Diamonds suffer from oversupply, price falls in new era

Only eight years ago, De Beers celebrated the opening of Snap Lake — a landmark project for the diamond producer.

The diamond mine in Canada’s remote North West Territories was De Beers’ first outside its African heartland and the first completely underground diamond mine in the country. By the end of 2014, $2.2bn had been spent on development and operations.

Yet today, not a single diamond is being produced at Snap Lake, which has been closed with the loss of more than 400 jobs as De Beers responds to one of the worst market downturns in diamonds for years. This year, De Beers will consider whether the mine has a viable future. As recently as 2014 the mine was producing 1.2m carats of diamonds annually.

The temporary closure of the mine summed up the problems facing the diamond industry during 2015, when a downturn gathered pace and led to financial pain for miners, dealers and retailers.

The industry confronted “a perfect storm of problems” in 2015, said Philippe Mellier, De Beers’ chief executive, this month.

Today, a greater degree of cautious optimism is apparent but many diamond analysts think the sector could still face tough times this year as the impact of rising supply and weak demand continues to be felt in the market. “Elevated inventory levels of rough diamonds and weak end markets will inhibit any recovery in rough diamond prices for at least 12 months,” analysts at Liberum, the equities brokerage, say.

There is a degree of consensus in diagnosing what has gone wrong in the industry over the past 18 months. Supply from projects such as Snap Lake and other new mines had grown steadily over a six or seven year period. It was absorbed by the “midstream” of the diamond trade — the polishers and dealers — aided by widely available cheap finance.

But signs of cooling retail demand, particularly in China, and more caution by the banks that provided financing for the diamond trade, led to pressure to reduce midstream inventories.

“Manufacturers and channel players had built considerable speculative stockpiles, supported by inexpensive financing and an industry-pervasive belief that rough diamond prices could only rise,” analysts at Citi, the investment bank, say. “When prices began to decline in 2015 amid tepid demand growth, particularly from Asia, and there was reduced industry financing as a prominent diamond financing bank reduced exposure, a pronounced destocking cycle ensued.”

Industry upheaval has led to friction between large miners such as De Beers and some customers

The consequent period of “inventory indigestion”, as many in the trade describe it, led to much lower demand for mined rough diamonds. At De Beers, rough prices fell 15 per cent in 2015 — contributing to the pressure on mines such as Snap Lake. De Beers also shut its smaller Damtshaa mine in Botswana.

Industry upheaval has led to friction between large miners such as De Beers and some customers over how the pain is being shared. De Beers, which has begun to introduce more transparency into its operations, insisted in December that its price cuts were leaving room for its customers to be profitable.

The industry turmoil last year points to a big difference between today’s diamond market and the situation a couple of decades ago, when De Beers had a monopoly on supply and could manage the market more effectively to control prices.

During last year’s downturn, De Beers, which is now owned by Anglo American, and its main rival, Alrosa of Russia, the largest miner by volume, did cut sales to try to manage supply: Liberum estimates that the duo have built up 20m carats of rough inventory over the past 18 months, against an annual market of 135m carats.

But today the pair control less than half of diamond supply, according to Citi, so their ability to influence the market is limited. Miners such as Rio Tinto, Petra Diamonds and Dominion Diamond are all a larger force than they were just four years ago.

The trade is now focused on how quickly demand will stabilise and increase, helping to eliminate the overhang of inventory. The signs are mixed.

Underlining its claims to be more transparent, De Beers has started to publish data from its 10 annual diamond sales events (known as sights). The first two sights of 2016 achieved revenues of $545m and $610m, regarded as a strong result. Meanwhile, Johan Dippenaar, chief executive of Petra, said last month that he was encouraged by stable diamond market conditions. And De Beers has taken the lead in pumping more money into marketing spending to encourage demand.

Yet there are continued headwinds in the form of the strong US dollar, which is dampening demand from some emerging markets. Chow Tai Fook, China’s biggest jewellery retailer, reported a 20 per cent drop in demand for gem jewellery over its key Chinese new year period. And weaker oil revenues for states in the Middle East are also denting consumer demand.

Notwithstanding the shutdown at Snap Lake, De Beers is preparing for the opening of a new Canadian mine this year — Gahcho Kué. Mr Mellier takes comfort in the fact that, while emerging markets remain fragile, the world’s largest and most mature market — the US — remains buoyant.

“We have seen the American consumer’s love affair with diamonds go from strength to strength,” he said in a speech this month. “As the industry begins once again to increase its investment in advertising, there is an excellent opportunity to win back share of wallet from other luxury products.”