others will indeed
be willing to take these goods. Nor can it sustain the
current absurdity where DTC sight boxes are auctioned
by Diamdel at 7-10 percent BELOW the DTC sight selling
prices. Some small lots have gone at even far greater
discounts to DTC box prices. This is as absurd as it is
ethically and morally questionable. Sightholders who
have made a long-term purchase commitment to the
DTC end up paying substantially more for DTC goods
than those occasional and non-committed buyers
participating in Diamdel auctions.
Destroying Brand Value
For Diamdel to destroy financial and DTC brandequity
value by even considering undercutting DTC
sightholders is more a manifestation of De Beers’
management’s despair to sell goods than anything
else. If, hypothetically, De Beers is budgeted to sell,
let’s say, US$7 billion worth of rough in 2012, of which
US$5 billion would go through the ITO system, and if,
theoretically, clients leave US$1 billion of ITO goods on the table, the ITO format would say “new ITO’s will be
at a level of US$4 billion, rather than US$5 billion.”
Irrespective of the way the ITO system works, in
the present so-called new “dynamic pricing” system,
most sightholders will not be willing to get “rewarded”
with higher ITO’s. I also don’t think that Diamdel clients
would want to become sightholders, as at auctions
they pick up boxes at BELOW the cost price of the
boxes and they are spared the prospects of having to
sell DTC sight allocations at discounts. By lowering the
ITO’s the next time around, De Beers will be creating
another obstacle for itself on how to move the goods
onto the market. Actually, ITOs have become MORE
important to De Beers than to clients.
Message Manipulations
De Beers is managing the market (or, we should
say, its own market) through certain manipulations
including controlling its “messages” (such as saying it
is “leaving goods in the ground”). Indeed, the internet
sightletter remarks that “for the second consecutive
Sight in the new contract period, the DTC was unable
to meet its full ITO commitments to many clients across
a range of boxes due to shortfalls in forecast
availabilities.”
We find that hard to believe. De Beers has made
a commitment to the Botswana government to sell to
it some 10-15 percent of its output for domestic window
sales. The Botswana government has created a
marketing company, Okavango Diamonds, which, at
any time, is allowed to purchase this entitlement. So
far, it hasn’t done so. The arrangement doesn’t work
retroactively – in other words, goods which Okavango
has not purchased so far can be freely sold by the
DTC. For this, and other reasons, I don’t “buy” the
shortfall argument. It should have a few hundred
millions in stock that had been earmarked for
Okavango.
Let’s not overlook that Mellier’s policy, expressed
in the company’s 2011 financial review, is that “De
Beers produces in line with demand from our
Sightholders. … In the second half of the year [2011], as
it became clear that the market was beginning to
cool, we made the conscious decision to focus our
resources on maintenance and waste-stripping
backlogs. By addressing these issues when we did, we
have put our mines in a strong position to ramp up
production, as Sightholder demand dictates, in 2012.”
Saying “we don’t have the goods” sounds better
than admitting that its clients will not take the goods at
current prices; it will also enhance the atmosphere of
rough shortages. The DTC, at the June 2012 sight,
reportedly also declined to sell some additional goods
requested by some clients, which will further enhance
the “shortages argument.” (I find this a rather strange
decision since, when the DTC ultimately will sell these goods, it will be at lower prices.) |
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Sense of Confusion
Watching De Beers and listening to DTC
sightholders and other stakeholders, one gets the
sense that De Beers portrays a lack of direction, a lack
of confidence and conviction among management
and down to the sales team. Those attending one of
the client and management functions at the last sight
underpin the notion that all is not well among DTC
decision makers. Some of this is understandable: the
transition to Anglo American management and the
move to Botswana create considerable anxieties
among many employees. They are all waiting for
Anglo.
We have written before that the company’s
management has become much more of a spreadsheet
exercise. Clients aren’t that important – and they
are replaceable. What seems clear is that the “good
old days,” when sightholders were enjoying doubledigit
premiums on the sight boxes, are something of
the past. These days will not come back. That changes
something in the relationship equation. One might say
that, in the past, De Beers “bought” client loyalty as it
was really worth it to be a sightholder. Now, De Beers
needs to “earn” client loyalty – and they don’t seem to
be making a great effort anymore.
Even though Mellier stresses in recent interviews
that it is recognized that diamonds are “a different
kind of commodity,” I am not sure that Mellier knows
what that means or that I understand what he meant.
Maybe it is our problem.
While Anglo American decided to buy out the
Oppenheimer family’s stake in De Beers, Rio Tinto, BHP
Billiton and, most recently, Alrosa’s 51 percent
shareholder, the Russian federal government, have all
put up sale signs on their respective diamond
businesses. These changes affect nearly 70-75 percent
of the entire rough diamond supplies. It was a surprise
to many that the Oppenheimer family decided to
move out of the business altogether. (If his family,
especially his sister Mary Slack and her four daughters,
needed money – he still could have kept a sizeable
share in the business for himself and son Jonathan.)
