Tough conditions for rough diamonds

Anglo American (AAL-L) reported diamond production fell in the second quarter ended June 30 by 11% to 7.2 million carats largely due to market conditions and a focus on planned maintenance and waste stripping while De Beers, in which Anglo American currently holds a 45% stake, reported profits for the first half of 2012 fell sharply year-on-year.

Softness in the diamond market sent De Beers’ first-half profit before finance charges and taxation down to $502 million from $1 billion in the year-ago period. Total sales slid 14% to $3.3 billion from $3.9 billion and diamond production dropped to 13.4 million carats compared to 15.5 million carats in the first-half of 2011.

The company forecasts it will produce between 28 million and 30 million carats of diamonds this year, a slight drop from the 31.3 million carats it produced last year.

Philippe Mellier, De Beers’ chief executive, told news agency reporters that the company is allowing “sightholders” — buyers of rough diamonds such as cutting and polishing centres — to defer up to half their diamond purchases until March 2013.  

But some analysts question that move, even in the current tough market conditions. Charles Wyndham , founder of Polishedprices.com in the United Kingdom, said in a telephone interview that the decision raises questions about whether it is really a sale at the price it claims to be, and argues it would be much better for De Beers not to sell the goods forward under the circumstances.

“Presumably they have to sell the goods as they have their own pressures but in the cold light of day if you were selling Mars candy bars and you said to your customers, ‘you can buy two tonnes now but you can defer one tonne of it until next March at today’s price,’ what would you think?”

“The market is not good to put it mildly,” he adds. “De Beers’ figures are obviously flattered because they haven’t dropped their prices in relation to market conditions. They’ve knocked a few percent off here and there—maybe 3%—but that’s all…Now if they hold the line, and if they can fill the volume they need to fill, then fine, but history would tend to suggest that even when the company had a much bigger market share they just couldn’t buck the trend.”

Wyndham adds that while the gap between rough and polished prices is still too wide and must come down, it is slowly narrowing.  “You can’t have prices for rough diamonds continuing to charge ahead of polished prices forever, it’s not logical,” he explains. “It just can’t continue to go on…it has to come somewhere between a sensible ballpark.”

In addition, considering the general economic malaise and what’s happening in Europe in particular, he says, polished prices have actually not performed all that badly. “All luxury goods have had a hard time and in relation to that, diamonds are probably not doing that badly…People are still getting married. As long as you don’t have a complete meltdown in Europe, I’m not that pessimistic, but that’s a huge caveat.”

Edward Sterck of BMO Capital Markets in London noted that De Beers sees moderate growth in global polished diamond sales in 2012, mainly supported by demand from the USA, China, Japan and Gulf markets, but that the company “expects trading conditions for rough diamonds to remain challenging in the second half of 2012.”

He pointed out that De Beers’ analysis of market conditions and its outlook in the second half of the year is in line with BMO Research’s expectations for “subdued prices in 2012 followed by a return to growth in 2013.”

Sterck also reported that Anglo American’s decision last year to purchase an additional 40% stake in De Beers from the Oppenheimer family is expected to close in the current quarter. The sale has received regulatory approval and will take Anglo American’s interest in De Beers to 85%.