Diamond cartel relies on deep pockets

As more and more Canadian companies join the rush for diamonds, the market for their discoveries is looking increasingly vulnerable.

A recent flood of gem-quality diamonds from Angola, where an estimated 50,000 garimpeiros are scooping up alluvial diamonds by the bucketful, has rattled the Central Selling Organization (CSO) — the marketing arm of De Beers which controls 80% of the world’s rough diamond trade. The giant cartel, which maintains high prices for diamonds by regulating sales and supply, is said to have spent more than US$200 million this year to absorb the stones smuggled out of Angola. So concerned is De Beers about the Angolan threat and the lingering worldwide recession that it has deferred purchases from cartel members and reduced its dividend for the first time in a decade.

Over the past year, shares of De Beers have fallen from a high of US$30 to US$10.50 on NASDAQ.

Historically, attempts to control commodity prices through cartels have been doomed to failure. Last to give way was the International Tin Council (ITC) that controlled world tin prices for almost 30 years. The inflated prices created by the cartel encouraged tin production outside the ITC membership and, coupled with declining demand, the oversupply eventually led to the collapse of the cartel, and of tin prices, in 1985.

But some analysts believe De Beers will be able to weather the Angolan storm, especially if a newly elected government puts an end to the illegal mining there.

“De Beer’s results are likely to remain dreadful for another 2 to 3 years and swinging dividend cuts can be confidently expected,” says Peter Miller at Yorkton Securities. “The balance sheet will become further strained, but the CSO will survive and prosper just as it has done in the past.” The diamond giant’s substantial cash reserves (US$2 billion held by sister companies Anglo American Resources and Minorco alone) and loan facilities are available as a buffer for unexpected supply. And the cartel has a 58-year track record. It survived a similar glut in the early 1980s when, by dumping individual diamond stocks, speculators drove the price of a 1-carat flawless diamond down to US$10,000 from US$60,000.

But there are other forces emerging in the diamond market that threaten the South Africans’ stranglehold. The global recession has damaged sales. In Russia, producers may have found a way around a wide-reaching sales contract with the CSO by establishing their own polishing stations. Since the agreement covers only rough stones, the polished diamonds could be sold to the West without violating the contract terms.

Russia produced an estimated 12 million carats worth US$1.1 billion in 1991. Although it is in the interest of all producers to maintain the cartel and the related price stability, the temptation to cheat could prove to be overwhelming for a nation desperate for hard currency, say some observers. De Beers itself has contributed to the supply glut by recently opening the Venetia mine in South Africa. Venetia is expected to produce 5.9 million carats per year by the end of 1993.

And if predictions made by several international experts unfold, Canada will also become a significant diamond producer before the end of the century. But will there be a market for the new deposits?

Bob Bishop, editor of the newsletter Gold Mining Stock Report and ardent follower of the Lac de Gras play, says the question is irrelevant at this stage in the game.

“The key difference between exploration stocks and most others is that they are (sometimes perceived to be) in the business of adding value by discovering something not formerly known to exist — an orebody, a mineral deposit that is economic to mine. The short-term stock play associated with this phenomenon is of far greater significance than one’s opinions of long-term price trends in the market.”