Diamonds In For A Rough Ride, But Future’s Still Brilliant

Saskatoon, Sask. — As diamond producers and explorers alike consider the global financial situation, they know they are in for a rough ride. However, even before the financial crisis hit, most in the diamond industry felt the industry was due for a crash, regardless of the state of the global economy.

For several years now, the demand for polished diamonds has increased steadily but not kept pace with the demand for rough diamonds. The price of rough diamonds continued to rise for three reasons: an overcapacity in manufacturing; the producers’ reluctance to stockpile; and the traditional belief that a customer had to buy in order to maintain his or her place at the buying table.

Supported by the diamond banks, diamond debt in the trading and manufacturing centres has increased to more than US$12 billion, almost as much as the value of annual rough diamond production. The difference between the price of rough diamonds and the price of polished diamonds was unsustainable.

This bulge in the diamond pipeline, which was created when De Beers sold off its stockpile of rough diamonds in the first years of this decade, has slowly been making its way through the system.

The surplus reached the diamond retailers this year, hitting a wall of declining consumer confidence and demand. During most Christmas seasons, retail jewellers will generally make 40% of their annual sales. That is unlikely to happen this year. Despite already beginning discounting and reducing prices, diamond jewelry sales in the U. S. will likely be down 15%. As retailers have reduced orders, jewelry manufacturers and polished diamonds wholesalers have reduced purchases.

As a result, buyers of rough diamonds are beginning to walk away. Over the past couple of months, sightholders purchasing from De Beers have left rough diamonds on the table. The secondary market for rough diamonds has dried up. Prices of rough diamonds have fallen about 15-20% since the summer, more in some categories of rough.

What is unique about this downturn is that it is the first the diamond industry has faced since De Beers lost control of the industry and relinquished its custodian role.

Thirty years ago, the industry would have waited for direction from London on what steps needed to be taken. In this new world of “Supplier of Choice,” multiple rough diamond producers and vertically integrated industry players, one wonders how the industry will respond. The initial signs are positive: an industry working together to share the burden.

India’s Gem & Jewellery Export Promotion Council (GJEPC) announced in November that the Indian diamond industry would stop all rough diamond imports into the country for a month starting on Nov. 25. The move, by the world’s dominant diamond-cutting jurisdiction, is an effort to reduce polished diamond inventories and provide diamond banks with a signal that the industry will not increase its indebtedness. It will also apply some pressure to diamond miners to reduce supply.

Also in November, the industry organized the Antwerp Diamond Symposium, a gathering of industry leaders to discuss the impact of the global financial meltdown on the diamond business, and to consider coping strategies. At the meeting, all major rough diamond producers committed to reducing supply to the market over the short term.

Russian diamond miner Alrosa has indicated that it will reduce rough diamond supply by up to 40%, while De Beers has said that it will also reduce production.

In Canada, De Beers will cut production from the Snap Lake and Victor mines, in the Northwest Territories and Ontario, respectively. Slowdowns are likely at BHP Billiton’s (BHP-N, BLT-l) Ekati mine and Rio Tinto (RTP-N, RIO-l) and Harry Winston Diamond’s (HW-T, HWD-n) Diavik operation, both in the Northwest Territories, as well.

This supply reduction will help sustain prices, a critical issue as much of the industry debt is backed by diamond inventory.

Industry analyst Chaim Even- Zohar estimates that the demand for diamonds at the retail level will fall about 10% over the coming year. This would translate into a decrease in demand for loose polished diamonds at the wholesale level of about 20%, and a 35% fall in demand for rough diamonds.

All is not doom and gloom; the medium to long-term outlook for the diamond sector is still very strong. Once the global economy begins to recover, and the American, Indian and Chinese consumers regain their confidence, current rough diamond production will be insufficient to supply the market.

Once the polished diamond surplus within the diamond pipeline is consumed, and the overcapacity in diamond cutting and polishing is reduced through closures and bankruptcies, polished and rough diamond prices will recover quickly.

A lack of major diamond discoveries and developments over the past 10 to 15 years, combined with maturing mines with reduced production and higher costs, means that current reserves are estimated to provide 20 years supply at current production levels.

We need to remember that, while still a luxury good, diamond jewelry continues to enjoy some demand even through recessions, as people still get married, have anniversaries and celebrate special events.

Canada should see a number of positive developments in the diamond sector during 2009.

Stornoway Diamond (SWY-T, SWYDF-o) made a significant step forward at its Renard project in Quebec’s Otish mountains with the recent release of a preliminary economic assessment — though without a road, the viability of the project is still in question. The Quebec government is conducting a prefeasibility study for a road into the Otish mountains that should be completed by mid-2009, and may provide continued momentum for the project.

Shore Gold (SGF-T, SHGDF-o) recently submitted the project proposal for its Star kimberlite project in central Saskatchewan to the province’s Environment Ministry, kicking off the environmental assessment process. The project has been expanded to include not only Shore’s 100%-owned Star kimberlite, but also the Orion kimberlites on the Fort la Corne joint-venture property, owned 60% by Shore and 40% by Newmont Mining (NMC-T, NEM-n). This likely signifies that Newmont is stepping up its involvement in the project.

In the Northwest Territories, an environmental assessment of De Beers Canada’s 51%-held Gahcho Ku project, a joint venture with Mountain Province Diamonds (MPV-T, MPM-x) (49%), will continue to progress slowly through the territory’s regulatory and review process.

While lower rough diamond prices and demand would hit the revenue side of these projects in the short term, the upside is that the economic slowdown would likely reduce construction costs. Subject to final economic assessments, financing, permitting and approvals, all three of these diamond projects could be producing in 2013, in time to ride the next wave.

Next year may not produce a lot of excitement in the ranks of the diamond juniors. And not because of a lack of projects — in fact, there are a number of projects with great potential — but rather a lack of confidence in the market. Difficulty in securing financing will slow and delay most exploration projects.

Diamond projects such as: Dianor Resources’ (DOR-V, RSDNF-o) Leadbetter; Diamonds North Resources’ (DDN-V, DDNFF-o)Amaruk; Shear Minerals (SRM-v) and Stornoway’s Churchill; Stornoway’s Aviat; and the Buffalo Hills joint venture of Diamondex Resources (DSP-V, DMDXF-o), Shore Gold, Encana (ECA-T, ECA-n) and Pure Diamonds Exploration (PUG-T, PUGZF-o), will all move forward next year, but not as quickly as perhaps desired, or deserved. Results from bulk-sample programs at these projects, and others should provide some stimulus for junior exploration companies’ shares and the market in general.

The decision in late November by BHP Billiton to exercise its buy-in rights for Peregrine Diamonds’ (PGD-t) Chidliak project on Baffin Island is another indication of the Canadian Arctic’s strong diamond potential.

The global diamond industry will have a difficult year in 2009, with reduced production by the rough diamond miners, bankruptcies and downsizing amongst the diamond cutters, polishers and jewelry manufacturers, and reduced sales at the retail level.

However, the industry’s fundamentals remain strong in the medium to long term, as even with slower growth, the demand for polished diamonds and diamond jewelry will soon outstrip the rough diamond supply. –Based in Saskatoon, Sask., the author is proprietor of Diamond Consultants Canada, which provides strategic planning and advice regarding all aspects of the diamond industry. He can be reached at mirving@sasktel.netor www.diamondconsultants.ca