Caution Still Reigns

RAPAPORT… The second half of 2010 started with the traditional quiet period as the U.S. embarked on its summer vacation, and Israel and Belgium prepared for their August break. Some industry observers questioned, however, whether the slowdown in trading could be attributed entirely to the holiday period or if other factors also contributed.

Certainly, there are valid reasons for caution. One cannot discount reports indicating a slump in demand for polished and increased pricing flexibility by sellers who are lowering their polished prices. At the same time, a shortage of rough — and even polished — in certain areas is leaving manufacturers frustrated as they forecast better demand in the months ahead. In addition, financial and commodities markets have turned more bearish, and subsequently stable, in the past two months, after a strong bull run in the first half.

None of these developments should come as a surprise — such is the nature of this roller-coaster recovery. “Just as we suffered more than the reduction in consumer demand suggested we should during the downturn, so we have recently been benefiting more than consumer demand increases would imply,” Varda Shine, managing director of Diamond Trading Company (DTC), wrote in a recent note to sightholders. “While the pace of growth is likely to slow a little in the second half, we should not be worried by this, as it is what we have always expected.”

Bearish Markets

Already, signs of a pullback have appeared, which Des Kilalea, an analyst for RBC Capital Markets, referred to as a “consolidation period” for the diamond sector. He noted that many in the cutting centers are expecting rough prices to soften by 5 percent to 10 percent as a result of “still sluggish” jewelry sales in the U.S., Europe and Japan and some slowing in demand growth in China.

While many have correctly observed a steady improvement in U.S. market conditions, the U.S. trends through July indicate a jittery environment. Most telling, consumer sentiment in July fell to its lowest level in 11 months, according to Thomson Reuters/University of Michigan’s Surveys of Consumers, which attributed the sudden drop to “extraordinarily weak” income and job prospects that have made consumers much more cautious spenders. This, after the U.S. Department of Labor reported that the economy lost 125,000 jobs in June.

And it appears that it’s not only the unemployed and lower-income earners who are tightening their belts. According to a recent report by Moody’s Analytics, one of the reasons the recovery has lost momentum is high-end consumers have become more cautious.  

The slump in mood may have resulted from the stock market declines seen recently — all the broad-based U.S. stock indexes are showing losses of more than 3 percent for the year to mid-July. The S&P 500 Index dropped 3.9 percent through the period, with the steepest downtrend taking hold from May on (see graph opposite). The economic uncertainty is further reflected in the diamond market, where polished prices moved to a slight downtrend in the month until July 20 (see graph on page 20).

Bullish Miners

Still, as Shine emphasized, the fundamentals of the industry remain positive and most industry players are expecting the second half, in particular the Christmas buying season, to be better than last year, especially given the depleted numbers of 2009.

Mining companies are ramping up sales and Gokhran, the Russian state repository, is hinting that it may sell a portion of its stockpile to the market. Their optimism is based partly on a speculative element seen among manufacturers, but mostly due to shortages reported in the market and the strong recovery seen in the first six months of the year.

ALROSA reported that it sold $1.93 billion worth of diamonds in the first half of the year, outpacing sales in the same period in each of the three previous years (see chart on this page). The company’s production, meanwhile, remained about stable at 17.4 million carats, indicating that higher prices were the growth driver. Other mining companies also saw better sales values on the back of significant rough price increases.

Among these, Gem Diamonds reported that the average price at its high-value Letseng mine in Lesotho rose 32 percent year-on-year in the first half of 2010 to $1,728 per carat, although prices remain far off the comparable 2008 levels (see chart on opposite page). Positive trends were also seen at Gem Diamonds’ Ellendale mine in Australia, where prices rose 171 percent to $434 per carat, while Petra Diamonds reported that the average price achieved at its South Africa–based Cullinan mine rose 114 percent to $141 per carat in the year that ended on June 30, 2010. 

A closer look at these numbers indicates some softening of prices from the first quarter to the next and miners will likely count on quarter-to-quarter stability in the current period, if not a slight further decline.

Confused Manufacturers

All these developments have affected the mood among traders and left them somewhat confused as to how the market is playing out at the moment. More than ever, it seems diamantaires may take the summer holiday off this year as they wait out the slow July-August period.

There is some hope that trading will be given a boost by the India International Jewelry Show (IIJS) in late August and then again by the September Hong Kong Jewellery & Gems Fair before the final push toward Christmas. As one Israel-based manufacturer said, “Now’s a good time to renovate and, hopefully, the final quarter will be good.”

He would be heartened by Shine’s conclusion to sightholders. “While 2010 may end up being a year of two halves, with the second six months being the responsible half, it is encouraging that the fundamentals of the industry mean that both should be positive,” she said. “Slow progress is better than no progress and by the end of the year we should still be comfortably ahead.”

While it is true that the recession hit hard and fast, it is not necessarily the case that the recovery should swing back in the same manner. In fact, long-term global economic growth, as well as that of the rough and polished diamond markets, will be easier to sustain if it develops at a slower pace. After the strong run experienced in the first half, it is indeed expected that growth should ease in the second six months. How the industry reacts could mean that the true test of a sustainable recovery therefore lies in the months ahead.