Investing in a Rapidly Changing Diamond
Industry
By:
Michael Molman
Diamonds
are called “a woman’s best friend”. They can be used to show off your incredible
wealth, cut granite, or launder money if you’re an African warlord. In any case
diamonds are the physical representation of opulence, and the industry is going
through a period of change that provides investors with huge opportunities.
The
diamond trade has traditionally been one of the most secretive industries in
the world. De Beers, a diamond cartel, had an almost absolute monopoly on the
business for over 100 years, during which it regulated the supply of diamonds
and kept prices inflated. A few diamond trading houses located mostly in
Antwerp, Belgium, were designated “sight holders” by De Beers and could
purchase rough diamonds in bulk (rough diamonds are diamonds yet to be cut and
polished). These diamond trading houses were the secret link between diamond
mines in African countries like Botswana and premium jewelry outlets in New
York, London and Hong Kong. Diamond trading was a largely deregulated affair and
deals were often done behind closed doors with little or no paper trail. While
other industries modernized, and were transformed by improving technology,
diamond trading remained entrenched in its roots.
This
all began to change during the early 2000’s when suddenly people began to
notice how diamonds were financing brutal regimes and atrocities in Africa. Movies
like “Blood Diamond” and “Lord of War” showed how diamonds illegally sourced in
war zones in Africa using slave and child labor, were used to finance war and
horror. Amid public uproar governments began to increasingly scrutinize the
diamond industry. Under increasing public pressure and government regulations
De Beers made the decision to only sell diamonds sourced at its own mines
(before De Beers would force independent diamond miners to market and sell
their diamonds through them, threatening to flood the diamond market with
supply if the independent miner refused.). Free of the De Beers diamond
monopoly smaller diamond miners began to grab market share and produce their
own diamonds and for the first time there was no single player regulating the
supply.
IDEX Diamond Index showing cut diamond
prices from January 2013 to July 2017. Oversupply and changing consumer tastes
have pressured prices.
Six years after
the bursting of the diamond bubble the industry still faces significant
hurdles, chief amongst which is lack of financing. Diamond trading is a capital-intensive
business, traders often borrow hundreds of millions to buy stones, and until recently
banks were willing to lend this money to them. However, due to a fall in
diamond prices traders are having a harder time paying back loans taken out
before the crash. This coupled with new regulations by governments have led banks
to make the decision to pull out of the diamond business entirely. Banks like
KBC Group and Standard Chartered, formerly the largest lenders to diamond
traders have decided to pull out of the business. Standard Chartered alone has
already taken over $400 million in losses on its diamond loans and still needs
to recoup some $1.7 billion in loans to diamond traders. KBC Group meanwhile
has taken more drastic measures in trying to recoup its diamond loans. In
August, KBC had the offices of diamond distributor Exelco which owed the bank
$30 million, raided. This raid forced Exelco, a De Beers “sight holder” and
prominent diamond trader which sold to retailers like Signet Jewelers and Jared
Galleria, to declare bankruptcy. Other diamond traders are hardly faring
better, fellow Antwerp diamond trading house, Arjav Diamonds, has seen revenue
decline over a third from two years ago to $542 million and has had debt
increase to over $500 million. Some traders have cash reserves so low they have
trouble finding people willing to do business with them.
While
diamond traders suffer under the weight of bad loans and lack of financing,
diamond retailers like Signet Jewelers and Tiffany face slower diamond sales in
Western markets. Changing consumer preferences and falling marriage rates are
taking their toll on companies who derive much of their income from selling
expensive diamond engagement rings. Meanwhile diamond miners have seen their
stocks crushed after a series of issues including mine setbacks, political
fights, and low prices. Shares of smaller diamond producers have on average
fallen 30% in 2017, meanwhile the overall mining sector is up by double digits.
Every part of the diamond supply chain seems to be in complete turmoil and this
has led to investors shunning the industry. However, there is light at the end
of the tunnel, certain developments are in the works that could revive and
transform the industry and that is where the opportunity is.
Diamonds
have many uses, as the hardest substance found on Earth they have many
industrial uses and because of their natural beauty they are popular in jewelry.
These features mean that no matter what diamonds will always been a source of
value, much like gold. However, while gold was mined in large enough quantities
to be used as currency, diamonds are rarer so it was never practical to use
them as money. This meant that even when gold currency was disbanded, several
gold exchanges popped up to allow traders to invest and trade the metal. Now days
over 60% of gold is used for investment purposes and only 40% is used for jewelry.
There is now a push to make diamonds the next gold, an investable commodity
that can be traded on exchanges around the world allowing investors to hedge
risk.
If
diamonds become an exchange traded asset like gold, silver or platinum, it
would bring greater liquidity, price transparency and stability to an industry
which has been in turmoil for years. This is not a new idea, the diamond
industry has been trying to set up diamond based investment derivatives for
years, the problem always was, unlike gold, there is no one type of diamond.
Diamonds come in different colors, clarity and cut, this makes it incredibly
difficult to create a standardized investment grade diamond product. Also, there has never been a spot price for
diamonds, prices usually varied from vendor to vendor. These things meant that to
invest in diamonds one needed to be an expert. This is beginning to change as
some people are trying to create a modern market for investment grade diamonds.
