RAPAPORT… After the August summer break, the diamond industry anxiously awaits the fourth quarter to continue the wave of optimism that enveloped the market in previous months. Trends in the market, however, are delivering opposing messages as to where things are headed for polished diamonds and those who deal in them. A snapshot of rough diamond trends indicates a healthy demand for goods and a stabilization of prices after a two- to three-month rally. On the other hand, retail sales for the most recently reported second quarter point to continued declines and consumer spending remains hesitant.
While Rapaport News has for speculated for some time that the rough and retail markets are well out of synch, the now-published statistics confirm this belief. As we approach the beginnning of the fourth quarter of 2009, the data provide an opportunity to assess how these two sectors are developing and which trend is the best reflection of real market conditions.
What the Optimists Say
Reports from the De Beers Diamond Trading Company (DTC) August sight and tenders hosted by other mining companies during the month show that there is a strong interest in buying rough diamonds at prices consistent with July levels. Following the rough price declines of late 2008, which resulted from the slump in demand, rough prices started to recover in April, increasing by approximately 10 percent per month or 30 percent to 40 percent from their low point in the first quarter — viewed by many as a market correction. While rough prices increased slightly again in August, demand was strong as diamantaires prepared for India’s Diwali festival and the Christmas season.
The burning question about the rough market, which the mining companies are banking on, is whether or not demand will continue at these higher levels, outstripping supply. There is a major concern that ALROSA will yet flood the market with goods — a concern heightened after the Russian company mined more than 18 million carats of diamonds in the first half of 2009, but withheld sales. The company resumed sales in July, selling about $150 million worth that month and another $200 million in August. Alarmingly, however, repeated reports note that the company expects full-year sales to reach $2 billion, meaning that ALROSA intends to sell at least double its normal quantity to the market in the four remaining months of the year.
While diamantaires still report shortages in certain category goods, there is a real danger of oversupply in the market with ALROSA back in the game and De Beers mines back to near-full capacity. It is unlikely that such volumes in the market are sustainable or realistic at this stage.
Those expecting rough demand to continue to rise point to Wall Street for backup. Markets have been rather bullish of late, with the Standard & Poors (S&P) 500 climbing above 990 points in mid-August, well clear of the 680-point low seen in March. Similarly, oil is back above $70 a barrel, after hovering around $40 in February and March (see graph below). All of these developments signify improved conditions in the financial markets, which the Federal Reserve acknowledged, adding that “economic activity is leveling out.”
And Now the Downside
Despite these positive trends, there is every indication that consumers are not following Wall Street, as they are not showing signs of emptying their pockets any time soon. U.S. retail sales fell a slight 0.1 percent in July, propped up by a 2.4 percent rise in auto sales, thanks to the government “cash for clunkers” program. Excluding cars and gasoline, retail sales dropped 0.4 percent during July, down 8.5 percent from a year earlier. In addition, unemployment continues to rise, albeit at a slower pace, and another 247,000 jobs were lost in July, meaning that close to 6 million Americans lost their jobs during the 12 preceding months. Given these factors, it is understandable that consumer confidence is down and continues to fall (see graph below). The Conference Board Confidence Index fell 5.5 percent in July, while the Expectations Index fell 5.3 percent. Lynn Franco, director of The Conference Board Consumer Research Center, concluded that “more consumers are pessimistic about their income expectations, which does not bode well for spending in the months ahead.”
With confidence down, it is also reasonable that jewelry was among the weaker sectors of the economy. In tough times, luxury items naturally take a backseat. The World Gold Council (WGC) reported that consumer demand for gold jewelry fell 22 percent during the second quarter of 2009 from the same period a year earlier. Second-quarter sales at publicly traded jewelry retail companies showed continued decreases, although there was a slight easing of the declines compared to the first quarter (see table below).
Most notably, Signet, the world’s largest jewelry retailer, saw second-quarter sales fall at the same rate as in the first three months, down by around 7 percent. Etailer Blue Nile, considered a barometer for the industry since it deals in all category diamonds, saw some improvement with a decrease of 5 percent, after a fall of 11 percent in the first quarter. Sales have naturally been more affected by the recession at the high-end jewelers, such as Harry Winston and Tiffany & Co. Tiffany has forecasted that its sales will decline 11 percent for the full fiscal year. Furthermore, Finlay Enterprises filed for Chapter 11 in August, joining the string of jewelry retailers already seeking bankruptcy protection.
Polished Trends
The second-quarter results emphasize the gap that has developed between the rough and polished diamond markets, as reflected in their retail performances. In addition, while rough prices rose earlier in 2009 and steadied through August, polished prices remained stable throughout the year at the lower level established in late 2008 (see graph below). There was some softening of polished prices in August due to Indian buyers resisting the high asking prices sought by foreign traders. Demand from India, where the trade was focused in August for the India International Jewellery Show (IIJS), was strongest for smaller goods of 0.30- to 1.50-carats, H-I, VVS-VS certs. There was also some improvement in the demand for stones above 3 carats in China and Hong Kong. Indeed, any real recovery in 2009 will be spurred by these Asian markets. Nevertheless, trade remains reliant on the U.S. and therefore weak, as reflected in the 48 percent drop in U.S. polished imports in the first half of 2009.
Relying on Retail
We reassert our view that retail is the strongest indication of how the market is playing out — now as much as ever. It is, after all, the only variable along the diamond pipeline that is not controlled by diamond people.
In contrast, the rough semi-boom of May through July was spurred by the lack of production in the first quarter, the lull in manufacturing in the same period and high hopes and growing expectations from diamantaires.
While these three factors have all begun to settle in the third quarter, it appears that the rough market overextended itself during the second quarter. It is therefore likely that demand and prices peaked for the year in August. In fact, we expect the rough market to downturn slightly toward the end of 2009. Should ALROSA flood the market with its stockpiled goods, a steeper correction will necessarily occur because retail demand is not strong enough to maintain such an influx of rough diamonds into the market.
Even without the extra ALROSA goods, we believe that the surge in rough is artificially high and does not yet reflect conditions on the ground. Only when the two markets meet, and rough demand is driven by jewelry retail growth, will a sustainable recovery seem likely. In the battle of influence over the diamond industry, retail should always win.
LH
