Diamond bubble
[Image Courtesy: Bulawayo24 News]

[dropcap]”T[/dropcap]he rough diamond distribution system is collapsing as De Beers and other mining companies attempt to force unsustainable artificially high rough diamond prices on the diamond trade.” said Martin Rapaport of Rapaport Group in his latest article “Rough Bubble Bust”. Rapaport further added, “The mining company’s refusal to lower rough prices is destroying the diamond trade, creating severe financial losses, illiquidity, supply shortages, and the loss of tens of thousands of jobs.”

“The major mining companies and the banks have milked our trade dry by systematically supporting rough prices that were significantly higher than polished prices. This effectively moved profits from the trade to the miners. The banks helped the miners squeeze profits out of the trade by showering money on firms that boosted rough prices to speculative unprofitable levels.”

Expecting De Beers’ second half rough diamond sales to fall by over 60%, Rapaport has called for drop in rough diamond prices by 30-50% by De Beers to infuse profits and liquidity in the industry and has also called for resignation of De Beers’ CEO Philippe Mellier.

BDI had earlier pointed out that De Beers was losing its grip on reality. Its March 2015 sight also resulted in 30-40% refusal of its allocated goods.

The economic meltdown of 2008 has shown us, the idea of “Too big to fail” doesn’t hold anymore. It’s high time for governments, ministers, banks and trade to stop relying on mining companies, question their decisions and weigh their actions against long term economics of survival of trade.

 

Building of The Bubble

Diamond Bubble
[Image Courtesy: Rapaport]
Over the years, diamond mining companies including De Beers kept the rough diamond prices high and continued increasing it, to the point that since some time now they were even higher than the prevailing polished diamond prices in the market. The cutting & polishing units, traders, jewelry manufacturers, designers, retailers and everyone else in the diamond pipeline though found the prices unviable but were supported by bankers.

Banks extended huge amounts of loans to the tune of billions of dollars to the mining companies as well as to the diamond intermediaries till the time rough prices kept increasing, considering only the short-term profits through interest receipts and ignoring the fact that those huge loans are not backed by sufficient asset value.

This essentially created a bubble in a ‘Ponzi scheme environment’ where many of the intermediaries bought roughs at unprofitable high prices but continued to be financed by banks and financial institutions and in effect were moving money to the diamond mining companies.

As Rapaport puts it “They did not buy rough to make money cutting it, they bought rough to get money from banks.”

Easy access to money facilitated many intermediaries to pay any prices that De Beers asked.

Though the diamond miners earned enormous profits through this bubble but they in turn destroyed the fundamentals of the diamond business. Genuine players in the diamond pipeline, unable to sustain the artificial high rough prices and make a legitimate profit were forced out of business.

“… As long as the rough kept flowing, the loans kept flowing, the interest payments got made and the bubble grew bigger and bigger. In this Ponzi scheme the mining companies made out like bandits because it did not matter if rough prices were too high. Rough was simply an excuse to get money.” 

Busting of The Bubble

Apart from the legitimate diamond trade getting out of business, the banks also eventually felt the pinch when the liquidity in the market evaporated and the banks realized that the diamond companies they financed were unable to payback the principal loan amounts. While some banks focusing on diamonds went out of business, others restricted and reduced their riskier diamond portfolio. Bankruptcies and check bouncing have already started.

While the short-term issues of declining diamond demand and other macroeconomic factors, termed as the ‘perfect storm’, compounded the problem, Rapaport argues that it is not the real issue facing the industry. The systemic collapse of the diamond trade structure caused by the rough bubble is the real problem.

However, it is not only the diamond pipeline and the bankers who are facing the heat. The implications of the bubble bust have also started reaching the diamond miners. De Beers’ last November sight realized USD 527 million, whereas the 2015 November sight was only about USD 70 million, strongly indicating that not just the industry is facing liquidity issues but players in the trade are now not ready to buy roughs at unjustified high prices. Rapaport expects De Beers’ 2015 H2 sales to plummet by over 60% to around USD 1 billion from last year’s nearly USD 3 billion second-half sales.

Diamond Bubble
[Image Courtesy: Rapaport]
As Rapaport rightly says “Ponzi bubbles are not good for anyone, even those that create them.”
“A great threat to the diamond industry is that the mining companies have exploited the legitimate diamond trade for so long that the trade is giving up on diamonds as a realistic way to make a living. The mining companies are killing the goose that lays their golden eggs.” 

De Beers, The Clarion Call & The Threat

The genuine profit margins meant for the diamond pipeline was sucked by diamond miners like De Beers, instead of being spent on marketing and sales to further the industry. De Beers’ business attitude has raised several questions whether the company wants the trade to survive at all or does it wants to keep the whole pie for itself.

“It looks like De Beers has been playing a double game and two-timing the diamond trade. They have been consistently perusing the idea that they can make more money cutting the diamond trade out and selling their diamonds directly to the consumer. Since they cannot do this completely and quickly, they have been using the diamond trade in a transitionary capacity.”

Apart from discussing other issues, Rapaport also makes a clarion call to De Beers on two counts. First, to reduce the rough diamond prices by 30 – 50% to inject the much needed liquidity and profitability in the trade and second, for Philippe Mellier – De Beers’ CEO to step aside and be replaced by a better leader who is concerned for the future of the diamond trade.

However, Rapaport lays out the threat to the industry despite the bubble bust,

“The greatest threat to the diamond industry is that the mining companies will continue to ignore the needs of the trade. They will keep their rough prices higher than polished, starving the diamond trade of vital profits and liquidity. More and more cutters will stop cutting, diamond supply will plummet, more dealers and retailers will leave the industry, forever.”

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