These actions raise the basic questions of what
the future holds for the diamond mining industry and
what it will mean for companies in the downstream
diamond businesses. Are these companies really selling
the golden goose, or is it simply that the goose no
longer lays golden eggs? |
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Managed by Employees
One must look beyond De Beers – and many of
the industry changes we are witnessing are not of DeBeers’ making. On rough pricing, the industry has
already seen a pivotal shift in how rough is priced and sold. That is the industry legacy of the crisis. Diamond
producers have come to believe that the best way to
manage a slowdown is to keep the goods in the
ground, something which other industries have also
followed. There, the diamonds are safe, can be
extracted when required, and don’t even run afoul
with anti-trust regulators.
What has undoubtedly changed for the worse is
the perspective of the producers themselves. These
businesses are no longer run by people who own
them. Instead, the businesses are managed by
professional managers appointed by the boards.
That’s the main change we see now at De Beers,
where, by tradition and by management contract, the
Oppenheimer family ultimately made the final
decisions.
These professional managers may or may not
have diamond business experience. Their sole focus is
the profitability of the company over the duration of
their tenure, which might be between three to five
years. For some of these managers, reducing rough
production seemed like the golden wand that could
help them push up volumes.
The “benevolent” producer does not exist
anymore, with all the large producers purely focused
on maximizing their prices, rather than ensuring the
basic health of the pipeline. A professional manager
has to justify to his board that he is securing the best
possible prices during the course of his tenure. He is not
really concerned about whether his customers are
really profitable or whether the producer is really the
supplier of choice. That would be the problem of the
next manager.
Prices over Sustainable Levels
Looking just at the last 12 DTC sights or so, one
can distinguish price movements in both directions
ranging from 25 percent upwards to 25 percent or
more downwards, depending on the boxes. DTC sight
box comparisons are complex, as in many instances
the composition of boxes have also seen changes –
and if a box containing from four to eight grainers
changes the ratio of sizes, this impairs the validity of
comparisons. Nevertheless, we believe that our charts
are broadly representative.
The chart shows the five categories of boxes
where DTC average prices were the lowest, when
compared to the prices in April 2011.
The chart shows the five boxes where DTC average
prices moved the highest, when compared to the DTC
box prices from April 2011 to today.
In most of these boxes, it’s interesting to see that
the average price seems to have actually increased
by up to 29 percent between the first and the fifth sight
of 2012.
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We do express some caution. These prices are
based on a simple average of individual boxes
constituting each category. They do not account for
the actual carats sold and, hence, may not necessarily reflect the actual mix provided within the boxes and
across boxes. Hence, these might not necessarily reflect
the average price achieved by DTC.
Russians followed DTC pricing policy. Their goods
are also priced much above market – in same if not
higher ranges than DTC. Alrosa’s product mix is different,
more smaller and better quality diamonds, where
prices moved up much more DTC Prices peaked in
July/August of 2011. At that point of time, most industry
players considered DTC rough prices about 10 percent
higher than what was sustainable. Over the course of
nearly one year, polished prices have dropped about
15 percent, while DTC prices also seem to have dropped
about 13 percent, which would mean that the current
prices would also be about 10-15 percent above
sustainable levels. |
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The Prospects of De Beers
Looking at a crystal ball, what is the likely
outcome for De Beers for its current supply and pricing
policies? We believe that it is more than likely that:
De Beers will lose market share to other producers.
Management may not meet its profit targets –
and staff may miss out
on bonuses.
De Beers may run
into more cash-flow
challenges (if there are
more sights where
US$100-US$150 million is left on the table.) This requires
reliance on Anglo American’s deep pockets. the
rudest awakening will come when De Beers’
management will wake up one morning to see that
the goods left in the ground today cannot be sold at
a higher price tomorrow.
Reducing rough supplies when you are not a
near-monopoly is
essentially a
suicidal move, with
other producers
(read Alrosa, BHP
Billiton, Rio Tinto,
Harry Winston
Diamond Corp.,
Gem Diamonds,
Petra, etc.) laughing their way to the bank. De Beers
inevitably will change its course, as survival is a stronger
instinct than ego, but the damage might be irreparable
if the changes aren’t done sooner rather than later.
The market is heading for three difficult years –
but De Beers will underperform other producers in
terms of profits and will lose market share. In the
diamond business, we are not still getting out of the
last crisis, we are heading into a new one at full speed.
True, that may not be up to De Beers. But De Beers is
making sure that it is positioned in a worse place than
other producers. This is in nobody’s best interest –
nobody! |
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