Diamond Futures
In
August of 2017 The Indian Commodity Exchange (ICEX) launched the world’s first
diamond based futures contract, to provide Indian diamond exporters with a way
to hedge prices. India is one of the largest centers for diamond trading in the
world, 14 out of every 15 rough diamonds that comes out of the ground is cut
and polished in India. From March 2016 to March 2017, India imported about 153
million rough diamond, worth about $19 billion and exported over $24 billion in
cut and polished stones. Indian banks, unlike their western peers, have been
eager to lend to diamond traders, partially filling the financial void left by
the exit of other western institutions.
Those
facts have encouraged some in India to launch a diamond futures contract to
help deliver greater liquidity and price transparency. Contracts will be for 1
carat with expiration in November, December and January. ICEX’s diamond future
gives traders their first opportunity to speculate on diamonds, which opens the
industry to the public for the first time.
Diamond Bullion
Futures
contracts are not for everyone, they tend to be too risky and complex for
average investors. Therefore, in October of 2017, the Singapore Diamond
Exchange (SDiX), launched another exchange traded diamond product, diamond
bullion. This bullion will be a credit card sized package of investment grade
diamonds, that will be exchange traded, allowing investors to trade it globally
similarly to how they trade gold or silver bullion. There will be two different
types of diamond bullion, silver; which began trading at $100,000, and gold;
which will include higher end stones and be worth $200,000 (begins trading in
January). The prices of these two types of bullion are determined by supply and
demand, like any other exchange traded asset. The diamonds included in each
bullion are authenticated by the Institute of Diamond Grading a Research, a
unit of De Beers which makes sure that the diamonds are ethically sourced (that
they are not blood diamonds) and are indeed investment grade.
Diamond bullion is
meant to open the diamond trade to the public like never before by providing
investors a standardized way to invest in diamonds. It also creates a real
possibility to make diamonds a whole new asset class onto itself, a safe haven
that could compete with gold and have a place in everybody’s portfolio.
The question is,
will investors accept diamonds as a new investment product? After all prices
have suffered in recent years and investors might be concerned about investing
in a commodity as controversial as diamonds. It is true it will take a while
for diamond exchange traded products to catch on and go mainstream, but
recently the diamond industry has begun to normalize. To support diamond prices
large producers like De Beers (no longer a diamond monopoly but still controlling
35% of the market), and ALROSA, a Russian mining giant (20% of the worlds
diamonds are sourced in Russia), cut production of rough diamonds. They also
made it more difficult for diamond traders to buy in bulk by requiring them to
be more corporate and provide financial information, something unheard of
previously. Meanwhile new company’s like Dfin (a London based corporate finance
firm) have plans to loan the diamond trading industry as much as $250 million to
take advantage of the current lack of competition in diamond financing. These
efforts to stabilize prices appear to have worked with rough diamond prices up
about 5% in 2017. According to diamond analyst Paul Zimnisky prices could rise
another 5-10% this year as the global supply glut begins to subside.
Diamond index
created by diamond analyst Paul Zimnisky that attempts to track global rough
diamond prices. Rough diamond prices have largely stabilized in 2017.
While
prices for rough diamonds begin to recover prices for polished gems used in jewelry
remain under pressure. Demand for diamond jewelry in markets such as the U.S
have been stable at best with diamond retailers like Signet Jewelers showing
sales declines. However, large diamond producers known for their expert marketing
techniques, are increasing their advertising budgets and changing their
marketing strategies to connect to a new generation of consumers. Diamond jewelry
sales are expected to increase 4% between 2016 and 2021.
Despite
the slowing sales of diamond jewelry, the real opportunity for the diamond
industry is for investment diamonds. At the moment 95% of diamonds are used for
consumer consumption, the other 5% are used for industrial purposes (this field
is mostly controlled by synthetic diamonds) and investment purposes. With
diamond trading becoming more open and with new diamond derivatives popping up
around the world, the demand for investment diamonds will increase. Especially
when you consider the fact that diamond production is expected to slow dramatically
in the coming years, with new diamonds being sourced from deeper and more
expensive mines.
Chart shows how diamond supply is
expected to fall off after 2030 with demand continuing to grow steadily.
Diamonds
have the potential to become the next big publically traded commodity, the
industry has already embraced the concept. Large miners such as De Beers and
smaller miners like Petra Diamonds have already voiced their support for
publically traded derivatives like India’s diamond futures, and Singapore’s
diamond bullion. Diamond exchange traded assets will stabilize the diamond
industry by opening it up to the public, providing greater price transparency
and liquidity. Investors will potentially have a new safe haven asset something
that can rival gold and protect them from inflation, geopolitical risk or stock
market crashes. People who start to pay attention to the industry now, while it
is hurting and transforming, stand to make a fortune when the transformation is
finished and the industry is thriving.
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Disclaimer: This material has been written for informational purposes only, it should not be considered as investment advice. Any investment decision should be made after consulting multiple sources and a financial advisor.
