Diamond Miners Band Together To Lower Prices Of Rough-Cut Stones

Wall Street Journal

ANTWERP, Belgium— The world's top diamond miners plan to slowly increase output to tamp down prices of the rough gemstones. The cautious move aims to appease customers who have been squeezed by flat retail prices.

The delicate choreography comes even as the top four diamond producers fret that demographic and other changes threaten to permanently sap demand for the gems and create a long-term crisis for the industry.

Prices for rough, uncut rocks have risen more than 40% since February. Meanwhile, retail sales are falling, to $65 billion this year from $74 billion in 2008, RBC said.

"A lot of companies are going to be out" of business because of higher rough prices, said Eyal Atzmon, whose Antwerp-based company El-Ran polishes and trades diamonds.

As the financial crisis crushed the luxury-goods market, De Beers Group, Rio Tinto, BHP Billiton and Alrosa Co. slashed production this year. The four diamond miners control 90% of global production and influence prices through a Byzantine yet legal system of closed sales, secret long-term contracts and a few auctions.

De Beers, for example, slashed output by more than 90% in the first quarter.

And Alrosa sold all its production to the Russian state in the first half, rather then sell rough diamonds to its regular customers who cut and polish the stones for sale to consumers.

Global diamond-mine production is forecast to fall to $8 billion this year from $13.1 billion last year, according to Toronto-based RBC Capital Markets.

With manufacturers and polishers complaining of vanishing profit margins, the big four miners pledged Monday to ease their pain.

"We had to avoid a large-scale and catastrophic collapse of our industry," Sergey Oulin, vice president of Alrosa, said Monday at an industry conference in this port city, the center of the world diamond trade.

While the miners are loath to see prices for uncut diamonds drop too sharply, they are also worried that they might put some of their customers out of business if prices stay high.

"There is a consensus that rough prices have gone too high," said Des Kilalea, an RBC analyst. "But what everybody craves in this business is stability."

The miners plan to increase production gradually to avoid destabilizing the market. Alrosa holds more than $1 billion of diamonds, but won't sell it all at once, Mr. Oulin said.

Production "all depends on what demand will look like in the future," said Tim Dabson, a De Beers executive director.

Any increase poses risks for the miners. Short-term retail demand was hit by the global recession. But even as economic growth resumes, the industry faces other longer-term challenges, particularly in the U.S., which accounts for 40% of retail sales.

"We know people over 55 treasure diamonds…but that's not so clear for the iPod generation," Mr. Dabson said. "We need to tap into that market."Other risks include the tendency of consumers in the growing economies of India and China to favor less-expensive gems than what sell elsewhere.

The industry also is contending with what Mr. Dabson called "ethical consumerism," the linking of diamonds to war, corruption and environmental degradation. The industry participates in the Kimberley Process, an effort to ensure that diamonds traded internationally aren't used to finance rebel groups.

The industry needs protection for "when we're hit by a crisis like the 'Blood Diamond' movie," said BHP Billiton marketing director Chris Ryder, referring to the 2006 Leonardo Di Caprio film about diamond mining in war-torn Sierre Leone.

He also said the industry needs to mount general "demand defense." De Beers, the biggest diamond producer, has said it would reduce its advertising budget, worrying executives throughout the industry. The big miners have discussed a collaborative $200 million ad campaign, but have yet to commit.

Mr. Dabson drew applause, however, by playing a De Beers TV commercial for the U.S. that features a couple ice-skating on a frozen pond.

Retailers are worried as well. Zale Corp., which operates 1,930 retail jewelry locations across the U.S., Canada and Puerto Rico, reported a net loss of $189.5 million for the fiscal year ending July 31 and a 16.8% drop in revenue. "Diamond fashion has been extremely hard hit," David Sternblitz, vice president and treasurer of Zale, said, adding that demand for diamonds has decreased commensurate with overall jewelry demand on account of the recession.

But while most diamond retailers face what Zale CEO Neal Goldberg has called "the most difficult year in retailing in memory," other diamond sellers are doing well. Blue Nile Inc., one of the U.S.'s largest online diamond retailers, has remained profitable and gained market share at an accelerated pace in the recession, as customers turned to the Web for discounts, said CEO Diane Irvine.

The recession has also been advantageous for diamond sellers in the very upper echelons, where customers are investing in million-dollar diamonds as safe investment alternatives. "It's a refuge for your money if you have the cash available," Henri Barguirdjian, CEO of Graff USA, said, adding that his company, where the average sale is $150,000, was 20% ahead of last year's retail sales in the U.S. market.

Despite such exceptions, most diamond retailers are suffering, with some of the larger U.S. jewelers – such as Fortunoff and Finlay Enterprises Inc. – filing for bankruptcy this year. Even if economic growth resumes, other longer-term challenges face the diamond industry, executives in Antwerp said.

Costs Searing Miners Could Boost Metals

Escalating production costs and cooling commodity prices are dragging down once-mighty mining and metals companies. But high costs could eventually force another price rally.

Traders are watching for the point where supply tightens thanks to a shakeout among producers that can't profit amid lower prices.

Some of the miners in the most pain are on acid -- lots of it. Sulfuric acid is used extensively in mining to extract nickel, copper, platinum, titanium, silver, diamonds, and uranium. But miners must compete for sulphur with the booming fertilizer industry. After a period when you could hardly give it away, sulfuric acid has gotten exceedingly scarce, rising some 1,000% in the past year. Some nickel mines consume $10,000 of acid just to extract a ton of nickel, now selling for about $20,000, down from $50,000 last year.

Mines and smelters also consume massive amounts of coal and oil to power blast furnaces, fuel trucks and process ore. Oil is up about 57% over the past year, while coking coal has tripled. Steel costs have soared; hard-to-find engineers can name their price; and the escalating cost of explosives -- derived from ammonia, a product of natural gas -- is blowing up margins. And while metal prices has soared recently, many jewelers, like Design Bands, buy up front, and have a large inventory that was bought at yesterday's prices. Companies like Design Bands are able to sell designer wedding rings at affordable prices.

In 2006 and 2007, when metals prices were climbing, inefficient and mothballed mines reopened. Now nickel, zinc and aluminum are fetching less than it costs such marginal suppliers to produce them, says Jim Lennon, senior commodities strategist at Macquarie Securities in London. When zinc, used to coat steel, climbed to $2 a pound in mid-2006, mines spending a dollar to produce it thrived. Zinc now runs about 80 cents.

Once more high-cost producers fall, says Jeremy Weir, chief executive officer of Galena Asset Management, a subsidiary of oil and metals trader Trafigura, "there's a likelihood that some of these markets that have been depressed from their highs could see a price recovery."

Factory Reading Is Key on Tuesday

Like commodities, the U.S. economy has been supported by strong global demand, a prop that has grown shaky.

Further evidence of this may come Tuesday morning, when the Institute for Supply Management releases its U.S. manufacturing index for August. Economists, on average, think it will slip a bit, to 49.5 from 50 in July. Any reading below 50 indicates factory activity is shrinking.

Though hardly robust, such a reading would be much higher than the 41 that usually marks a recession. Though it has slowed considerably in recent years, the index hasn't come close to that level, even during the fourth quarter of 2007, when gross domestic product contracted.

Healthy export demand has kept factories treading water. A weak dollar has helped, by making U.S. exports cheaper and more competitive. The dollar has rebounded this summer, but that shouldn't affect exports for some time.

What could show up soon is the slower growth gripping various economies around the world. The ISM's index of new export orders fell to 54 in July -- still relatively strong, but the lowest reading of the year.

By: Ann Davis
Wall Street Journal; September 2, 2008