Market Equilibrium

We publish courtesy of RAPAPORT

By Avi Krawitz

RAPAPORT… An encouraging sign that the diamond market is on the road to recovery has become apparent in the past few weeks: Both polished and rough prices have maintained relative stability, as has demand. The result is that after a long period of volatility, the market seems to have achieved some equilibrium between supply and demand.

Stability in the polished market was evident at the August Mumbai show, where — despite strong trading — there were no real shortages of goods. In addition, prices remained reasonably steady, even though there were notable differences between buyers and sellers.

Similarly, the demand for rough has calmed somewhat and appears to be driven by manufacturing need, rather than speculative buying, resulting in, or possibly because of, price stability seen over the past two months.

As we approach the second anniversary of the Lehman Brothers’ collapse, the diamond market appears to be in a healthy place. However, this should not be taken for granted, as a number of underlying concerns could still spoil the party.

The most imminent of these are growing anxiety about the global economic recovery and the prospect that high volumes of extra rough may enter the market.

Additional rough could come from the Russian government, which said this week that it has been asked to start selling its $1 billion stockpile from the state repository, Gokhran; and from Zimbabwe’s Marange mine, which will hold its second Kimberley Process (KP)-approved sale of goods in the coming weeks.

An Antwerp-based diamond consultant to the Zimbabwe government indicated this week that Marange has the capacity to produce up to 40 million carats of diamonds per year valued at around $2 billion, which would catapult the country to standing as one of the world’s top three diamond producers. The coming September tender will likely be larger than the August tender, where approximately 900,000 carats of rough was sold.

Ethical issues aside, and given the apparent equilibrium in the market, the industry must ask if it can absorb such quantities of rough. The long-term effect of higher supply would be an easing of prices, a good thing — provided that the diamonds are sold in an economically responsible manner. The danger lies in the possibility that high volumes of rough will be dumped on the market at unrealistic prices in order to turn a quick profit, causing the market to crash as it did when prices spiraled after the Lehman Brothers debacle.

While the Russians have pledged to sell its excess goods responsibly, Zimbabwe has offered no such assurance – it certainly needs the money – and it is not clear that the government will plan its production or sales around economic outlook. While it has demonstrated the will to sell as many diamonds as possible as quickly as possible, the prices reported at its tenders so far signal reasonable levels, even if they appear slightly overstated.

As mentioned, bringing more rough on the market may not be a bad thing and may break the equilibrium in a positive way by stimulating more demand. However, its historic exposure to speculative price practice makes it vulnerable, which— becomes all the more real when considering the current economic environment.

After a period indicating improved activity in the U.S., recent reports have been less encouraging. The Commerce Department said the U.S. economy grew by 1.6 percent in the second quarter against its previous estimate of 2.4 percent. Federal Reserve chairman Ben Bernanke acknowledged that the recovery has slowed in recent months, adding that “consumer spending may continue to grow relatively slowly in the near term as households focus on repairing their balance sheets.”

His concerns were confirmed later when the Conference Board Consumer Confidence Index fell 2 percent year on year in August as employment concerns continue to weigh on consumers.

This doesn’t bode well for the diamond industry’s prospects for the Christmas season and many manufacturers seem wary of this reality as they plan their holiday stock purchases. For all intents and purposes, there should be above-average rough demand in August and September. However, most seem to be waiting to assess polished demand at the Hong Kong show before committing to a business outlook for the season. A strong show may well spur a flurry of trade, while the opposite is also true.

The result is that the current market equilibrium could be a consequence of uncertainty rather than economic principle. While mining companies, particularly De Beers, have expressed caution via restrained production, manufacturers may have settled into a new, lower level supply comfort zone, even if they seek rough from new sources.

But though it recognizes its own fragility, the diamond market welcomes the current stability, even if it is short-lived. It’s not a position the industry is accustomed to, especially in the past two years. What happens in the next quarter will likely tip the scale — it’s just a question of which way.

Note: This article is an excerpt from a market report that is sent to RapNet members on a weekly basis. To subscribe, go to www.rapnet.com or contact your local Rapaport office.

The writer can be contacted at avi@diamonds.net.

©Copyright 2010 by Martin Rapaport. All rights reserved.

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