LETTERS TO THE EDITOR — Prices of diamond stocks just don’t

Since you provided space for readers who were incensed by Paul Sarnoff’s article (“Canadian Diamond Stocks Can Be Dangerous to Your Wealth” in the July 7/93 Gold Stock Advisory), I hope you will also provide space for those of us who are incensed with those who continue to support the current stock prices for Dia Met Minerals.

While it is encouraging to see such emotion and optimism for Canada’s mining industry, as exhibited by people involved with the diamond plays, their non-biased positions are not serving investors appropriately. I do not purport to be a diamond expert nor do my comments require that I be one. I am not going to say whether a diamond mine will or will not be found in Canada. What I have to say is rational, being based on my 20-plus years in the industry.

To put the diamond play in perspective, the resources afforded various projects by companies such as RTZ, BHP and De Beers are a small percentage of those companies’ overall worldwide exploration budgets. The Northern Miner estimates more than $50 million will be spent in the search for diamonds in various camps this year. While the amount is not trivial given today’s economic environment and bearish prices for base metals, it is small when compared with the funds spent in the ’70s and ’80s in areas such as Ontario’s Hemlo district and Saskatchewan’s Athabasca region.

What appears to be missing in many “pro-diamond” stances taken in the press is an understanding of the true market relationships within the diamond industry. The world diamond market is essentially controlled by one company — De Beers. This company has developed a monopoly by virtue of the control it has over production. Diamond prices are artificially set through a combination of focused advertising and limitation of supply by holding surplus production in inventory.

Current diamond prices reflect De Beers’ control of the market. In future, as surplus production grows from areas such as Russia and South America, there is a strong likelihood that De Beers may find it cannot continue to control the price. As we have seen with the Organization of Petroleum Exporting Countries, the uranium cartel in the ’70s and the attempt by the Hunt brothers to control silver prices, when control is lost, prices plummet. The same can be expected for diamonds.

One characteristic which sets this country’s diamond camps apart from others in the world is the Canadian Shield. Both Russia and Africa are unglaciated and, as such, the bedrock tends to be weathered to fairly deep levels. Soft bedrock means lower mining costs. The Shield, on the other hand, tends to be somewhat siliceous and hard, which has a direct impact on mining costs. When this is factored in with the tax regimes and labor costs associated with mining in northern Canada, it is clear that the cash flow from such an environment cannot equate to that generated by diamond mines in other parts of the world.

At $60 per share and with 10.9 million shares outstanding, Dia Met might be fully valued if the company were currently earning around $2 per share and the market felt a price-to-earnings ratio of about 20 times (similar to Hemlo) were warranted. Dia Met is not, by any means, close to being a Hemlo. In fact, Dia Met is not earning $2 a share and there is no information at present that suggests it ever will. There is no indication from any of the diamond camps that a feasibility program is to be carried out on any particular pipe.

Anybody with experience in the mining industry knows that a long, winding road still has to be travelled and that numerous obstacles could prevent Dia Met from ever earning anywhere near $2 a share.

Given the risks, and the time required to bring any mine on-stream, the underlying value of the potential of any property is best determined by discounting the expected performance at a rate to reflect the uncertainty associated with the project. One can argue that an existing mine about to go on-stream should be discounted at 15% or 20%. This is after costs are certain and prices are more certain. In the case of Dia Met, one should at least double the discount rate, given the current status of the project. If one were to employ Wayne Fipke’s numbers (which, in my estimation, are grossly unreasonable) of $21.36-per-share earnings for Dia Met (T.N.M., Aug. 2/93) and apply a 10-year lead time for the company to realize that earning potential, in 1993 dollars, the $21.36 per share is $1.55 (discount @ 30%) and 74 cents (discount @ 40%). When a multiple of 20 is applied, the stock price should have a range of $14.80 to $31. If the profit margin turns out to be 20% (more realistic in my estimate), then these prices would be half ($7.40 to $15.50).

There will always be a market for Dia Met shares and there will always be some people willing to buy. As time goes on and there fail to be any indications that a mine will be developed, the price will fall, just as similar stocks have fallen in the past.

Mining is risky and the rewards can be substantial. For diamond stocks, those rewards are well into the future. Current prices are being buoyed by inflated expectations and the glamor associated with the clear, shiny stone. A hundred years ago, it was gold in the Klondike goldfields; today it is diamonds. The only difference is that in the 1890s there was gold in the creeks, which made a few people rich. We have yet to find diamonds in quantities that would make Dia Met investors rich (save for those who have already reaped the benefits by selling at $65; they, at least, have found their mother lode). William Olsson, P.Geol.

Calgary, Alta.